HEALTHCARE LEGISLATION and the BEHAVIOR of PHARMACEUTICAL COMPANIES: The ROLE of POLITICAL COST and STOCK MARKET PRESSURE

• In Event: SESSION 6D: Industries and Regulation

Abstract

This study examines whether pharmaceutical companies managed earnings in the periods preceding the 2010 healthcare law and further considers whether the firms differ in their responses to the threat of the law as a function of their exposure to the expected wave of patent expirations and prior performance. The initial tests examine whether the behavior of abnormal accruals prior to the legislation is consistent with earnings management to mitigate the expected political costs; the latter analysis is motivated by the specter of economic difficulties that pharmaceutical firms faced during the healthcare legislation, including severe stock market pressures due to global economic downturn, expected patent cliffs, and fewer “blockbuster” drugs in the firms’ pipelines. We associate the economic difficulties with earnings management incentives that are directly in conflict with those that arise from the healthcare law, and predict that pharmaceuticals with greater exposure to such economic difficulties have fewer incentives to report lower earnings for fear of greater stock market penalty. We document abnormal decreases in accruals for the pharmaceuticals during the healthcare legislation; however, we document greater income-increasing accruals over the test period for firms with greater exposure to patent cliffs. We also find some evidence of abnormal income-increasing accruals for under-performing firms before the passage of the healthcare law. These latter results appear to demonstrate increased sensitivity of these latter firms to capital market pressures.

Authors

• Maggie Hao, Lamar University

• Emeka T Nwaeze, University of Texas-San Antonio