Stock Trading Activity around New Product Introductions – Cost of Capital Implications from the Pharmaceutical Industry

We analyze the relationship between new product introductions, trading activity, and systematic risk changes. The analysis is placed within a real options framework in which new product introductions are associated with the exercise of a real option. Using a unique hand-collected data set on new drug approvals, we find opposing results to previous work. Trading activities change after new product announcements and stock become more liquid. However, we have no evidence on changes in systematic risk. After adjusting for potential biases caused by increased leverage and frictional trading, estimates for systematic risk are indifferent before and after the new product announcement. Our results have implications for the firm’s cost of capital and internal investment decisions. Investors’ required return remains unchanged and cost of equity for technological-intensive companies is invariant to new product introductions and the exercise of corresponding real options.