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Ownership Vs. Contract: How Vertical Integration Affects Investment Decisions in Pharmaceutical R&D

Ilan Guedj

Bates White, LLC

October 1, 2005

McCombs Research Paper Series No. FIN-01-06
AFA 2006 Boston Meetings Paper

This paper explores the effect of vertical integration on investment behavior in the pharmaceutical industry. I study a detailed, project-level sample of 4057 drug candidates that were sponsored by 40 large pharmaceutical firms during the period 1984-2001. Of these projects, 447 were conducted through a contractual alliance with another, smaller company that had discovered the drug candidate. The existence of these two types of governance structures allows me to compare integrated and non-integrated projects within the same firm. Controlling for project and firm characteristics, I document that pharmaceutical firms are more selective in continuing their integrated projects than in continuing projects governed by contract. I hypothesize that this difference is caused by the rigidity of the contract that governs non-integrated projects, making them less flexible in adapting to changes in the firm's situation. In line with this hypothesis, I document that although more frequently continued, non-integrated projects have a lower probability of success. Moreover, investment in non-integrated projects is less sensitive to the firm's cash flow and to the existence of other projects in the firm.

Number of Pages in PDF File: 56

Keywords: Vertical Integration, Investment Decisions, Internal Capital Markets, Pharmaceutical Industry

JEL Classification: G32, L22, L65

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Date posted: March 7, 2005 ; Last revised: February 8, 2014

Suggested Citation

Guedj, Ilan, Ownership Vs. Contract: How Vertical Integration Affects Investment Decisions in Pharmaceutical R&D (October 1, 2005). McCombs Research Paper Series No. FIN-01-06; AFA 2006 Boston Meetings Paper. Available at SSRN: https://ssrn.com/abstract=677371 or http://dx.doi.org/10.2139/ssrn.677371

Contact Information

Ilan Guedj (Contact Author)
Bates White, LLC ( email )
2001 K St., NW
Suite 700
Washington, DC 20006
United States
HOME PAGE: http://www.bateswhite.com/professionals-Ilan-Guedj.html
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