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Organizational Scope and Investment: Evidence from the Drug Development Strategies and Performance of Biopharmaceutical Firms

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  • Ilan Guedj
  • David Scharfstein

Abstract

This paper compares the clinical trial strategies and performance of large, established ("mature") biopharmaceutical firms to those of smaller ("early stage") firms that have not yet successfully developed a drug. We study a sample of 235 cancer drug candidates that entered clinical trials during the period 1990-2002 and were sponsored by public firms. Early stage firms are more likely than mature firms to advance drug candidates from Phase I to Phase II clinical trials. However, early stage firms have much less promising clinical results in their Phase II trials and their Phase II drug candidates are also less likely to advance to Phase III and to receive Food and Drug Administration approval. This pattern is more pronounced for early stage firms with large cash reserves. The evidence points to an agency problem between shareholders and managers of single-product early stage firms who are reluctant to abandon development of their only viable drug candidates. By contrast, the managers of mature firms with multiple products in development are more willing to drop unpromising drug candidates. The findings appear to be consistent with the benefits of internal capital markets identified by Stein (1997).

Suggested Citation

  • Ilan Guedj & David Scharfstein, 2004. "Organizational Scope and Investment: Evidence from the Drug Development Strategies and Performance of Biopharmaceutical Firms," NBER Working Papers 10933, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:10933
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    References listed on IDEAS

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    1. Stein, Jeremy C, 1997. " Internal Capital Markets and the Competition for Corporate Resources," Journal of Finance, American Finance Association, vol. 52(1), pages 111-133, March.
    2. Vojislav Maksimovic & Gordon Phillips, 2002. "Do Conglomerate Firms Allocate Resources Inefficiently Across Industries? Theory and Evidence," Journal of Finance, American Finance Association, vol. 57(2), pages 721-767, April.
    3. Raghuram Rajan & Henri Servaes & Luigi Zingales, 2000. "The Cost of Diversity: The Diversification Discount and Inefficient Investment," Journal of Finance, American Finance Association, vol. 55(1), pages 35-80, February.
    4. Lerner, Josh & Shane, Hilary & Tsai, Alexander, 2003. "Do equity financing cycles matter? evidence from biotechnology alliances," Journal of Financial Economics, Elsevier, vol. 67(3), pages 411-446, March.
    5. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    6. Hyun-Han Shin & René M. Stulz, 1998. "Are Internal capital Markets Efficient?," The Quarterly Journal of Economics, Oxford University Press, vol. 113(2), pages 531-552.
    7. David S. Scharfstein & Jeremy C. Stein, 2000. "The Dark Side of Internal Capital Markets: Divisional Rent-Seeking and Inefficient Investment," Journal of Finance, American Finance Association, vol. 55(6), pages 2537-2564, December.
    8. Naveen Khanna, 2001. "The Bright Side of Internal Capital Markets," Journal of Finance, American Finance Association, vol. 56(4), pages 1489-1528, August.
    9. David S. Scharfstein, 1998. "The Dark Side of Internal Capital Markets II: Evidence from Diversified Conglomerates," NBER Working Papers 6352, National Bureau of Economic Research, Inc.
    10. DiMasi, Joseph A. & Hansen, Ronald W. & Grabowski, Henry G., 2003. "The price of innovation: new estimates of drug development costs," Journal of Health Economics, Elsevier, vol. 22(2), pages 151-185, March.
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    More about this item

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives
    • O32 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Management of Technological Innovation and R&D

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