Financing Life Science Innovation

Venture Capital, Corporate Governance and Commercialization

A. Styhre

• Publisher: Palgrave Macmillan
• Year: 2015
• ISBN:
  9781137392480
• Topic: Business
• Subtopic: Management
• Index: Business

Financing Life Science Innovation reviews the literature on venture capital, corporate governance, and life science venturing and presents a study of the Swedish life science industry and the venture capital investors being active in financially and managerially supporting life science start-up firms.

Part I

Elements of Life Science Innovation

1

The Financialization of the Economy

Introduction: the creation of biovalue

“By ventures, I mean privately held entrepreneurial firms with significant external equity investment from professional investors,” Garg (2013: 90) writes. This is an operative definition that will be used in this volume. Today, the life sciences are not only capable of producing new drugs and therapies that benefit patients and their relatives by increasing the quality of life and prolonging the lives of millions; they can also produce various forms of what Mitchell and Waldby refer to as biovalue, a composite term that refers to “the yield of both vitality and profitability produced by the biotechnical reformulation of living processes” (2010: 336). When technically manipulating biological materials in a variety of ways, for example, “transformed into cell lines, genetic sequences, or genetically modified organisms” (ibid.), biovalue is produced and thereafter translated into economic capital. This connection between biovalue and economic value constitutes what has been called the bioeconomy, the wider institutional field wherein life science research acquires its economic and financial worth (Birch and Tyfield, 2013). The term biovalue is useful because it captures how the biological, material substratum being worked on – a genome sequence, a cell line, a biological pathway, or an organ – can be translated into economic worth and become subject to the calculative practices that lie at the very heart of the capitalist regime of accumulation. There is, in other words, a certain “transposition” between the material substratum and the economic capital being apprehended by the term biovalue. Just like biovalue is translated into economic and financial capital, so is financial capital the source of biovalue in the first place. Inherent in this translation of biovalue – life science know-how that serves as the basis for therapies – into financial capital is what Sunder Rajan (2012) refers to as “systems of valuation,” calculative practices based on statistical and numerical analyses, ethical considerations, shorthand practices, and rules of thumb used by calculating agents. Being able to recognize the financial value in a certain biovalue is not a trivial matter. In the new millennium, numerous life science funds has failed to deliver adequate returns on investment made given the level of risk-taking because of the difficulties involved in calculating biovalues and in anticipating the risks involved in bringing new therapies to the market.

Clark introduces the term healthscapes, influenced by Appaduari’s (1996) influential vocabulary, to denote the heterogeneity of what Clarke et al. (2010: 57) refer to as the “medical industrial complex.” The term healthscapes is not a trivial term but includes a great variety of actors and terms:

Healthscapes are ways of grasping, through words, images, and material culture objects, patterned changes that have occurred in the many and varied sites where health and medicine are performed, who is involved, sciences and technologies in use, media coverage, political and economic elements, and changing ideological and cultural framings of health, illness, healthcare, and medicine. (ibid.: 105)

This healthscape includes patients, physicians and other professional health care groups, regulators, authorities, pharmaceutical companies, medical technology firms, politicians, patient interest groups, laboratory animals, cell lines, and experimental organisms, and so forth: that is, all sorts of “humans and non-humans” (in the convenient phrase of actor-network theorists) that constitute the field of health care and life science research. In addition, the healthscape also includes capital owners such as venture capital funds, pension funds, state-governed innovation funds, and so forth: that is, specialized professional groups that invest in biovalue and ensure that it is translated into an adequate return on investment in the form of economic value (i.e., finance capital). In much research, these two worlds are rarely combined or brought together; sociologists, management researchers, and science and technology students are concerned with examining how life science research and clinical practice are translated into new therapies, brought into the health care clinics, and launched in markets. Finance market researchers and venture capital studies target the various practices of venture capital investment and the corporate governance of these investors. Only at sometimes do these two research activities cross their paths. This is a curious condition as the biovalue being produced in life sciences laboratories at the universities and in both multinational corporations and small and medium-sized companies are capable of generating substantial profits. “The healthcare industry is now 13 percent of the $10 trillion annual US economy,” Clarke et al., report (2010: 57), and many studies has shown that, for example, the pharmaceutical industry has reported substantially higher bottom line performance over time in comparison to other major industries such as the manufacturing and construction industries and retail (Lexchin, 2006).

When you make it in the life sciences, the yield is substantial. The concern is that it is very complicated to predict what life science research projects that will eventually come out as winners. First, it is hard to predict how certain compounds will interact with the human biological system in the full-scale clinical trials, making what seemed to be a promising new chemical entity (NCE) in the laboratory setting very disappointing when tested in a population of patients. Second, from history we can learn that it is not always easy to predict the market potentials for new therapies. For instance, as Lakoff suggests, in the early 1960s, pharmaceutical companies could not easily assess the market potential for a new category of antidepressant drugs:

Pharmaceutical firms were hesitant to develop antidepressant components given what a very limited market ... By 2001, annual sales of antidepressants had reached $1.3 billion in the US. They were the second most prescribed class of drugs, after heart medication, with 7.1 million Americans taking them. (Lakoff, 2007: 58)

However, in the recent decades and the last decades, pharmaceutical companies have learned that therapeutic needs not only exist as some kind of undisputed fact, but market opportunities are also a matter of active market creation (Angell, 2004). Critics have consistently emphasized how pharmaceutical companies not only supply therapies to handle perceived needs but also actively influence how, for example, psychological health (Lakoff, 2007, 2006; Healy, 2002) and sexual performance and interest (Åsberg and Johnson, 2009; Fishman, 2004; Mamo and Fishman, 2001) are perceived and consequently medicalized. As Lakoff (2007: 59) recognizes, pharmaceutical companies are not “social critics” but experts facing “practical problems” under the influence of profit motives, and therefore they are responding to the problem of how to define or create markets like any other industry in the regime of competitive capitalism – that is, through market creation and marketing.

This chapter will address the concept of financialization, denoting the increasingly more prominent role played by financial actors in the contemporary economy, and connect that concept to both venture capital and innovation literature. In the next step, financialization is closely associated with the development of both the biotechnology industry and life science venturing at large: that is, the recent interest in exploiting biovalue in what Rose (2007) refers to as the bioeconomy, the economic regime of accumulation where the life sciences are regarded as one of the high growth potential industries in the Western economies. In other words, the access to both finance capital and competent venture capital investors, having a detailed understanding of the risks involved in life science venturing, is the primus motor of the bioeconomy; in fact, the entire life science industry developed from within the university research system from the mid-1970s is closely co-produced with the financialization of the economy after 1980 (Cooper, 2008). There is, in other words, a very intimate relationship between, on the one hand, the institutional field of life science research and on the other hand an overarching financialization of the economy that deserves to be explored in greater detail in order to understand how biovalue can be transformed into financial capital that in turn can be reinvested in new life science research activities. In the bioeconomy, science and capital are folded into one another.

The concept of financialization

Krippner defines financialization as “a pattern of accumulation in which profits accrue primarily through financial channels rather than trade and commodity production” (2005: 174). Krippner also makes a distinction between an “activity-centered view” (e.g., the image of the “post-industrial society”) and the “accumulation-centered view” that stresses “where profits are generated in the economy” (ibid.: 176). Dore similarly defines financialization as “the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of domestic and operational economies” (2008: 1097–1098). In these two accounts, financialization denotes the increased role of finance actors and finance institutions in the contemporary economy. Krippner emphasizes that the term financialization has taken on a number of meanings in the social science and economic literature, and has at least four discernible meanings: (1) the use of shareholder value corporate governance; (2) the dominance of capital-markets over bank-based finance; (3) the increased power of the rentier class; and (4) the “explosion of financial trading associated with the proliferation of new financial instruments” (2005: 181). When Krippner and Dore speak of financialization, they mean above all the share of accumulated profits in the economy derived from – as well as benefitting – finance market actors. Over the period beginning around 1980, and the new neoliberal policy stressing a deregulation of the finance markets to increase competition and efficiency, first in the UK and the United States and eventually to a various degree elsewhere, this share has grown dramatically:

[In the U.S.] Financial sector profits as a proportion of all profits in the economy grew slowly between 1848 and 1970, dropped across the 1970s, and increased dramatically after 1980 ... This trend peaked in 2002 when 45 percent of all taxable profits in the private sector were absorbed by finance sector firms. (Tomaskovic-Devey and Lin, 2011: 539–540)

In the case of Europe, a similar trend is being observed:

Within the EU-27 [the 27 members of the European Union] ... the FIRE [Finance, Insurance and Real Estates] sector contributed to no less than 28.8 percent of GDP in 2010, topping industry (18.5 percent) and every other sub-branch of the service sector. In Germany with its strong industrial sector the FIRE-share of GDP was even above the EU-average (30.4 percent), again topping industry (23.4 percent) significantly. (Deutschmann, 2011: 353)

The driving force for this gradual growth of the finance industry, both in sheer size and in proportion to other industries, has been heavily debated by economists and economic sociologists. From a neoclassical economic theory perspective, part of the growth is derived from growing productivity in the sector based on human capital investment (Tomaskovic-Devey and Lin, 2011: 540). Other commentators have claimed that it is the new neoliberal and neoconservative policies emphasizing the effectiveness of unregulated markets, ultimately based on what economists refer to as the efficient market hypothesis, strongly associated with the University of Chicago economics department and with Eugene F. Fama. This effort to deregulate financial markets has opened up for a series of finance market innovations such as collateralized debt obligations (CDO) and credit default swaps (CDS) that have been claimed to play a key role the finance market collapse of 2008 (Stiglitz, 2010; Crotty, 2009; White, 2009). Yet another group of critical scholars has emphasized the financialization of the economy as a political program, steeped by neoliberal and neoconservative political orientations occurring after 1979–1980 in the UK and the United States as Margaret Thatcher was elected prime minister and Ronald Reagan took office in the White House: “What lies behind the phenomenon of financialization is the actual transformation of advanced capitalism into a rentier society, where the private asset holder has become dominant over the entrepreneur. From a sociological view, financialization can be characterized as a hegemonic regime of rentiers over entrepreneurs,” Deutschmann suggests (2011: 382; see also Lapavitsas, 2012).

Following Krippner (2011, 2005), the financialization of the economy was not very likely to be something that could be planned in detail ex ante, but is instead the outcome from new policies and political programs with the ambition to handle the high inflation and high unemployment rates in the 1970s, the effects of the two oil crises that caused many problems in the 1970s economies (Stein, 2011), and various macroeconomic and even demographic conditions. It is not very likely that policymakers taking office by the end of the 1970s, like Paul Volcker, the new chairman of the Federal Reserve appointed by President Carter, could fully predict the effects of all the events that led up to the situation in 2002 when the finance industry accounted for a record-high 45 percent of all taxable profits in the private sector in the United States. Neither could they have been able to anticipate the events of 2008 when the risk-exposed American sub-prime housing market and the toxic assets held by finance institutions derived from this market caused the most conspicuous economic crisis in the post-World War II period. Instead, the financialization of the economy needs to be understood as the outcome from various uncoordinated conditions and, importantly, of the “institutional work” (Suddaby and Viale, 2011; Lawrence, Suddaby, and Leca, 2009) of an emerging class of knowledge workers being trained in the newly reawakened discipline of financial economics (Dobbin and Zorn, 2005).

In the 1980s, the effects of financialization were given public attention as a new category of finance actors engaged in so-called leveraged buyouts (LBO). Stearns and Allan identify three factors explaining the LBO wave that swept over the American economy in the mid-1980s: (1) the increase of capital through the inflow of foreign savings in the United States (in turn based on high overseas savings and positive trade balance in, for example, Japan, and an overrated dollar), (2) the deregulation of the finance sector, and (3) the issuing of junk bonds to finance LBOs, a new finance market innovation. Stearns and Allan stress the role of junk bonds in particular:

Between 1983 and 1989, nonfinancial corporations issued $160 billion of junk bonds to the public. The sum accounted for more than 35 percent of total public bonds offerings. About two-thirds of these issues were associated with restructurings (i.e., leveraged-buyouts and acquisitions). (Stearns and Allan, 1996: 706)

As this new class of finance industry entrepreneurs earned a reputation for buying undervalued American corporations and divesting them, there was much criticism against such activities (even though economists like Michael C. Jensen at Harvard welcomed such “restructuring” of corporations as they served to reduce what Jensen and agency theorist refer to as agency costs). However, the Reagan administration, taking a strong “pro-business” position to distance itself from both the “1960s’ liberals” and the preceding Carter administration, was advised by neoliberal and libertarian economists including Milton Friedman and the future chairman of Federal Reserve, Alan Greenspan, who promulgated a strong laissez-faire ideology that signalled that the state would limit its regulatory role. “By changing how antitrust laws would be enforced, it specifically disturbed the institutional arrangements set up to monitor and limit mergers,” Stearns and Allan write (1996: 706). However, when George W.H. Bush took office in 1989, the new administration started to “clean up the excesses tolerated by Reagan’s permissive regulators” (ibid.: 712): major figures in the LBO wave like Michael Milken were send to jail, an event that indicated that firm belief in deregulated financial markets was not always in the best interest of all constituencies.

In addition to the growth of the finance industry and the emergence of a professional finance market analyst class, recruited from elite American universities such as Princeton and Harvard (Ho, 2009), financialization has also strongly influenced the corporate governance and the top management composition in major corporations. First of all, propelled by agency theory and its flamboyant advocate, Michael C. Jensen, corporations were increasingly concerned with enriching shareholders under the label shareholder value creation. Since American corporations were undervalued after the 1970s bear markets, and there was an inflow of capital into the US economy in the early 1980s, CEOs were increasingly concerned about the price of their companies’ stocks. Stock prices too low to book value would make them a target for LBO activities, which in turn would put the CEO’s job at stake. In addition to macroeconomic changes, new policy, and the enterprising activities of the new finance industry actors, agency theory provided a theoretical argument (to be discussed in detail in the next chapter) in favour of shareholder value creation, based on the proposition that the holders of stock contract for the right to the residual cash flow. Agency theory was part of a general neoliberal and laissez-faire discourse gaining momentum in the 1980s.

The shareholder value ideology and the financialization of the economy had two principal consequences. First, the organizational form of the conglomerate, the major corporation hosting by and large unrelated activities, became “deinstitutionalized” (Davis, Diekmann, and Tinsley, 1994). Rather than top management and board of directors making the decision about where to invest what agency theorists call the “residual cash flow” – the cash that is left when all other costs are covered – this cash should be returned to the shareholders for them to reinvest in industries with a high potential for growth and returns. The conglomerate model, by and large the outcome from corporate law aimed at curbing the growth of trusts and monopolies rather than securing shareholders’ interest’ here as suggested, became unfashionable. The second consequence was that finance-trained and finance market-minded CEOs were recruited to major corporations. Rather than operating through board membership, institutional investors thought it would be better to hire CEOs who directly operated in accordance with their interests. In addition, the chief financial officer (CFO) position was changed from being a relatively marginal and highly technical role in the corporation, primarily aimed at securing the access to capital over the economic cycle, to a more prominent position at the helm of corporation. In many cases, executives trained in the engineering sciences had to give way for a new generation of business school graduates majoring in finance, an event that represented a major shift in corporate governance: the managerial capitalism of, for example, Alfred P. Sloan et al. had to surrender to the finance market capitalism or “investor capitalism (Useem, 1996) of the new regime of capital accumulation. “The financialization processes transferred the power from a managerial elite rooted in companies to an opportunistic alliance between mobile managers and investment funds,” ...

Table of contents

• Cover
• Title
• Introduction: Competitive Capitalism and the Role of Capital Investment
• Part I  Elements of Life Science Innovation
• Part II  Empirical Studies
• Part III  Analysis and Contribution
• Notes
• Bibliography