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Innovation and Competition in Drug Development

Paper Session

Saturday, Jan. 5, 2019 2:30 PM - 4:30 PM

Atlanta Marriott Marquis, International C
Hosted By: American Economic Association
  • Chair: Leemore Dafny, Harvard Business School

Missing Novelty in Drug Development

Danielle Li
,
Massachussetts Institute of Technology
Josh Krieger
,
Harvard Business School
Dimitris Papanikolaou
,
Northwestern University

Abstract

This paper provides evidence that risk aversion leads pharmaceutical firms to underinvest in radical innovation. We define a drug candidate as novel if it is molecularly distinct from prior candidates. Using our measure, we show that firms face a risk-reward tradeoff when investing in novel drugs: while novel drug candidates are less likely to be approved by the FDA, they are based on patents with higher indicators of value. We show that---counter to the predictions of frictionless models---firms respond to a plausibly exogenous positive shock to their net worth by developing more of these riskier novel candidates. This pattern suggests that financial market imperfections may lead even large public firms to behave as though they are risk averse, therefore hindering their willingness to invest in potentially valuable novel drugs.

Killer Acquisitions

Colleen Cunningham
,
London Business School
Florian Ederer
,
Yale University
Song Ma
,
Yale University

Abstract

Firms may acquire innovative targets to discontinue the development of the targets' innovation projects in order to preempt future competition. We call such acquisitions ``killer acquisitions.'' We develop a parsimonious model and provide empirical evidence for this phenomenon in drug development by tracking detailed project-level development histories of more than 60,000 drug projects. We show theoretically and empirically that acquired drug projects are less likely to be continued in the development process, and this result is particularly pronounced when the acquired project overlaps with the acquirer's development pipeline and when the acquirer has strong incentives to protect its market power. We also document that alternative interpretations such as optimal project selection, organizational frictions, and human capital and technology redeployment do not explain our results. Conservative estimates indicate that about 7% of all acquisitions in our sample are killer acquisitions and that eliminating their adverse effect on drug project development would raise the pharmaceutical industry's aggregate drug project continuation rate by more than 5%. These findings have important implications for antitrust policy, startup exit, and the process of creative destruction.

Reactive Outsourcing of Technological Innovations

Manuel Hermosilla
,
Johns Hopkins University

Abstract

Large innovative firms routinely strengthen their new product pipelines by outsourcing developing technologies from other (typically startup) companies. This practice is portrayed by scholars and practitioners as a high-involvement, carefully planned and executed process. We contribute to their understanding by highlighting a novel concept and documenting an associated trade-off: technologies outsourced “reactively” (following development setbacks of other projects in their pipelines) are less likely to reach the market. Our argument is supported by evidence from the pharmaceutical industry, where outsourcing (drug candidate licensing) plays a central role for innovation, and where Phase 3 outcomes provide a rich source of quasi-experimental variation that we exploit for inference. The analysis takes advantage of recent methodological advances that leverage machine learning for causal inference. Compared to traditional methods, these techniques make more efficient use of data and allow for a more detailed description of the effects at play. Results suggest that, whereas reactive outsourcing behavior is not rare in the pharmaceutical industry, its incidence and consequences can be predicted to occur in specific environments.

Find and Replace: R&D Investment Following the Erosion of Existing Products

Josh Krieger
,
Harvard Business School
Xuelin Li
,
University of Minnesota
Richard Thakor
,
University of Minnesota

Abstract

How do R&D-intensive firms react to negative shocks to their existing products? Such shocks have important implications for the investment decisions of such firms, given the frictions they face as well as the regulatory and competitive environment they operate in. We explore this question using detailed project-level data from drug development firms. Using FDA Public Health Advisories as an exogenous and idiosyncratic negative shock to the profitability of approved drugs on the market, we examine how firms and their competitors react in terms of their investment and financing decisions. We document that these negative shocks lead affected firms to increase R&D expenditures, financing this with debt. In terms of investment behavior, these shocks lead affected firms to increase the likelihood of acquiring early-stage drugs projects from other firms, rather than developing new projects internally. We also find evidence of spillover effects, indicating that other firms in the industry learn about their own project prospects after competitors experience advisory shocks. Rather than turning to external acquisitions, these competing firms appear to re-shuffle their own drug portfolios—they are more likely to suspend trials of existing drugs, and are are also more likely to internally begin research of drugs in different therapeutic areas.
Discussant(s)
Fiona Scott Morton
,
Yale University
Jason O’Connor
,
Federal Trade Commission
Ariel Dora Stern
,
Harvard Business School
Craig Garthwaite
,
Northwestern University
JEL Classifications
  • O3 - Innovation; Research and Development; Technological Change; Intellectual Property Rights
  • L1 - Market Structure, Firm Strategy, and Market Performance