Developing Novel Drugs
NBER Working Paper No. 24595
We analyze the economic tradeoffs associated with firms' decisions to invest in incremental and radical innovation, in the context of pharmaceutical research and development. We develop a new, ex ante, measure of a drug candidate's innovativeness by comparing its chemical structure to that of previously developed drug candidates: this allows us to better distinguish between novel and so-called “me-too” drugs. We show that, on average, novel drug candidates 1) generate higher private and social returns conditional on approval (as measured by revenues, stock market returns, clinical value added, and patent citations) but 2) are riskier in that they are less likely to be approved by the FDA. Using variation in the expansion of Medicare prescription drug coverage, we show that firms respond to a plausibly exogenous positive shock to their net worth by developing more chemically novel drug candidates, as opposed to more “me-too” drugs. This pattern suggests that, on the margin, firms perceive novel drugs to be more valuable ex-ante investments, but that financial frictions may hinder their willingness to invest in these riskier candidates.
Document Object Identifier (DOI): 10.3386/w24595