WHY DO PRESCRIPTION DRUG PRICES INCREASE? STATE MEDICAID EXPANSION, EXECUTIVE COMPENSATION AND CORPORATE GOVERNANCE

Abstract

We exploit a quasi-random shock, i.e., Medicaid expansion, to the demand on prescription drugs and examine its impact on drug prices conditional on manufacturing firms’ financial characteristics. We use this shock to study the role of executive compensation, board independence and corporate governance, in setting drug prices. We find suggestive evidence that drug prices increased in expansion states. We also find that stock option awards are associated with lower drug prices. This provides evidence for Ross (2004)’s magnification effect that stock options may reduce the risk-taking of a CEO. Corporate governance appears to have a more complicated relationship with drug prices. This study addresses an underrepresented area in finance and provides a blueprint for researchers in finance to utilize a unique data set to answer research questions in finance and economics.