Optimal Financing Design for Drug Development Firms

Research Policy, forthcoming

70 Pages Posted: 27 Sep 2024 Last revised: 18 Oct 2024

See all articles by Richard T. Thakor

Richard T. Thakor

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

Andrew W. Lo

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

Date Written: September 25, 2024

Abstract

We examine optimal financing design for R&D-intensive firms developing new drugs. When firms raise external financing using equity, they underinvest in R&D. But when the set of contracts is augmented to include more general (non-linear) payoff schemes, options combined with equity financing, this underinvestment is reduced. We then use a mechanism design approach and show that such non-linear schemes can attenuate R&D underinvestment by using a novel financing design that combines equity with put options to provide bilateral insurance to firms and investors. Investors insure firms against R&D failure and firms insure investors against high R&D payoffs not being realized. Interviews with industry experts indicate both the attractiveness and feasibility of the new financing design.

Keywords: R&D Investments, Innovation, Drug Development, Biotechnology, Capital Structure, Mechanism Design

JEL Classification: D82, D83, G31, G32, G34, O31, O32

Suggested Citation

Thakor, Richard T. and Lo, Andrew W., Optimal Financing Design for Drug Development Firms (September 25, 2024). Research Policy, forthcoming
, Available at SSRN: https://ssrn.com/abstract=4968434 or http://dx.doi.org/10.2139/ssrn.4968434

Richard T. Thakor (Contact Author)

University of Minnesota - Twin Cities - Carlson School of Management ( email )

19th Avenue South
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

Andrew W. Lo

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

100 Main Street
E62-618
Cambridge, MA 02142
United States
617-253-0920 (Phone)
781 891-9783 (Fax)

HOME PAGE: http://web.mit.edu/alo/www

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
166
Abstract Views
519
Rank
383,624
PlumX Metrics