As you sow, so shall you reap
Evidence of innovation and drug portfolio
diversification from the stock market
April 2010
As you sow, so shall you reap
Evidence of innovation and drug portfolio diversification
from the stock market
Bansal, Anushri, GRS Delhi
Abstract
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%. However, the
pharmaceutical industry’s sustainability and profitability is dependent 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 long lasting 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.
Executive summary
Purpose of the study: to assess the stock market rewards to pharmaceutical companies for
innovation, which the study defines as both bringing new drugs to the market and diversifying
the drug portfolio.
Major findings:
•• FDA approval receives an enthusiastic and enduring response from the stock market.
•• Amount invested in R&D, type of drug and FDA review status can encourage or discourage
innovation by affecting the interval between patent and FDA approval.
•• The market rewards firms for diversifying their drug portfolios and for having obtained
multiple patents in the past.
Implications for future decision-making: the market rewards make innovation worth seeking out,
in spite of the attendant higher risks.
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Innovation and drug portfolio diversification 2
April 2010
Introduction
Bringing new drugs to market is a time-consuming
and expensive process. According to industry
estimates for 2006, a typical drug took around
10-15 years to develop and cost roughly $1.3 billion.
According to (Dickson and Gagnon 2004; DiMasi
2001; DiMasi, Hansen and Grabowski 2003; DiMasi
and Grabowski 2007; Congressional Budget), the
increasingly inflexible regulatory environment has
made drug development a challenging venture, and
the research required to bring a single drug to market
often involves testing 5,000-10,000 compounds.
Scientific advancements in medicine have helped
billions of people, but have also led to greater
complexities and increased both the risks and costs
of drug development. Garnier (2008) states that
research and development (R&D) spending by the
pharmaceutical industry increased from $2 billion
in 1980 to $43 billion in 2006.
Product discovery and innovation are essential to a
pharmaceutical firm’s sustainability and profitability.
In the book Critical Assessments, Wood (1991, 53)
states that: “Innovations introduce new products,
embody resource discoveries and technological
improvements.” Such innovations help create surplus
revenues and hold out abnormal profits as a reward.
In light of these challenges and potential rewards,
Towers Watson looks at returns for innovation for
66 companies in the biopharmaceutical industry.
To measure the market rewards to innovation, we
use patent issue and FDA approval as proxies for
success. Patent application occurs at the beginning
of the R&D process, and a patent grant gives the
firm a first-mover advantage against its competitors.
A patent can thus be considered an incentive to
innovate. An FDA approval, on the other hand, gives
a firm licence to market the drug and thus marks the
culmination of its R&D efforts.
The research measures abnormal returns following
announcements of a patent grant and FDA approval
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and then examines abnormal returns generated by
different kinds of drugs (standard, orphan, priority, new
molecular entity [NME] and new chemical formulation)
developed by pharmaceutical companies.1
Given that the length of time required to develop a
drug increases the risks attendant to drug discovery,
we also analyze the factors that affect the interval
between a patent grant and FDA approval.
Our research suggests that while the stock market
does not react to a patent grant, it rewards an FDA
approval. Moreover, the rewards of this approval
persist for several days after the announcement. The
market discounts the value of most patents, given the
high risks and uncertainty involved in the development
and application process. But FDA approval heralds the
introduction of a successful drug, which increases the
parent company’s valuation.
The interval between receiving a patent grant and
receiving final FDA approval is called the timedifference. Our research shows that time-difference
is affected by the R&D investment, the type of drug
and the FDA review classification. A pharmaceutical
company should pay heed to these factors as they
indirectly affect its ability to innovate successfully.
Diversifying the company’s drug portfolio entails high
risk and cost, but the stock market rewards such risktaking. The market especially rewards companies that
diversify from the production of ‘me-too’ drugs, which
Heaton (1994, 283) defines as “compounds that
have very similar properties to one already known.”
The market also recognizes frequent participants,
measured by the number of patents granted in
previous years.
These valuations enable the managers of
pharmaceutical companies to make strategic
1 For definitions and terminology, refer to the Appendix 1.
Innovation and drug portfolio diversification 3
April 2010
decisions about investing and allocating resources in
R&D that consider the associated risks as well as
the rewards.
The remainder of the paper is structured as
follows. Section 2 describes available literature
on returns to innovation in the pharmaceutical
industry. Section 3 talks in detail of the eventstudy methodology used to evaluate stock market
performance. Section 4 describes the sources of
data used and the compilation done for the analysis.
Section 5 entails the empirical findings from our
event study. The effect of different factors on the
time taken between a patent grant and FDA approval
is discussed in section 6, while section 7 evaluates
whether the market appreciates the risk-taking
behaviour of the firm both in terms of costs and risks
of drug portfolio diversification. The paper concludes
in section 8.
disciplinary actions) on firm valuations. The data
was collected from the Wall Street Journal Index for
a 28-year period (1962-1989) and included those
firms from the food and drug industries that were
present in the CRSP database. Using the eventstudy methodology, these authors find an increase
in valuation following FDA approvals recognising
the degree of uncertainty and risk involved in the
regulatory process. Moreover, they find evidence
of leakage of news supporting views of ‘profitable
“Diversifying
“
the company’s
drug portfolio entails high risk
and cost, but the stock market
rewards such risk taking.”
Literature review
Lacey and Sharma (2004) look at how new product
development outcomes have an effect on firm
performance. Using the market model they do an
event-study to analyse and compare the impact of
positive news on FDA approval to FDA-related negative
news. They use the FDA website for approvals and
the Lexis/Nexis database for news on adverse
events. Using a sample set of 344 approvals and
41 rejections by the FDA, their findings indicate
that stock market exuberance on positive news is
outweighed by downturn following negative news. In
all cases, the magnitude of losses was much higher
than gains from positive news.
In a follow-up study by Lacey and Sharma (2008),
they look at whether the stock market is able to
distinguish the “treatment potential of an approved
drug.” This they measure by looking at stock market
reaction to drugs, differentiated by chemical type and
review status given by the FDA. Stock market returns
generated for drugs with priority review are three
times higher than for standard drugs.
In an attempt to answer the question: “Does the
public announcement of approval of new drugs
affect the market valuation of the sponsoring
pharmaceutical company?”, Ahmed (2007) uses
the event-study methodology on 400 events of 11
pharmaceutical companies ranging over 23 years.
Using OLS and 2SLS regression models he finds
mixed results of statistically significant positive
abnormal returns and insignificant cumulative
abnormal returns following the event. Main data
sources for this study are the FDA and COMPUSTAT
databases.
Analysing the impact of government regulations on
a firm’s wealth, Bosch and Lee (1994) examine the
effect of FDA decisions (approvals, rejections and
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opportunities’ through insider trading. Disciplinary
decisions by the FDA result in strong and significant
negative reactions from the stock market.
Taking the existing literature a step forward, this
paper aims to distinguish between the effects of a
patent grant and FDA approval for the same drug
on stock market valuation. This would help us
evaluate whether the market regards a patent grant
as a successful innovation by the stock market.
Moreover, it brings to fore the importance of time in
the drug-development process. The paper ends by
investigating the importance of innovative product
development for pharmaceutical companies.2
Methodology
This study estimates the impact of a drug patent
grant and FDA approval on the value of the
sponsoring pharmaceutical company. The date of the
patent grant and FDA approval are taken as event
dates in the stock market. We use the market model
to estimate the events’ impact on stock market
returns of the company. These returns are calculated
over stipulated event windows as in a paper by Lacey
and Sharma (2004, 308). In our case these are:
•• Three-day event window (the day before through to
the day after the event).
•• Five-day event window (two days before through to
two days after the event).
•• Pre-event window to check for leakages (ten days
through to two days before the event).
•• Post-event window to check for persistence (two days
after the event through to ten days after the event).
2 For definitions and terminology, refer to the Appendix 1.
Innovation and drug portfolio diversification 4
April 2010
In order to calculate the impact of the event, we need
to calculate abnormal returns. Abnormal returns have
been defined by MacKinlay (1997, 15) as “the actual
ex post return of the security over the event window
minus its normal return over the event window. The
normal return is defined as the expected return
without condition on the event taking place. For firm
i and event date τ, the abnormal return is AR˙ιτ = R˙ιτ –
E(R˙ιτ | X˙ιτ), where AR˙ιτ, R˙ιτ and E(R˙ιτ | X˙ιτ) are the
abnormal, actual and normal returns respectively for
time periodτ” and Xτ is the “conditioning information
for the normal return model”.
We perform this analysis separately for the event of a
patent grant and the event of an FDA approval.
For any security i, the normal returns in the market
model is estimated over an estimation window (in
our case -310 days through to -11 days), through an
ordinary least square regression (OLS): R˙ιτ = a˙ι + b˙ι
Rmτ + ε˙ιτ , where R˙ιτ and Rmτ are the returns on security
i and the market portfolio over period τ. a, b are
the parameter estimates which we use to ‘predict’
normal performance during the event window.
Abnormal returns are then calculated as in the event
window. Cumulative abnormal returns (CARs) for each
security over different intervals are calculated using:
We then perform regression analysis to see the
impact of portfolio diversification on the stock market
valuation of the firm. This we do by looking at the
following factors that affect abnormal returns: size
of the company, type of drug, chemical composition
of the drug and the number of patent and FDA
approvals in the past. We use the log of real market
capitalization as a proxy for size of the firm.
CARi ( τ 1τ2 ) =
τ2
∑ ARiτ
τ = τ1
•• According to the Princeton University Data and
Statistical Services (n.d.) the average abnormal
returns for each company stock are tested to see
if they are statistically significant from zero, using:
Test = ( 1 n∑ AR ) AR _ SD , where AR is the abnormal
return and AR_SD is the standard deviation of the
abnormal returns.
•• The number of companies which have significant
average abnormal returns a day preceding, on the
day and a day after the event is calculated.
•• The average abnormal return for five days preceding
through to five days following the event is calculated.
•• CARs for all companies for each event window are
tested for robustness.
Next we look at the impact of various factors on the
time-difference between a patent grant and an FDA
approval using regression analysis. Our independent
variables are: R&D expenditure at patent grant, type
of drug, chemical composition of the drug and past
experience of the company.
In order to convert the data into real terms we use
the IMF country-wise GDP deflator, for each country in
our sample, using 2000 as the base year.
Data
Our main sources for data are: US Food and Drug
Administration (n.d.a), Bloomberg, DataStream
and the US Food and Drug Administration (n.d.b),
International Monetary Fund (2007).
Our sample consists of all drug approvals of
Original New Drug Approvals (NDA) by the FDA from
1997-2007 inclusive. These data were matched using
drug names to get patent information for the same
set of companies from bigpatent.com (an official site
of the orange book by FDA). The patent grant dates
range from 1984-2005, corresponding to our FDA
approvals from 1997-2007. These data were crossreferenced on the Electronic Orange Book of the FDA
using patent numbers and NDA application numbers.
This gave a sample set of 66 companies and 220
events. The daily shares return data for all calendar
days from 1984-2007 for the companies in the
Abnormal returns (%)
Figure 01. Abnormal returns — timeline
0.8
0.6
0.4
0.2
0
–5
–4
–3
–2
–1
0
1
–0.2
2
3
4
5
Days
–0.4
statistically significant
Patent grant
FDA approval
Source: Towers Watson calculations based on data from US Food and Drug Administration
(n.d.a), Bloomberg, DataStream and the FDA Electronic Orange Book.
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Innovation and drug portfolio diversification 5
April 2010
Figure 02 shows that, on average, 15 firms from
our sample of 66 are affected by the announcement
of a patent grant or an FDA approval. Also, of the
firms recording a change in shareholder valuation,
roughly 62.5% exhibit positive returns on the day of
the announcement.
sample were taken from Bloomberg. The daily market
return data were taken from DataStream using the
World DS Pharm – Price Index (PHRMCWD (PI)).
This was matched with our security data using
calendar days.
The IMF country-wise GDP deflator has been
taken from the International Monetary Fund, World
Economic Outlook Database, October 2007.
If a company’s returns are negative a day before the
event, it might be because of earlier ‘false alarms’.
News leaks that never led to actual announcements
in the past would give the market reason to treat the
upcoming event with skepticism.
Timeline of market reactions
We look at how the announcement of a patent grant
and FDA approval affect the stock market valuation of
a firm five days before and after the event.
“On
“ average, 15 firms from
our sample of 66 are affected
by the announcement of
a patent grant or an FDA
approval. Also, of the firms
recording a change in
shareholder valuation, roughly
62.5% exhibit positive
returns on the day of the
announcement.”
Market virtually ignores patent grant
but rewards FDA approval
As shown in the movement of returns from a patent
grant in Figure 01, all market returns around
the event date are statistically insignificant. This
indicates the market’s general unresponsiveness
to a patent grant.
After an FDA approval, the increase in returns on the
day of the event and the next day can be categorized
as an announcement effect. This reflects the
importance of FDA approval for a pharmaceutical
company, given the costs, risks and time required to
get a drug ready for the market.
Announcement affects stock market
valuations of companies
As discussed by Lacey and Sharma (2004),
the losses from product development setbacks
are greater than the profits gained by product
development successes. The news of a patent issue
or an FDA drug approval might be outweighed by
other company-specific news that affects returns
Next, we compute the number of companies
exhibiting a change in shareholder value on
the announcement day and one day after
the announcement.
Figure 02. Announcement effect
0
5
10
15
Number of companies
20
Patent grant
Day –1
4
7
Day 0
9
6
Day +1
7
7
FDA approval
Day –1
7
8
Day 0
11
6
Day +1
10
Positive
5
Negative
Source: Towers Watson calculations based on data from US Food and Drug Administration
(n.d.a), Bloomberg, DataStream and the FDA Electronic Orange Book.
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Innovation and drug portfolio diversification 6
April 2010
negatively the day of or after the event. According to
the US Food and Drug Administration (n.d.c), negative
news could be a patent expiration, drug recall or drug
safety warning by the FDA.
We next look at how a patent issue and FDA approval
affect the returns for various event windows by
analyzing CARs for all firms.3
Market unresponsive to patent grants
As shown in Figure 03, considering all companies as
a group, the stock market valuation across different
windows for a patent grant is as follows:
•• There is evidence that the news of an upcoming
drug patent is leaked to the market. However, a
negative CAR of 0.88% indicates that the market
regards this news with skepticism.
•• A patent grant leads to an increase in the
sponsoring firm’s market value in the five-day event
window, but the firm’s market value falls between
three and 11 days after the event.
The stock market’s response to the news of a
patent grant is mixed. The market recognizes and
rewards the patent grant by increasing the overall
value of the firm. However, the rewards are shortlived, and the firm’s returns become negative within
three to 11 days after the event. The market’s initial
exuberance might give way to caution in the face of
the uncertainty and high risk of failure during the
development phase.
Market rewards FDA drug approval
The market reacts much more positively to an FDA
drug approval than to a patent. When we track FDA
“To
“ the stock market, FDA
approval represents successful
innovation and the market
rewards the pharmaceutical
firm’s improved prospects with
a substantially higher valuation.”
approvals for the same drugs that received a patent,
we see positive significant abnormal returns across
all event windows.
•• A positive CAR of 2.2% between three and 11
days before the event suggests that news of an
impending FDA drug approval is often leaked.
•• High and positive CARs in the three- and five-day
event windows once again highlight the importance
of a drug approval for a pharmaceutical company.
•• Positive CARs in the post-event window suggest
that the effects of an FDA approval persist long
after the event.
An FDA approval suggests good times ahead for
the firm’s performance. To the stock market, FDA
approval represents successful innovation and the
market rewards the pharmaceutical firm’s improved
prospects with a substantially higher valuation. The
higher valuations emphasize the necessity of taking
risks and investing in R&D.
3 See regression Table 1 in Technical Appendix
CARs (%)
Figure 03. Cumulative abnormal returns across firms
7
5.83
6
5
4
3
2.2
2
0.69
1
0
–1
–2
2.44
2.05
–0.88
–3
–4
–5 Pre-announcement
–0.17
–2.29
3-day
5-day
Post-announcement
Event windows
statistically significant
Patent grant date
FDA approval date
Source: Towers Watson calculations based on data from US Food and Drug
Administration (n.d.a.), Bloomberg, DataStream and the FDA Electronic Orange Book.
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Innovation and drug portfolio diversification 7
April 2010
A long, slow path from patent grant to
FDA approval
R&D expenditure affects time-difference
Figure 05 shows a negative relationship between
average annual R&D expenditure and time-difference.
This implies that the larger the investment in R&D,
the shorter the duration of the drug development
process. This inference is quite logical, given that
higher R&D investment would concentrate more
resources into production of a drug.
Drug development is an extremely complex and timeconsuming process. According to our analysis of a
23-year period from 1984-2007, the time lag between
patent grant and FDA approval ranges from a few months
to up to 19 years. The mean interval is 7.01 years.4
During this interval, the drug goes through various
stages of development, from the pre-clinical phase to
the clinical phases (Phase I, Phase II and Phase III)
and, finally, to the FDA for an approval.
Moreover, drug development is very risky. The
probability of attaining an FDA approval for a
compound that has attained a patent grant is
0.02%.5 Figure 04 provides an overview of
the development process.
4 The drug development process generally takes 10-15 years (Congressional
Budget Office 2006). Our data show a downward bias, which might be
because a preclinical phase takes six to seven years, and a patent is
generally granted during that phase. We consider the analysis from the date
of patent grant and thus the discrepancy.
5 This is a reasonable assumption given that out of 5,000-10,000
compounds that enter the R&D pipeline, only one drug makes it all the way
to FDA approval, and a drug receives a drug patent during its preclinical
development phase.
Against this backdrop, we look at the relationship
between R&D investment and time-difference.
Figure 04. Time-difference: FDA approval
1 FDA-approved drug
FDA approval
5
c
o
m
p
o
u
n
d
s
Phase III
Phase II
Phase I
250
5,000
Patent
Pre-clinical
0
1
2
3
4
5
6
7
8
9
10
Mean time-lag (years)
Source: Towers Watson calculations based on data from Pharmaceutical Research and
Manufacturers of America (2008) and European Federation of Pharmaceutical Industries
and Associations (2007).
Average R&D expenditure
($ million)
Figure 05. R&D expenditure by time-lag
1600
1400
1200
1000
800
600
400
200
0
1-3
Average R&D expenditure
4-6
7-9
10-13
Time-lag (years)
Linear (average R&D expenditure)
Source: Towers Watson calculations based on data from US Food and Drug Administration
(n.d.a), Bloomberg, DataStream and the FDA Electronic Orange Book.
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Innovation and drug portfolio diversification 8
April 2010
Effects of R&D expenditure and other
factors on time-difference
cumbersome for orphan drugs, the FDA gives drug
companies an incentive to invest more in innovation.
To confirm the relationship between R&D expenditure
and time-difference and to explore the effects of other
factors, we perform regression analysis and find the
following results:
Portfolio diversification and firm valuation
•• A 1% increase in R&D expenditure leads
to a marginal decrease of around four months in
time lag.
•• An orphan drug6 is characterized by a lower
time-difference than a standard drug. This might
be because a drug that treats a rare disease or a
critical medical condition attains an accelerated
development/review status from the FDA.
Having established that the stock market rewards
innovation in new drug development, this section
analyzes whether:
•• The market appreciates risk-taking behaviour by
the firm, in terms of both costs and diversification.
We look at the impact of an event on the market
valuation of a firm that invests in producing an
NME, a drug with a new chemical formulation, a
priority drug and an orphan drug.7
•• The market recognizes frequent participants, as
measured by the number of patent grants and FDA
approvals in previous years.
The interval between a patent grant and an
FDA approval depends on factors such as R&D
investment, the kind of drug being developed and
FDA review policy.
We use FDA statistics and classifications to assess
the level of innovation of new drug application (NDA)
approvals in the past decade.
FDA review policy impacts innovation
The review and approval process generally takes
18 months, according to the FDA. An accelerated
development/review status can shorten the duration
of the time-difference, which can be extremely
important. By making the review process less
Figure 06 shows that from 1997-2007, 43 of 220
drugs received an FDA priority review. This implies
that only 20% of drugs in our sample represent
6 For definitions and terminology, refer to Appendix 1.
7 For definitions and terminology, refer to Appendix 1.
Figure 06. New drug applications by therapeutic applications and
chemical type (1997-2007)
20% Priority
71% Standard
9%
0
10
20
30
40
50
60
Orphan
70
Percentage
90
100
80
Formulation
NME 87%
28
New formulation 86%
56
13
Other 47%
83 5
17
Priority
16
81
Standard
2
Orphan
Source: Towers Watson calculations based on data from US Food and Drug
Administration (n.d.a).
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Innovation and drug portfolio diversification 9
April 2010
a significant advance over existing medicine.
Most companies invest in standard drugs whose
therapeutic qualities are similar to those of existing
drugs, thereby requiring little modification and
keeping R&D costs low. According to estimates by
DiMasi, Hansen and Grabowski (2003), the mean
clinical-period-out-of-pocket costs are 33.5% higher
for a priority drug than for a standard drug.
Moreover, out of the 220 drugs in our sample, 87
are NMEs that contain an active ingredient that
has never been marketed before. According to a
research report by the The National Institute for
“The
“
market offers sizable
rewards for undertaking the
risk of product diversification
and also rewards frequent
participants.”
Health Care Management Research and Educational
Foundation (2002), highly innovative drugs — those
that represent an advance over available therapy and
contain a new active ingredient — are much less
common than standard drugs. Our research finds that
only 28% of drugs fall into the former category.
In this context, we analyze whether the stock market
rewards firms for bringing innovative products to
market. More specifically, we try to establish whether
companies that market drugs with new active
ingredients or that attain a priority review by the FDA
outperform companies that ‘play it safe’ with less
innovative, standard drugs.
The stock market appreciates drug
diversification and experience
•• Priority and orphan drugs. Confirming our
expectations, the stock market rewards firms
for taking risks and diversifying their drug portfolio.
The valuation for a drug attaining priority review or
orphan status by the FDA is roughly 2% higher than
the valuation attained by a standard drug.
•• Patent grants in previous years. The higher the
number of patents issued to the company in previous
years, the higher its market valuation in the five-day
event window of an FDA approval. This shows that
the market recognizes and rewards companies that
have been granted patents in previous years.
The market appears to reward firms for portfolio
diversification over and above the production of
standard drugs. These results should encourage firms
to undertake risks and diversify the drug portfolio
because the remuneration for doing so is significant.
Innovation directly affects performance
Based on a 23-year period from 1984-2007, we
analyze a drug’s progress from the time it receives a
patent to when it reaches the FDA for approval.
The substantial change in shareholder valuation
on the announcement day and persistence of high
market returns a few days after the announcement
highlights the importance of FDA approval to the
drug company.
FDA policies — along with 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. Some of these factors
also encourage innovation by reducing the interval
between a patent grant and FDA approval.
The market offers sizable rewards for undertaking
the risk of product diversification and also rewards
frequent participants.
In light of such conclusive evidence, we can say
with assurance that innovation affects the overall
performance of a drug firm. Managers making
strategic investment and resource allocation
decisions should consider these findings and their
impact on overall firm performance as they embark
on R&D efforts.
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Appendix 1
Most of the technical terminology has been taken
from US Food and Drug Administration (n.d.a) unless
otherwise mentioned. Following are the definitions for
the terms used in the paper:
“Active Ingredient – An active ingredient is any
component that provides pharmacological activity or
other direct effect in the diagnosis, cure, mitigation,
treatment, or prevention of disease, or to affect the
structure or any function of the body of man
or animals.”
“New Drug Application (NDA) Number – This six digit
number is assigned by FDA staff to each application
for approval to market a new drug in the United
States. A drug can have more than one application
number if it has different dosage forms or routes of
administration. In Drugs@FDA, you can find the NDA
number under the column named “FDA Application.”
towerswatson.com
NDA chemical types
Number
Meaning
1
New molecular entity (NME)
2
New ester, new salt, or other
noncovalent derivative
3
New formulation
4
New combination
5
New manufacturer
6
New indication
7
Drug already marketed, but without an
approved NDA
8
OTC (over-the-counter) switch
“New Molecular Entity (NME) – A New Molecular Entity
is an active ingredient that has never before been
marketed in the United States in any form.”
Innovation and drug portfolio diversification 11
April 2010
“Accelerated Development – After the IND has been
filed, a drug that can be used by patients who are
suffering from life-threatening or seriously debilitating
conditions, for which no other drug treatment exists,
can qualify for accelerated development. Approval
can be based on surrogate endpoints or on an FDA
determination that the drug can be used safely if
distribution is limited.”
“Me-too drugs – arise when a company produces a
compound that has very similar properties to one
already known and which offers in preliminary clinical
trials little medical advantage to the physician or
patient.” (Heaton 1994)
“Chemical Type – The Chemical Type represents the
newness of a drug formulation or a new indication for
an existing drug formulation.”
Review Classification – The NDA and BLA
classification system provides a way of describing
Review classifications
Letter
Meaning
P
Priority review drug: A drug that appears to
represent an advance over available therapy
S
Standard review drug: A drug that appears to
have therapeutic qualities similar to those of
an already marketed drug
O
Orphan drug – a product that treats a
rare disease affecting fewer than
200,000 Americans
drug applications upon initial receipt and throughout
the review process and prioritizing their review.
(List of Review Classifications and their meanings)
Technical appendix
Table 1. Abnormal returns - timeline
Abnormal returns (%)/days
Patent grant
FDA approval
Day –5
–0.028
(0.0019)
0.066
(0.0012)
Day –4
0.083
(0.0013)
0.263*
(0.0013)
Day –3
–0.123*
(0.0007)
0.105
(0.0014)
–0.023
00.219
(0.0008)
(0.0019)
Day –1
–0.033
(0.0029)
–0.111
(0.0019)
Day 0 (Event day)
0.333
(0.0021)
0.133
(0.0018)
Day 1
0.302
(0.0019)
0.643**
(0.0025)
Day 2
0.206
(0.0019)
0.335
(0.0024)
Day 3
0.149
(0.0018)
–0.201
(0.0018)
Day 4
–0.058
(0.0011)
0.100
(0.0014)
Day 5
–0.027
(0.0007)
0.094
(0.0018)
172
222
0.000
0.000
Day –2
Observations
R-squared
Robust standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1
towerswatson.com
Innovation and drug portfolio diversification 12
April 2010
Table 2. Cumulative abnormal returns
Cumulative abnormal
returns (%)/event
window
Patent grant
FDA approval
–0.885***
(0.002)
2.198***
(0.0043)
3-day
–0.170
(0.0056)
5.831***
(0.0073)
5-day
0.694***
(0.0025)
2.047***
(0.0036)
–2.286***
(0.0037)
2.438***
(0.0055)
222
222
0.000
0.000
Pre-announcement
Post-announcement
Observations
R-squared
Robust standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1
Table 3. Time difference between patent grant and FDA approval
Time difference between patent grant and FDA approval
Log of R&D expenditure at patent grant
–0.349**
(0.156)
Priority drug
2.876*
(1.472)
Orphan drug
–3.823***
(0.762)
NME
1.351
(0.925)
New formulation
1.298
(0.928)
Priority drug*NME
–3.582*
(1.917)
Priority drug*New formulation
–1.500
(2.041)
Orphan drug*NME
2.390
(1.525)
Number of FDA approvals in year prior to approval
0.030
(0.355)
Previous patent grants
0.009
(0.403)
Constant
Observations
R-squared
7.371***
(1.069)
153
0.091
Robust standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1
towerswatson.com
Innovation and drug portfolio diversification 13
April 2010
Table 4. Portfolio diversification
Abnormal
returns (%)
Preannouncement
3-day
5-day
Postannouncement
Log of market cap
at FDA approval
0.298*
(0.162)
–0.388
(0.316)
–0.318
(0.315)
–0.083
(0.134)
Priority drug
1.935
(1.964)
0.254
(2.277)
2.066*
(1.093)
1.699
(1.929)
Orphan drug
0.748
(0.767)
1.505
(1.247)
2.099*
(1.199)
0.593
(1.162)
NME
0.150
(0.642)
–1.175
(1.347)
0.064
(0.704)
0.598
(0.659)
New formulation
0.328
(1.383)
–0.250
(0.641)
1.311
(0.936)
0.709
(0.801)
Priority drug*NME
–2.184
(2.199)
–0.001
(2.563)
0.325
(1.329)
0.354
(2.216)
Priority drug*
New formulation
–2.171
(2.608)
–0.053
(2.580)
–1.000
(1.546)
–1.842
(2.069)
Orphan drug*
New formulation
1.081
(1.160)
–0.421
(2.532)
–0.986
(2.298)
–0.715
(1.609)
Previous FDA
approvals
0.096
(0.275)
0.320
(0.314)
0.156
(0.225)
0.031
(0.198)
Previous patent
grants
–0.186
(0.294)
–0.143
(0.336)
0.529*
(0.275)
–0.156
(0.266)
–3.130**
(1.526)
4.698
(3.769)
2.068
(3.036)
0.612
(1.556)
175
175
175
175
0.059
0.040
0.074
0.045
Constant
Observations
R-squared
Robust standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1
towerswatson.com
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