As You Sow, so Shall You Reap: Evidence of Innovation and Drug Portfolio Diversification from the Stock Market

Drug discovery and development is a risky and time-consuming process. Typically, a new product costs around $1.3 billion and takes 15–20 years to reach the shelves, while an overwhelming majority of innovations fail along the way. The probability of attaining a US Food and Drug Administration (FDA) approval for a compound that has attained a patent grant is a mere 0.02 per cent. However, the pharmaceutical industry’s sustainability and profitability is dependant on product discovery and innovation. Against such a background, this article looks at returns to innovation for 66 companies in the biopharmaceutical industry. Based on Original New Drug Approvals (NDA) by the FDA from 1997–2007 and patent grants from 1984–2005, this study assesses market rewards for bringing new drugs to the market and undertaking risks by diversifying product portfolios. Using an event-study analysis, this article makes two conclusions. First, FDA drug approval receives a positive and longlasting response from the stock market. Second, FDA policies alongside factors such as R&D expenditure, drug type and reputation of the company based on previous drug approvals, play an instrumental role in encouraging pharmaceutical companies to innovate, by reducing the interval between a patent grant and FDA approval. Finally, the market offers sizable rewards for undertaking the risk of product diversification and also rewards frequent participants.