Paying off the Competition: Contracting, Market Power, and Innovation Incentives

72 Pages Posted: 30 Jun 2021 Last revised: 31 Oct 2024

See all articles by Xuelin Li

Xuelin Li

Columbia University

Andrew W. Lo

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

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

This paper explores the relationship between a firm's legal contracting environment and its innovation incentives. Using granular data from the pharmaceutical industry, we examine a contracting mechanism through which incumbents maintain market power: ``pay-for-delay'' agreements to delay the market entry of competitors. Exploiting a shock where such contracts become legally tenuous, we find that affected incumbents subsequently increase their innovation activity  across a variety of project-level measures. Exploring the nature of this innovation, we also find that it is more ``impactful’’ from a scientific and commercial standpoint. The results provide novel evidence that restricting the contracting space can boost innovation at the firm level. However, at the extensive margin we find a reduction in innovation by new entrants in response to increased competition, suggesting a nuanced effect on aggregate innovation. 

Keywords: Drug Development, Pharmaceutical Industry, Contracting, 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: Contracting, Market Power, and Innovation Incentives (June 19, 2021). MIT Sloan Research Paper No. 6040-19, Available at SSRN: https://ssrn.com/abstract=3870420 or http://dx.doi.org/10.2139/ssrn.3870420

Xuelin Li

Columbia University ( email )

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Andrew W. Lo

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

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Richard T. Thakor (Contact Author)

University of Minnesota - Carlson School of Management ( email )

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

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Cambridge, MA 02142
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