Interfirm Collaboration, Ownership Stakes and Hold-Up Costs: Evidence from the Pharmaceutical Industry

Abstract

Theory shows that ownership stakes between firms can mitigate hold-up costs that would
otherwise impede interfirm collaboration. We construct a model of the pharmaceutical industry
that predicts hold-up costs are an inverted U-shaped function of the collaborative drug’s likelihood
of approval. Using a sample of collaborations between pharmaceutical firms on specific drugs and
detailed drug and firm-level data, we find strong support for the model’s predictions: ownership
stakes are a hump-shaped function of the likelihood of drug approval. We conclude that ownership
stakes extend the boundaries of the firm by enhancing its ability to collaborate with other firms.

Keywords: Equity stakes; hold-up costs; license agreements; pharmaceutical and biotechnology industry; firm boundaries; likelihood of approval

JEL Classification: D22, G32, G34, I15, L14, L16, O32