Academic journal article Financial Management

Wealth Effect of Drug Withdrawals on Firms and Their Competitors

Academic journal article Financial Management

Wealth Effect of Drug Withdrawals on Firms and Their Competitors

Article excerpt

In this paper we examine the impact of a drug withdrawal on shareholders of firms and their direct competitors. We find shareholders suffer significant wealth losses when there are reports of adverse drug reactions and when the firm actually withdraws a drug from the market. Additionally, shareholder wealth losses are inversely related to the firm market capitalization. Firms that withdraw drugs during advanced clinical investigations experience greater wealth loss than drugs withdrawn during post-marketing surveillance. Wealth losses are lower if many firms withdraw the same type of drug and if that drug has available substitutes.

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The news of a product recall usually receives considerable attention from the stock market. For example, the withdrawal of Firestone tires in August 2000 caused its producer Bridgestone to lose over 45% of its market value. For pharmaceuticals, the intense public scrutiny is usually not limited to safety issues, but extends to their effectiveness. Previous studies on product recall present conflicting evidence on stock returns. Hoffer, Pruitt, and Reilly (1988) and Bromiley and Marcus (1989) report insignificant wealth losses, but Pruitt and Peterson (1986) show a significant decline in shareholder wealth.

In this paper, we focus on the wealth effects of drug withdrawals. We note that there are meaningful economic differences between a product recall and withdrawal. Davidson and Worrell (1992) show a higher loss in shareholder wealth for product withdrawals than for product recalls. A recalled product is likely to be reintroduced after some modifications, but a withdrawn product results in the elimination of a revenue source, as most products are never reintroduced.

The intra-industry impact of a drug withdrawal can be either a contagion or a competitive effect (Lang and Stulz, 1992). According to the contagion effect, competitors should have negative returns similar to those of the firms withdrawing a product. The contagion effect happens whenever there is any systemic concern for safety of similar drugs or expectation of higher regulatory costs. But quite to the contrary, in an industry that is an oligopoly, the competitors gain market share and have a positive stock return when firms withdraw a product. We examine the impact of a drug withdrawal on direct competitors (i.e., firms that produce similar drugs).

We contend that not all drug withdrawals impact the cash flow of the affected firm in the same manner. The information content of the news plays a role in determining the extent of the expected loss in future cash flows. Our sample of 108 withdrawals spans 32 years. This long time frame allows tests on subsamples stratified by the information content of the news. We examine the impact of availability of substitutes for withdrawn drug, simultaneous withdrawal of a class of drugs by many firms compared to withdrawal affecting only one firm, reasons for the withdrawal, the stage at which the drug is withdrawn, and the market size of firm withdrawing the drug. We also examine wealth effects when there is an announcement of unintended, but severe side effects, called adverse drug reactions (ADRs). (1) In addition to being a harbinger of bad news (possibility of a future withdrawal), an ADR announcement has a negative impact on the firm's brand name or goodwill. Thus, an ADR reduces expected future cash flows. The stock prices of pharmaceutical firms should react to reflect this new information. [n cases where a drug withdrawal is preceded by an ADR, the total wealth loss is the sum of wealth losses from the ADR and the withdrawal.

Our results show that stockholders of drug producers incur substantial losses at the announcement of a drug withdrawal. The information content of the news plays a significant role in explaining the cross-sectional variation in abnormal returns. The losses are higher for cases in which a drug has no available substitute. …

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