Evaluation and Learning in R&D Investment

55 Pages Posted: 2 Jan 2023

See all articles by Alexander P. Frankel

Alexander P. Frankel

Chicago Booth

Joshua Krieger

Harvard University - Business School (HBS)

Danielle Li

Massachusetts Institute of Technology (MIT)

Dimitris Papanikolaou

Northwestern University - Kellogg School of Management - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: December 31, 2022

Abstract

This paper examines the role of spillover learning in shaping the value of exploratory versus incremental R&D. Using data from the pharmaceutical industry, we show that novel drug candidates generate more dynamic spillovers than incremental ones. That is, despite being more likely to fail in the development process, novel drugs are more likely to inspire the development of subsequent successful drugs. Motivated by this fact, we develop a model where firms are better able to evaluate the viability of incremental drugs, but where investing in novel drugs helps firms learn about future related projects. Our model provides an empirical diagnostic for assessing the relative value of evaluation versus learning, namely that if firms place greater value on learning, then they should set a lower revenue threshold for investing in novel relative to incremental drugs. We in fact find that firms place less value on learning: they are less likely to invest in novel drugs and in turn novel drugs have higher revenues on approval. Finally, we provide suggestive evidence that some of these patterns are driven by concerns about the appropriability of spillover knowledge.

Keywords: Innovation, Exploration, Knowledge Spillovers, Project Evaluation, Drug Development

JEL Classification: O3, 032

Suggested Citation

Frankel, Alexander P. and Krieger, Joshua and Li, Danielle and Papanikolaou, Dimitris, Evaluation and Learning in R&D Investment (December 31, 2022). Available at SSRN: https://ssrn.com/abstract=4315940 or http://dx.doi.org/10.2139/ssrn.4315940

Alexander P. Frankel

Chicago Booth ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Joshua Krieger

Harvard University - Business School (HBS) ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States
617-495-5864 (Phone)

HOME PAGE: http://www.hbs.edu/faculty/Pages/profile.aspx?facid=951435

Danielle Li (Contact Author)

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

Dimitris Papanikolaou

Northwestern University - Kellogg School of Management - Department of Finance ( email )

Evanston, IL 60208
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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