Medicare prescription drug legislation: An analysis of economic effect

Medicare had tried to incorporate outpatient prescription drugs into their benefits regime for many years. Medicare Prescription Drug, Improvement, and Modernization Act of 2003 is the most recent success after the repealed Medicare Catastrophic Coverage Act of 1988. There have been a lot of discussion and concerns about the effect of the prescription drug legislation about whether it creates big windfall profits for the private sectors. This thesis uses event study to investigate the economic effect of the Medicare legislations of 1988 and 2003 on two types of industries--pharmaceutical and health insurance. The event study uses daily stock return data from CRSP and analyzes the abnormal returns associated with important information about the prescription drug benefits. The empirical results suggest no evidence that the prescription drug legislation of covering outpatient drugs has led to expectations of windfall profits from the pharmaceutical and health insurance companies that significantly boost their stock prices. As far as abnormal returns are concerned, the cross-sectional analysis indicates that larger firms and better leveraged firms withstood the impact of prescription drug legislation better than their smaller and heavily debt financed peers. The empirical results also suggest that whether the prescription drug benefits are administered privately or publicly can influence the relevant industries differently.