Linking Product Development Outcomes to Market Valuation of the Firm: The Case of the U.S. Pharmaceutical Industry

The purpose of this research was to examine empirically the effects of new product development outcomes on overall firm performance. To do so, first product development and finance literature were connected to develop three testable hypotheses. Next, an event study was conducted in order to explore whether the changes in the stock market valuation of firms are influenced by the outcomes of efforts to develop new products. The pharmaceutical industry was chosen as the empirical context for the present studyʹs analysis largely because the gate-keeping role played by the Food and Drug Administration (FDA) provides a specific event date on which to focus the event study methodology. As such, this studyʹs events were dates of public announcements of the FDA decisions to approve or to reject the New Drug Applications submitted by the sponsoring firms. Consistent with the efficient market hypothesis, this studyʹs results show that market valuations are responsive strongly and cleanly to the success or failure of new product development efforts. Hence, one of this studyʹs key results suggests that financial markets may be attuned sharply to product development outcomes in publicly traded firms. This study also finds that financial market losses from product development failures were much larger in magnitude than financial market gains from product development successes—indicating an asymmetry in the response of financial markets to the success and failure of new product development efforts. Hence, another implication of this studyʹs results is that managers should factor in a substantial risk premium when considering substantial new development projects. The present studyʹs results also imply that managers should refrain from hyping new products and perhaps even should restrain the enthusiasm that the financial community may build before the product fully is developed. The effect on firm value is severe when expectations about an anticipated new product are not fulfilled. Managers in effect should take care to build reasonable and realistic expectations about potential new products.