NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Missing Novelty in Drug Development

Joshua L. Krieger, Danielle Li, Dimitris Papanikolaou

NBER Working Paper No. 24595
Issued in May 2018, Revised in January 2019
NBER Program(s):The Program on Aging, The Asset Pricing Program, The Corporate Finance Program, The Health Care Program, The Monetary Economics Program, The Public Economics Program, The Productivity, Innovation, and Entrepreneurship Program

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.

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Document Object Identifier (DOI): 10.3386/w24595

 
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