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

67 Pages Posted: 28 Jun 2021 Last revised: 20 Feb 2023

See all articles by Xuelin Li

Xuelin Li

Columbia Business School

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 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.

Suggested Citation

Li, Xuelin and Lo, Andrew W. and Thakor, Richard T., Paying Off the Competition: Contracting, Market Power, and Innovation Incentives (June 2021). NBER Working Paper No. w28964, Available at SSRN: https://ssrn.com/abstract=3875131

Xuelin Li (Contact Author)

Columbia Business School ( 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

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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