Intellectual Capital and Corporate Performance of Indian Pharmaceutical Industry: A Panel Data Analysis

Presented by: Dr. Aparna Bhatia Khushboo Aggarwal

Introduction

The dawn of knowledge and information has changed the mechanism of companies. Earlier the focus of the companies was on the optimum utilization of physical and tangible assets only; but now the companies create their competitive advantage through the effective use of the manpower and other intangible assets owned by them. Intangible assets like intellectual capital (IC), trademarks, brands, patents, know-how, innovation, research and development (R&D) expenditure, customer base, networks, organization structure etc. are the drivers and roots of the companys value. Intangible assets have become imperative part of companys performance and success. Intangible assets are always present in the companys operations. Intangibles were discussed by Lawrence R. Dicksee in 1896 for the first time. The relative importance of tangible assets has decreased with the increase in the importance of intangible assets and hence it has taken primacy over traditional physical resources in the pursuit of competitive advantage. But, it has only been in the last couple of decades that this field has skyrocketed into prominence. In fact, claims have been made that physical and financial assets are rapidly becoming commodities and are not primary drivers of the economy. Intangible assets have become part and parcel for the companies in many ways. It has been recognized that intangible assets, especially intellectual capital (IC) are the keys to attaining competitive advantage for the firms. Intellectual capital has also been viewed as the roots of a companys value. The intellectual capital of a firm plays a significant role in the modern approach of value creation. Therefore, measuring the value of IC is vital for firms managers because both tangible and intangible assets are considered as potential strategic assets.

Research Methodology
Research objectives The main objective of this paper is to study extent of growth in IC of Indian pharmaceutical industry over a period of time and to examine the impact of Intellectual Capital (IC) on the performance of Indian Pharmaceutical Industry. Sample and time period The sample for the above study is taken from Business Standard (BS) 1000. List of 58 pharmaceutical companies was given by Business Standard (BS) out of which 50 companies have been selected for the above study. Eight companies were deleted as complete information w.r.t the variables were not available for the study. The time period for the study is eleven years i.e. 2001-2011. To study the trend of investment this time period has been split in three points of time i.e. 2001, 2006 and 2011. The span of more than a decade would be helpful to establish the consistency and predictability for research conclusions. Data Source The data is collected through secondary sources. The relevant data required for present research is collected from Electronic database PROWESS of Centre for Monitor Indian Economy (CMIE). This database was chosen because all the information required for the above study was readily available in this. Methodology Dependent variables Return on Assets (ROA) and Return on Equity (ROE) have been taken as the dependent variables.

Contd..

Independent Variables In the present study for measuring the value of IC, Pulic, (1998) model has been applied. IC has been dened variedly, but the most commonly accepted denition classies it into human, structural and customer capital (Pulic, 1998) The study uses Value Added Intellectual Coefficient (VAIC) and its Components (Value Added Capital Coefficient for firm(VACA); Human Capital Coefficient for the firm(VAHU); Structural Capital Value Added for the firm(STVA) as the independent variable. Therefore, VAICTM= VACA+VAHU+SCVA Control variables Four control variables are included in the analysis. Size of the firm (SIZE) is determined through natural logarithm of firms book value of total assets . Age of the firm (AGE) is calculated as the difference between 2011 and the founding year of the organization . Leverage (LEV) is calculated as ratio of the total debt to book value of assets of the firm and Physical Capital intensity (PC) is measured by the ratio of a companys fixed assets to its total assets.

Contd..
Regression models For conducting the empirical research above mentioned four models have been run ROA=+1VAICTM+2Lev+3Size+4Age+5PC+. (model 1) ROE=+1VAICTM+2Lev+3Size+4Age+5PC+. (model 2) ROA=+1VAHU+2STVA+3VACA+4Lev+5Size+6Age+7PC+... (model 3) ROE=+1VAHU+2STVA+3VACA+4Lev+5Size+6Age+7PC+ (model 4) Where, ROA= Return on Assets ROE = Return on Equity VAICTM= Value Added Intellectual Coefficient VAHU= Value Added Human Capital SCVA= Structural Capital Value Added VACA= Value Added Capital Coefficient Lev= Leverage PC= Physical Capital = Error Term

TABLE I: - Trends in VAIC

Results and Analysis

The first objective was to see the trend in growth of VAIC which is shown in Table I.
Company name Aarti Drugs Ltd. Abbott India Ltd. Ajanta Pharma Ltd. Ankur Drugs & Pharma Ltd. Arvind Remedies Ltd. Aurobindo Pharma Ltd. Aventis Pharma Ltd. Biocon Ltd. Cadila Healthcare Ltd. Cipla Ltd. Claris Lifesciences Ltd. Dishman Pharmaceuticals & Chemicals Ltd. Divi'S Laboratories Ltd. Dr. Reddy'S Laboratories Ltd. Elder Pharmaceuticals Ltd. F D C Ltd. Glenmark Pharmaceuticals Ltd. Granules India Ltd. Hikal Ltd. Ind-Swift Laboratories Ltd. Ind-Swift Ltd. Indoco Remedies Ltd. 2001 5.24 6.63 3.22 -0.11 3.28 2.43 8.87 -0.29 3.71 2.69 6.75 3.09 8.77 6.18 2.28 3.07 2.67 4.98 9.23 9.84 5.15 3.1 2006 5.55 4.98 2.28 10.59 4.22 3.1 3.19 4.68 7.05 2.59 6.63 3.01 6.4 2.19 2.25 3.53 2.8 4.01 4.36 8.92 3.48 2.07 2011 4.57 1.33 2.48 6.1 6.05 1.17 4.3 3.03 6.62 2.7 4.15 5.09 5.98 2.87 2.41 3.45 3.52 2.47 3.78 9.26 5.5 1.55

Ipca Laboratories Ltd. J B Chemicals & Pharmaceuticals Ltd. Jubilant Life Sciences Ltd. Jupiter Bioscience Ltd. Lupin Ltd. Natco Pharma Ltd. Nectar Lifesciences Ltd. Neuland Laboratories Ltd. Novartis India Ltd. Orchid Chemicals & Pharmaceuticals Ltd. Panacea Biotec Ltd. Parenteral Drugs (India) Ltd. Piramal Healthcare Ltd. Plethico Pharmaceuticals Ltd. Ranbaxy Laboratories Ltd. Sharon Bio-Medicine Ltd. Shasun Pharmaceuticals Ltd. Strides Arcolab Ltd. Sun Pharmaceutical Inds. Ltd. Surya Pharmaceutical Ltd. T T K Healthcare Ltd. Torrent Pharmaceuticals Ltd. Unichem Laboratories Ltd. Venus Remedies Ltd. Vinati Organics Ltd. Wanbury Ltd. Wockhardt Ltd. Wyeth Ltd. Growth rate

1.8 2.83 3.32 21.74 3.55 3.99 12.63 3.02 4.41 6.07 4.69 4.93 3.02 1.78 3.15 11.55 4.09 5.89 6.32 11.11 0.35 4.25 2.3 3.85 5.38 5.14 2.48 1.67 -

1.61 2.41 3.87 17.84 2.85 2.83 9.88 3.3 2.87 5.02 3.81 2.67 2.49 8.71 1.35 12.24 3.92 4.87 8.06 12.68 -0.75 1.64 3.35 10.55 1.92 2.4 4.81 3.14 1.58%

2.48 2.3 3.91 18.22 3.38 2.86 8.47 3.15 3.06 4.22 3.31 3.33 3.83 4.52 3.12 6.47 -5.46 4.88 9.08 7.96 0.76 3.02 2.59 6.26 6.45 -0.65 1.02 6.45 16.40%

The Annual Compound Growth Rate (ACGR) of 50 leading pharmaceutical companies from BS-1000 has been calculated. It was just 1.58% in 2006 as compared to the base year 2001. However, there is seen a tremendous rise in investment in VAIC in the year 2011, showing a growth rate of 16.40%. This increase in growth of IC indicates that the companies are managing and paying attention to investment in human capital along with structural and physical capital. The companies seem to have realized that investment in intellectual capital helps them in generating profits. The role and importance of high-tech organizations in a knowledge-based economy is well recognized. Pharmaceutical industry is deemed as one of the most hightech, high innovative and well balanced industry in respect of human intervention and technology. This industry is consistently making more investment in order to protect their intellectual property rights and enhance their research and development (R&D) capacity. It mainly relies on intellectual capital for a source of innovation and business performance. As such, when an organization increases its intellectual capital, it is expected that its performance will be enhanced.

For studying the impact of IC on the profitability of pharmaceutical industry panel regression was used. For checking the stationarity of the data HarrisTzavalis unit root test was used. This test assumes that the number of panels tends to be infinite while the number of time periods is fixed (Harris and Tzavalis, 1999). All the data was found to be stationary. Then to have better results both fixed and random effect models are applied on the panel data. Results of both the models are checked through applying Hausman Specification Test (Hausman, 1978). If Prob < Chi2= 0.05 (i.e. significant) then fixed effects is used. The test suggested random effect model.

Panel Regression with ROA as the dependent variable

R-sq: within = 0.1234 Obs per group: min = 11 between = 0.4903 avg = 11.0 overall = 0.2620 max = 11 Random effects u_i ~ Gaussian Wald chi2(5) = 121.89 corr(u_i, X) = 0 (assumed) Prob > chi2 = 0.0000 -----------------------------------------------------------------------------ROA | Coef. Std. Err. z P>|z| [95% Conf. Interval] -------------+---------------------------------------------------------------VAIC | .3615575 .0467452 7.73 0.000 .2699387 .4531764 Age | .2172349 .0449101 4.84 0.000 .1292128 .305257 Size | .3271033 .8905873 0.37 0.713 -1.418416 2.072622 PC | -8.699022 3.955687 -2.20 0.028 -16.45203 -.9460173 Lev | -1.314318 .3285065 -4.00 0.000 -1.958179 -.670457 _cons | 5.497523 3.75738 1.46 0.143 -1.866806 12.86185 -------------+--------------------------------------------------------------sigma_u | 4.5169727 sigma_e | 9.5189563 rho | .18378872 (fraction of variance due to u_i)

Assessment of Table reveals that overall R2 is 26.2 percent suggesting that the variation in profitability as measured by ROA is explained by the independent variables only to the extent of 26.2% and the remaining variation is due to the impact of some other factors. Wald Chi2= 121.89 [degrees of freedom (d.f) =5] which is highly significant at 1 % is indicating a good model fit. The results of VAIC (P-value < 0.000) shows that it has positive and significant impact on the performance (ROA) of the company after controlling for the effects of age, size, physical capital and leverage. Age and physical capital are significant in estimating the dependent variable (ROA) though age has positive effect on ROA while PC has a negative impact. Leverage too has negative and significant impact indicating that when leverage increases ROA decreases. Size is not significant in affecting ROA, though it has positive effect on ROA. This proves that as the VAIC of a company increases, ROA also increases.

This indicates that IC plays a major role in creating value for stockholders as well as for other stakeholders. Moreover, IC plays a most important factor in reducing a companys production costs.

Panel Regression with ROE as the dependent variable

R-sq: within between overall Random effects corr(u_i, X) = 0.1236 = 0.0823 = 0.1093 u_i ~ Gaussian = 0 (assumed) Obs per group: min avg max Wald chi2(5) Prob > chi2 = = = = = 11 11.0 11 72.74 0.0000 -----------------------------------------------------------------------------ROE | Coef. Std. Err. z P>|z| [95% Conf. Interval] -------------+---------------------------------------------------------------VAIC | .5937079 .1030524 5.76 0.000 .3917289 .7956869 Age | .1213994 .073291 1.66 0.098 -.0222482 .2650471 Size | -.2672887 1.760368 -0.15 0.879 -3.717546 3.182968 PC | -6.32157 8.028484 -0.79 0.431 -22.05711 9.41397 Lev | -4.002179 .718725 -5.57 0.000 -5.410854 -2.593503 _cons | 19.83177 7.559982 2.62 0.009 5.014477 34.64906 -------------+---------------------------------------------------------------sigma_u | 5.4822499 sigma_e | 21.810745 rho | .05942511 (fraction of variance due to u_i)

Assessment of Table reveals that overall R2 is 10.9 percent which do not seem enough for a good model. The value of Wald Chi2= 72.74 [degrees of freedom (d.f) =5] which is highly significant at 1 % indicating a good model fit. The results of VAIC (P-value < 0.000) shows that it has positive and significant impact on the performance of the company after controlling for the effects of age, size, physical capital and leverage. Age has significant and positive impact on ROE at 10% level of significance indicating that as age of the company increases the ROE also increases. On the other hand, leverage has negative and significant impact on ROE. PC and Size have a negative impact on ROE though these are insignificant. The result specifies that Intellectual Capital specially, in pharmaceutical industry is gaining momentum all over. In other words, the results of VAIC demonstrate that increase in value creation efficiency affects firms profitability.

Panel Regression with ROA as the dependent variable and components of VAIC
R-sq: within = 0.6124 Obs per group: min = 11 between = 0.3716 avg = 11.0 overall = 0.4945 max = 11 Random effects u_i ~ Gaussian Wald chi2 (7) = 789.12 corr(u_i, X) = 0 (assumed) Prob > chi2 = 0.0000 -----------------------------------------------------------------------------ROA | Coef. Std. Err. z P>|z| [95% Conf. Interval] -------------+---------------------------------------------------------------VACA | 8.530643 1.227876 6.95 0.000 6.12405 10.93724 VAHU | 2.027139 .0913874 22.18 0.000 1.848023 2.206255 SCVA | -.038981 .1605337 -0.24 0.808 -.3536213 .2756592 Age | .2881123 .0426796 6.75 0.000 .2044617 .3717629 Size | -2.286852 .685471 -3.34 0.001 -3.630351 -.9433536 PC | .4025307 2.931057 0.14 0.891 -5.342235 6.147296 Lev | -1.54548 .2502984 -6.17 0.000 -2.036056 -1.054904 _cons | 1.250191 2.838139 0.44 0.660 -4.312459 6.812841 -------------+---------------------------------------------------------------sigma_u | 4.6831618 sigma_e | 6.3731319 rho | .35063822 (fraction of variance due to u_i)

ROA is the dependent variable and components of VAIC i.e. Value Added Human Capital (VAHU), Value Added Capital Coefficient (VACA) and Structural Capital Value Added (SCVA) are the independent variables. The effects of Size, PC and Leverage have been controlled for. Overall R2 is 49.4 percent indicating a reasonably fair explanatory power of the model. The value of Wald Chi2= 789.12 [degrees of freedom (d.f) =7] which is highly significant at 1 % indicating a good model fit. The result shows that VACA and VAHU are positively and significantly related with ROA. SCVA is negatively related with ROA, though the z-value (0.808) is insignificant. 1% change in VACA will bring 8.53 percent change in ROA and similarly 1% change in VAHU will bring 2.02 percent change in ROA, when age, size, physical capital and leverage are controlled for. Age and size affects ROA positively and significantly. Leverage has a negative and significant impact on ROA. Physical Capacity (PC) has a positive impact on ROA, though it is insignificant. The result of this model indicates that out of all the components of VAIC, VACA is the most influencing factor affecting ROA. This indicates that capital employed (physical and financial) still remains important for stockholders and stakeholders through its significant role in value creation.

Panel Regression with ROE as the dependent variable and components of VAIC
R-sq: within between overall Random effects corr(u_i, X) = 0.4068 = 0.1551 = 0.3201 u_i ~ Gaussian = 0 (assumed) Obs per group: min avg max Wald chi2(7) Prob > chi2 = = = = = 11 11.0 11 315.49 0.0000

-----------------------------------------------------------------------------ROE | Coef. Std. Err. z P>|z| [95% Conf. Interval] -------------+---------------------------------------------------------------VACA | 36.64608 3.29444 11.12 0.000 30.1891 43.10307 VAHU | 1.783757 .2309438 7.72 0.000 1.331115 2.236398 SCVA | -.1223844 .4315894 -0.28 0.777 -.9682842 .7235153 Age | .1130227 .0713136 1.58 0.113 -.0267494 .2527947 Size | -2.181246 1.594036 -1.37 0.171 -5.305499 .9430071 PC | -1.572677 7.162395 -0.22 0.826 -15.61071 12.46536 Lev | -6.437075 .6601189 -9.75 0.000 -7.730884 -5.143266 _cons | 12.17162 6.746589 1.80 0.071 -1.051453 25.39469 -------------+----------------------------------------------------------------

 In the Table overall R2 is 32.0 percent indicating a reasonably fair explanatory power of the model. The value of Wald Chi2= 315.49 [degrees of freedom (d.f) =7] which is highly significant at 1 % indicating a good model fit. The result shows that VACA and VAHU are positively and significantly related with ROE. This means that 1% change in VAHU will bring 7.72 percent change in ROE and similarly 1% change in VACA will bring about 11.12 percent change in ROE when age, size, physical capital and leverage are controlled for. Physical Capital (PC) has a negative impact on ROE though it is not significant. Leverage too has negative and significant impact on ROE. SCVA is negatively related with ROE, though the value is insignificant. The result of this model indicates that out of all the components of VAIC, VACA is the most influencing factor affecting ROE. This indicates that stakeholders still accept the performance of the firm in terms of tangible assets and less in terms of intangible assets.

Conclusion

As the world is moving into globalization, investors need non-financial disclosure besides the traditional financial measures to assist them in their investment decision-making. In other words, companies need to invest in IC to stand for the gain. The finance function has a key role to play in managing knowledge assets and appreciating the sources of firms value . This paper analyzed the impact of IC on the performance of Indian Pharmaceutical industry for a period of eleven years i.e. 2001-2011. 50 pharmaceutical companies were chosen from Business Standard (BS 1000) on the basis of net sales. The data set comprises a panel structure with both cross-section and time series properties. The empirical results revealed two findings. (i) IC has grown rapidly over a period of time. Intellectual Capital has a significant impact on performance though (ii) Physical capital is the major factor affecting the Indian Pharmaceutical industry.

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