Paying off the Competition: Market Power and Innovation Incentives

60 Pages Posted: 30 Jun 2021 Last revised: 6 Aug 2021

See all articles by Xuelin Li

Xuelin Li

University of South Carolina - Darla Moore School of Business

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering; Santa Fe Institute

Richard T. Thakor

University of Minnesota - Carlson School of Management; Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering

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Date Written: June 19, 2021

Abstract

How does a firm’s market power in existing products affect its incentives to innovate? We explore this fundamental question using granular project-level and firm-level data from the pharmaceutical industry, focusing on a particular mechanism through which incumbent firms maintain their market power: “reverse payment” or “pay-for-delay” agreements to delay the market entry of competitors. We first show that when firms are unfettered in their use of “pay-for-delay” agreements, they reduce their innovation activities in response to the potential entry of direct competitors. We then examine a legal ruling that subjected these agreements to antitrust litigation, thereby reducing the incentive to enter them. After the ruling, incumbent firms increased their net innovation activities in response to competitive entry. These effects center on firms with products that are more directly affected by competition. However, at the product therapeutic area level, we find a reduction in innovation by new entrants after the ruling in response to increased competition. Overall, these results are consistent with firms having reduced incentives to innovate when they are able to maintain their market power, highlighting a specific channel through which this occurs.

Keywords: Drug Development, Pharmaceutical Industry, Monopoly, Antitrust, Market Power, Competition, Innovation

JEL Classification: D42, D43, G31, K21, L41, L43, L65, O31, O32

Suggested Citation

Li, Xuelin and Lo, Andrew W. and Thakor, Richard T., Paying off the Competition: Market Power and Innovation Incentives (June 19, 2021). Available at SSRN: https://ssrn.com/abstract=3870420 or http://dx.doi.org/10.2139/ssrn.3870420

Xuelin Li

University of South Carolina - Darla Moore School of Business ( email )

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Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering ( email )

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Santa Fe Institute

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Richard T. Thakor (Contact Author)

University of Minnesota - Carlson School of Management ( email )

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Minneapolis, MN 55455
United States

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering ( email )

100 Main Street, E62-618
Cambridge, MA 02142
United States

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