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

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 singleproduct 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). *We are grateful to Thomas Roberts, M.D. and Stan Finkelstein for collaborating with us in collecting the Phase I clinical trials data. We also appreciate their insights into the clinical trials process. Catherine Chang, Stephanie Sherman, Jimmy Sun, and Athanasios Vorvis provided exceptional research assistance. We thank Pierre Azoulay, Malcolm Baker, Patrick Bolton, Evan Beckman, Murillo Campello, Amy Hutton, Josh Lerner, Sendhil Mullainathan, Oguzhan Ozbas, Gary Pisano, Antoinette Schoar, Daniel Scharfstein, and Jeremy Stein for helpful discussions, seminar participants at Columbia, Dartmouth, Illinois, NBER, and Princeton for their comments. This research was supported by grants from the National Science Foundation, Harvard Business School Division of Research, and the Program on the Pharmaceutical Industry at MIT.