A popular tool for estimating regulatory costs is the event study. The idea is that stock prices should reflect rational market expectations of the discounted after-tax present value of the company’s stream of future profits. If a regulation (or similar abrupt event) occurs, stock prices will rise or fall quickly to capture its effects.
A Supreme Court opinion issued today illustrates why it pays to interpret these data with care.
The Court unanimously ruled that Myriad Genetics, Inc. did not have the legal right to patent two human genes. You would think that losing the case would cause the firm’s stock price to fall. The decision was delivered this morning, but within an hour or so the company’s stock price had risen about 10%. (Since then, these gains have retreated; a current price graph is here.)
As is their custom, business reporters (USA Today, AP, Wall Street Journal) speculate with alacrity about why the stock price rose. Some say the price increase reflects a portion of the Court’s decision which states that certain other elements of the company’s inventions may be patentable.
But these inferences make sense only one knows what already captured in the market price before the event. In this case, the market appears to have expected Myriad to lose. Its stock price probably would have crashed if the market had expected it to win. If Myriad’s win on a secondary issue (the potential patentability of complementary DNA) is enough to send the stock price north, then perhaps the market also expected Myriad to lose on that issue as well.
The effect of a scheduled event on stock prices depends on market expectations prior to the event. But it’s not easy to divine what these expectations were. Interpreting changes in stock prices subsequent to regulatory events should be done with extreme caution. It’s hard to be confident that we even know whether prices should rise or fall, much less by how much.