On September 2, Pfizer agreed to pay $2.3 billion to settle civil and criminal allegations that it violated federal rules governing drug sales. The pharmaceutical manufacturer was charged with illegally promoting its pain-killer Bextra and three other medications by offering doctors speaking fees and subsidized trips to resorts, among other benefits. The settlement was the largest ever levied against a U.S. company.

While the amount of the settlement is significant, the indirect costs to the company may be even higher over time in terms of lost shareholder value.

A new research paper now puts a price on the less tangible costs to a company’s value that can arise when marketing efforts backfire. Titled “Regulatory Exposure of Deceptive Marketing and Its Impact on Firm Value,” the paper examines declines in financial market value experienced by drug companies that have been the target of deceptive marketing citations by the U.S. Food and Drug Administration. The paper’s authors are Diana C. Robertson, a Wharton legal studies and business ethics professor; Sundar Bharadwaj, a marketing professor at Emory University’s Goizueta Business School and currently a visiting professor of marketing at Wharton; and Martha Myslinski Tipton, a marketing professor at Singapore Management University.

Robertson applauds the Pfizer penalty because it is large enough to draw attention to the potential risk of overly aggressive marketing and may serve as an example to others. “We don’t know if the Justice Department is making an example of Pfizer to keep others from engaging in this behavior, but usually it does have that kind of outcome,” says Robertson. The settlement, adds Bharadwaj, may actually help the entire drug industry by restoring credibility to pharmaceutical firms and thus enhancing their sales and long-term value. “It reassures consumers that the FDA and Justice Department are paying attention and that other consumers won’t be hurt.”

This is the fourth settlement in the space of seven years between the government and Pfizer or one of its subsidiaries over charges of illegal drug-marketing practices.

The authors acknowledge that the majority of marketing managers and researchers are more interested in finding ways to add shareholder value rather than focusing on the consequences of unethical or fraudulent marketing efforts that could wind up costing firms more in the long term. Most studies on corporate social responsibility or reputation look at added value in terms of improved customer perceptions or higher employee morale, says Robertson. “There are fewer studies looking at negative effects, which seems surprising given the number of scandals we have.”

Or, as Bharadwaj puts it: “Most academic marketing research is focused on value creation. We look at how marketing can lead to value destruction. There are two sides to the story.”

Vioxx vs. Budweiser

In their research, to be published in the November 2009 Journal of Marketing, the authors examined 170 FDA letters citing inappropriate marketing practices, including promotion of drugs for so-called “off-label” uses — conditions for which the product was not officially approved by the FDA. The letters provided a “treasure trove” of data, according to Bharadwaj.

The paper also points out that spending by pharmaceutical companies on product promotion totaled nearly $3 billion in 2005 and has been growing at an average annual rate of 10.6% since 1996. Ever since the FDA allowed drug companies to expand direct-to-consumer (DTC) marketing in 1997, spending on advertisements to reach patients has grown at an average rate of 14.3%. For example, the paper cites research showing that Merck’s DTC promotional spending in 2000 on Vioxx — an arthritis drug that eventually was withdrawn over safety concerns — exceeded advertising dollars spent by the corporate parents of Budweiser and Pepsi to support each of their megabrands.

 “For a number of pharmaceutical companies, spending on marketing is greater than on R&D, which indicates that these organizations are under pressure to provide returns because R&D is not paying off as well,” says Bharadwaj. “They use marketing to help them. The question we have is, given the actions they take that are in violation of regulations, does it hurt the firm or help the firm?”

Building on other academic literature, the researchers assume changes in stock prices reflect information that has just been made available to investors. To gauge the impact of the FDA citations on shareholder value, the researchers compared stock prices of the firms in the two days following release of the FDA letters against what would have been expected before the letter was made public. The authors used three indexes — the S&P 500, NYSE and Nasdaq — and a pharmaceutical industry stock portfolio as a proxy for the market.

They conclude that deceptive marketing incidents which are uncovered lead to “significant negative abnormal returns.” The decline amounts to a drop of 1% in market value, which translates into an $86 million loss of shareholder wealth for a median-sized firm in the study sample. In the case of Pfizer — whose market capitalization was nearly $98 billion in June 2009 — the loss would have been about $1 billion.

“Understanding these costs is critical because indirect costs of negative events can amount to a significant proportion of a firm’s market valuation,” the paper states. “Furthermore, many negative marketing-related events, such as when a firm is exposed for using deceptive marketing, have no immediate impact on cash flows but garner a quick investor response.”

The researchers then looked deeper into the FDA data to explore what might drive variations in the level of negative response by investors to the citations. To do that, they examined the letters in more detail, and then grouped the cases by the type of deception:

  • omitted risk information
  • unsubstantiated effectiveness claims
  • unsubstantiated superiority claims.

The paper points to Merck’s Vioxx as a particularly egregious example of omission of risk. The authors suggest that the company’s failure to acknowledge the drug’s potentially fatal side effects was a more serious transgression than, for example, failure to list nausea as a side-effect.

Unsubstantiated claims of effectiveness can lead to poor prescribing decisions that put consumers at risk for little benefit, or for less benefit than they would have received from another treatment. “The potential negative word-of-mouth from disappointed patients in the current environment of blogs and online forums is likely to be significant,” according to the paper.

When it comes to companies that made unsubstantiated claims of superiority over other treatments, the study notes that it is prohibitively expensive and difficult for competitors and regulators to conduct comparative brand studies. As a result, this type of problem is less likely to result in litigation or substantial change in prescription volume. Moreover, “the lack of severity in the violation is not likely to draw enough attention to significantly alter behavior and cash flows,” the authors conclude.

The researchers also examined the FDA letters to gauge the targeted audience of the marketing message, including physicians and current and past users of the medication. According to Bharadwaj, many different groups of people are susceptible to deceptive pharmaceutical marketing practices, particularly patients who cannot be expected to understand complex medical treatments. When the victims are perceived as more vulnerable, the consequences in the market are greater. Adds Robertson: “People are less able to make judgments about the efficacy of drugs than other products.” In addition, the article notes that physicians face consequences from deceitful drug marketing in the form of malpractice actions.

For each characteristic of the deceptive act cited in the FDA letters, the authors calculated how much shareholder value would be lost. The study found greater loss of shareholder value for cases involving “egregious” deception of highly vulnerable populations, as in the Vioxx case.

The authors suggest that the paper’s most important contribution is its examination of the effect of brand size on investor response when the company is found to have used deceptive marketing practices. They calculated the direct effect of a brand’s market share on returns and found little overall impact. However, the impact of event characteristics, such as the egregiousness of the violation, had a significant effect on products with large rather than small brand share.

“We can conclude that firms cited for deception related to brands with high market share are punished more for highly egregious acts or deception aimed at vulnerable populations than for acts of deception that are less severe or physician-directed,” the paper states. “However, firms cited for deception related to brands with low brand market share experience no significant difference in impact for acts of high or low egregiousness or by target audience.” These results are consistent with the researchers’ expectation that when the brand’s market share is large, the brand is more salient and the investors are better able distinguish the impact of different types of deception.

The authors say the results of their research can help managers and Wall Street executives, in any number of industries, make more informed decisions about the potential fallout from deceptive marketing strategies. “Our findings indicate that Main Street managers need to consider both the target audience and the potential harm when communicating with outside stakeholders,” they write.

Bharadwaj acknowledges that while the research quantifies the costs of deceptive advertising after exposure by the FDA, it is possible that companies can gain enough added value from a deceitful practice in the time before they are cited for a violation — if they are cited at all — to come out ahead. “In the net, they may have been better off,” he says. “But if they do get cited, there are significant costs.”

Counting on Not Getting Caught

Indeed, Robertson says the researchers interviewed Wall Street analysts as part of their study and learned that many companies consider the upside of deceptive marketing techniques worth the risk of being called out by regulators.

The study, in fact, indicates that managers believe they will not be cited for violating the FDA’s guidelines, emboldening them to take on the risk of deceptive marketing practices. The researchers show that while spending on direct-to-consumer advertising has increased dramatically — by 269% — the number of citations has decreased by nearly 85%. Meanwhile, the size of the FDA staff enforcing the marketing rules has remained constant while the office’s budget has decreased by 3.25%. At the same time, the authors note that the process of getting a citation has increased over the years in difficulty and length, extending the average time necessary from several days to 78 days.

“As a result of these factors and despite assurances from the FDA that all pharmaceutical communications are reviewed, firms may believe that detection is not certain,” the authors write.

They go on to argue that policymakers should consider whether the loss of firm value following the publication of a citation outweighs the positive effect on sales enjoyed by putting out a misleading message. While they did not intend to calculate the overall payoff of deceptive marketing in this study, the authors say the analysis could be used when determining future fines.

Bharadwaj raises another concern related to the research. Many drug companies are developing sophisticated online marketing operations that open up new fertile territory in which deceitful marketing practices could take place. “The web is like the Wild West as far as pharma advertising is concerned,” he says, noting particular concern about ads on Google or other search engines that appear to be placed by an objective group related to a specific disease or condition but that, in fact, link to information provided by the drug company. Without the drug company’s name on the material, it is not clear whether deceitful claims about efficacy or risk are enforceable. The FDA, he adds, is asking for public input into creating new guidelines to monitor this type of online marketing.

Consumers searching for information about cardiac disease, for example, might click on a site that has only the name cardiac in the web address with no indication that they are linking to a drug company site. “The consumer doesn’t see any tie to a pharmaceutical company. They think it is a neutral health care web site,” says Bharadwaj. “The customer is worse off because he or she has been misled.”