EntreMed Business Case on Behavioral Finance

Introduction

Behavioral finance is the state where, biases and psychological drivers affect the financial decisions made by investors and other practitioners in finance (Kenton, 2019). It suggests that investors are not entirely rational and that they are normal. Their financial decisions are driven by their own bias, emotions, cognitive errors, and social factors. This is against the traditional financial theory that has, over the years, portrayed investors as rational. Understanding behavioral finance has two major benefits: helping one avoid common mistakes in financial markets and assisting one to identify opportunities based on predictable people’s biases. This business case will focus on CASI Pharmaceutical, which deals with pharmaceuticals. It changed its name from EntreMed International Company in June 2014 after being through economic turbulence over the years. The company’s actions will be analyzed concerning behavioral finance based on its products. It will also identify the influence of such bias on the business plan and value. Further, the reactions of the competitors, investors, and managers will also be looked into. It will finally give thoughts on what would have been done differently and share more recommendations on the topic.

CASI Pharmaceuticals is a biopharmaceutical company that develops drugs to treat cancer and other diseases. The company utilizes drug strategies from the United States of America and China. It is located in Rockville, Maryland, and Beijing, China. The company was founded in 1991 and is US NASDAQ listed. The company’s main objective is to develop and speed up the launching of pharmaceutical solutions and therapeutics in the United States of America, the Chinese territory, and worldwide. The company’s mission is to bring high-quality and value-for-money pharmaceutical products and therapeutics to the market. The company’s financial decisions are made by the management team, which is comprised of the chairman, who also serves as the chief executive officer, the president; the chief medical officer; the chief operating officer, who is also the general counsel and secretary, the senior vice president of business development, the general manager who doubles up as the sales and marketing manager in Beijing and the chief operating officer in Beijing. Having been listed in the NASDAQ stock market, the company has investors who buy and sell its shares.

The company, in 1998, successfully developed a drug that could cure cancer. They tested the drug in the lab with mice, which was successful.  The results of the tests were awe-inspiring, although it was mice data. The New York Times published the story about the development at EntrMed on the front page in its Sunday edition. The next day, the company’s stocks rose by over 300%. This valued the company higher than its true valuation due to the decisions made by investors out of the published story about cancer drug development.

This kind of financial decision made by those investors can be linked to the one behavioral finance principle called herd behavior. In every market, there is a tendency for many investors to be swept by the prevailing market trends and fail to consider rationality in making their decisions. EntreMed Pharmaceuticals’ stock prices rose steadily, making it to be valued excessively high.  Later, when the investors woke up from their herd behavior and realized that their euphoria was not reflecting reality. The herd behavior can lead investors to make the wrong financial decision. It also affected the company positively due to the fluctuating price of the stocks.

The company’s increased “false” valuation due to the media reports changed its business plan to reflect the valuation. Shrinking of the prices after investors understood that the story was just fueled by the media exposed the company to suffer as they adjusted to a better-valued company’s business plan. The company’s valuation grew excessively high due to investors’ increased interest in buying shares from the company. The false high valuation of a company leads to high prices of its shares and products, which may reduce its demand, affecting the company fatally economically. However, during this period, the company benefited greatly from the luck created by the media.

The competitors to EntreMed pharmaceuticals were adversely affected by such an event. These are other companies that develop cancer drugs and therapeutics. Many investors opted to sell their shares in the competitors’ companies and buy shares from EntreMed Pharmaceuticals. This situation gave EntreMed a competitive advantage and increased investment over the competitor and popularity in the world. More positively, the EntreMed Pharmaceuticals development boosted the whole biotechnology industry by raising interest among investors towards such companies. The financial analysts’ take on the happenings predicted that there would be growth in the biotechnology industry concerning stock markets and the growing interests of investors. On the other hand, the investors had discovered the industry’s potential and therefore paid close attention to companies in biotechnology that pursued cancer therapies.

The overall herd behavior of the investors towards the development of a cancer cure was advantageous to the managers owing to the benefits that were brought to the company’s brand as a whole and the increased valuation. Often, investors realize their mistake after being involved in herd behavior while buying shares. This reduces a company’s valuation to where it was before the investors took interest or at some points below. Therefore, a possible unintended consequence that might have occurred to the company is that, after a short time, when the investors realized their irrationality, they pulled back and lowered the company’s prices.

The company should have adopted a low-price and distribution strategy. Low prices are commonly used to beat competitors and gain market share. Further, the company should have designed a larger margin for the distributors to gain more preference for them. By so doing, the company, having already been established as a potential investee, would grow naturally and attract investors with more rationality and lasting investors.

A distribution strategy is a method used to identify and make use of channels that help the products of a company to reach the desired customers. The pricing strategy, on the other hand, is a method to ensure that the products distributed are sold at competitive prices to allow the company to benefit from its production and to be affordable to the customers. In implementing the distribution and pricing strategy, various systematic steps ought to be followed as described below:

  1. Identifying a proper channel- A manufacturer should consider several factors before identifying the best distribution channel. Firstly, what channel best works for such products? Companies should be aware that longer channels bring the list profits back. For EntreMed Pharmaceuticals, a distribution channel that involves distributors, wholesalers, and retailers would be ideal. This is to give the company enough time to focus on product development.
  2. Considering the end, customers-It is also essential for businesses to take time and understand their customers. This will always affect the choice of a distribution channel and the prices acceptable to the customers. Whereas a short or direct distribution of products to customers brings more profits to the company, more extended channels reach more customers and therefore allow for larger coverage. Therefore, EntreMed, pharmaceutical should consider the above realities before strategizing on adopting distribution channels.
  3. Evaluate and adapt- The Company has many choices of suitable distribution and pricing strategies. It is prudent to evaluate the options to ensure that it goes with the most efficient strategies. After the evaluation, the company can select the most efficient channel and adopt it.

Behavioral economists consider that some people are irrational in decision-making, and such people need incentives to think right (Vullinghs, 2018). Such incentives help them to make better decisions for themselves. Some companies like Walmart have used incentives to help customers make better financial decisions. They offered the customers a point for a grant draw whenever they saved $100 on their prepaid card.

It is always essential to assess each party’s needs in financial decision-making. This helps ensure the incentive created is valid and will likely bear the desired fruits. To win investors in a business, one has to ensure that the business is attractive enough for the investors. It should have projections and the possibility of being listed on the stock market.

Incentives play an important role in helping a company towards its goals. An incentive can be as simple as streamlining the business process to avoid delays or to attract more customers due to the company’s efficiency. A development at FedEx is an example of such incentives. However, when intensifying investors, the incentives must align with the company’s key performance indicators.

Applying incentives may, at times, be risky to the company. It may lead to a change in the business model or change course. For instance, the recent development by Facebook introducing the advertisement feature changed its initial goal of connecting people worldwide. The advertisements have changed as people give more attention to advertisements than other people.

Therefore, considering the above benefits and risks associated with incentives, EntreMed needed to create incentives to drive investors into investing more in the company. The company could do so by developing cancer treatment and testing it on humans to give the desired results. Through that, the investors, especially the irrational ones, would have the unbiased choice to invest in a well-valued company and avoid the herd behavior common among many investors.

The common rule of thumb in business is the buy low and sell high principle. Although a piece of simple advice, investors may have challenges in making investment decisions. This calls for the need for investors to have financial advisors. Financial advisors can analyze markets and suggest the best investment decision to the investors. However, in communication with such irrational investors, the financial analyst has to package the information in a way that attracts the attention of the investor. In the 2018 economic recession, many investors sold their shares low. This decision was irrationally made against the buy low and sell high principle. Most investors did the opposite (buy high and sell low). Therefore, for EntreMed Pharmaceuticals, the best communication to irrational investors after they started investing in the company after the media reports would be to make them see a greater picture of the company’s future growth and the entire biotechnology industry. This would save the company by retaining the investors and helping the investors in buying low and selling high.

 Handling irrational shareholders is an important aspect of any project and business. It is irrational to think that all shareholders are rational. There are several ways in which irrational shareholders can be handled. Such ways are discussed in depth below:

The first way is expecting the shareholders to have a moment of irrationality as the project goes on. Acknowledging the possibility of such moments helps one to plan to avoid being caught by surprise when that time comes. It helps the business to plan alternatives to avoid losses in case the business is negatively affected by the irrationality of investors.

The second way a business can handle irrational shareholders is by creating strong friendships with them. Spending more time with them leads to a stronger relationship created, and the less the chances of them making irrational decisions against your business. Such strong relationships help one focus on making the business better due to the strong team created with minimal fear of irrationality.

Being empathetic is another way of dealing with shareholders who may be irrational. Sometimes, the shareholders go through challenging situations in making investment decisions. Their fear may have some real cause and therefore, businesses or project managers should not be so judgmental. They should try to understand the shareholder’s fears and work towards solving the issue to restore their confidence.

Conclusion

Behavioral finance has been an important subject in modern economics as it accounts for the impact of human bias to financial decisions. It explains why an average investor tends to sell their stocks when the prices fall and buying back later when the prices rise again, making a loss. Understanding this subject helps businesses in making informed decisions because investors are human beings and are normal people rather than programmed rational beings. It also helps the investors to avoid making biased speculations and thus making informed wealth management strategies. Businesses and project managers who understand this subject can design their businesses to be an incentive to investors and while onboard, manage their expectations to keep the business growing. In collusion, businesses, projects, and markets should embrace understanding behavioral finance principles for prosperity and strategic wealth management in modern times.

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