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

Abstract

How do innovative firms react when existing products experience negative shocks? We explore this question with detailed project-level data from drug development firms. Using FDA Public Health Advisories as idiosyncratic negative shocks to approved drugs, we first examine how drug makers react through investment decisions. Following these shocks, affected firms increase R&D expenditures, driven by a higher likelihood of acquiring external innovations, rather than developing novel projects internally. Such acquisition activities are concentrated in firms with weak research pipeline. We also find that competing developers move resources away from the affected therapeutic area and into exploratory projects. Our results have important implications about how firms’ commercialization capital investments affect their subsequent R&D decisions.

Keywords: R&D Investments, Drug Development, Product Shocks, M&A, Biopharmaceutical Industry, FDA

JEL Classification: D22, G31, G34, L21, L65, O32, O34, O38