Product Regulation and Stock Prices: The Case of the US Food and Drug Administration

Abstract

This study focuses on the stock market effects associated with the announcements of product approvals, denials and recalls by the US Food and Drug Administration (FDA), and the impact of product approvals on research and development expenditures (R&D) and forecasts of earnings by Value Line. When the FDA announces approvals, the shareholder wealth of affected firms increases significantly. The announcements of denials and recalls by the FDA are associated with stock price declines. The stock price impact of recalls is dependent on whether the firm voluntarily withdraws a product or if the withdrawal is mandated by the FDA. Specifically, voluntary recalls are not associated with a change in stockholder wealth, while FDA mandated recalls are associated with decreases in stock price. In addition, we find that partial product recalls have a smaller impact than total recalls. An examination of the effects on competitors' stock price reveals losses when the FDA announces an approval or a recall, but no imt for a d. An analysis of changes in risk around FDA decisions suggests that, on average, betas do not change around approvals, recalls or denials. In addition, our results suggest that announcement period stock price behavior is unrelated to risk changes except for approvals where returns are positive and significant for firms with either increasing risk or no change in risk. We also find that approvals are associated with increases in R&D and forecasts of earnings for the sample firms, with returns to stockholders upon announcement of the approval being related to the increases in R&D and short-term earnings forecasts.FDA product regulation; Stock price; Risk; R&D expenditures; Earnings forecasts JEL classifications:G14,K23,L5,

Capital market reaction to defective IT products: The case of computer viruses

“…Similarly, research on the impact of product recall announcements in the pharmaceutical, drug, and food industries found that the market penalizes both the causing firm and often its competitors for creating defective products (Hingorani et al, 1994;Salin and Hooker, 2001;Thomsen and McKenzie, 2001). In addition, recalls impact smaller food companies more than larger and more diverse ones (Salin and Hooker, 2001).…”

“…In addition, recalls impact smaller food companies more than larger and more diverse ones (Salin and Hooker, 2001). Mandatory recalls have a larger impact than voluntary recalls (Hingorani et al, 1994;Salin and Hooker, 2001) and highly severe food recalls have a larger impact on stockholder wealth than medium and low severity recalls (Thomsen and McKenzie, 2001). The food, drug, and automotive industries are highly regulated and many of the recall announcements are instigated by government agencies.…”

“…Studies published over the last 20 years in various industries indicate that market reaction to recall announcements is a catalyst that controls the creation of defective products (e.g., Jarrell and Peltzman, 1985;Hoffer et al, 1988;Bromiley and Markus, 1989;Barber and Darrough, 1996;Hingorani et al, 1994;Salin and Hooker, 2001;Thomsen and McKenzie, 2001;Pruitt and Peterson, 1986;Davidson and Worrell, 1992). The degree of impact varies depending on the industry, the severity of the defect, the scope of the problem, and the originator of the recall.…”

Valuation implications of pharmaceutical companies' R&D regulatory approval notifications

“…Regulatory impositions increase the cost and time it takes to bring new drugs to market, and spawn a literature focusing on shareholder wealth effects around FDA announcements. Early studies evaluate FDA approvals, rejections, recalls, disciplinary decisions, spill-over effects and the extent of information leakage (Bosch & Lee, 1994;Hingorani et al, 1994;Dranone & Olsen, 1994;Torabzadeh et al, 1998;Sharma & Lacey, 2004). Collectively, this literature reports significant increases in shareholder wealth for drug approvals, decreases for rejections and recalls, spill-over effects on competitors, and Our paper is motivated by a number of factors.…”

Information acquisition and the value of bad news

“…Several surveys identify building a reputation for transparent reporting as the main rationale for earning warnings (Tucker, 2010) and warning firms may surpass silent ones with comparable current performances (Tucker, 2007;Pukthuanthong, 2010). Similarly, the negative stock price reaction to product recalls is weaker when they are voluntary than when they are initiated by regulatory bodies (Hingorani, Shastri and Shastri, 1994;Chen and Nguyen, 2013). When explaining possible reasons for the absence of a negative reaction to a food recall by IBP Inc, Salin and Hooker (2001) postulate that "the microbiological contamination in the ground beef was identified before reaching consumers, a fact that could have bolstered investors' confidence in IBP's management of foods safety risks."…”