The Effect of Salience on the Equity Market Reaction to Innovation Announcements: Theory and Evidence from Patent Grants and FDA Drug Approvals

We analyze, theoretically and empirically, the implications of salience on innovation announcements in the biopharmaceutical industry. We hypothesize that equity market investors are more likely to pay attention to an innovation announcement that is more salient: thus, investors pay more attention to FDA drug approvals of pharmaceuticals compared to that paid to patent grant announcements of the same molecule. Based on this assumption, we develop a dynamic model with limited investor attention of patent grant and FDA drug approval announcements in the biopharmaceutical industry. We show that, in addition to an announcement effect, there will be a stock return drift following innovation announcements, with the magnitude of the former increasing and the latter decreasing in investor attention. We test model predictions using a matched sample of biopharmaceutical industry patent grant announcements and subsequent FDA drug approval announcements of the same molecule. Our empirical results are consistent with our model predictions.