Pharmaceutical-Biotechnology R&D: Pharmaceutical-Biotechnology R&D: Technological Performance Technological Performance ImplicationsImplications

JONGWOOK KIMJONGWOOK KIM

Western Washington UniversityWestern Washington University

College of Business and EconomicsCollege of Business and Economics

Introduction: Research questionIntroduction: Research question

How do different governance mechanisms – How do different governance mechanisms – both formal and informal – impact alliance both formal and informal – impact alliance performance?performance?

How do formal governance mechanisms that seek How do formal governance mechanisms that seek to mitigate information asymmetry impact alliance to mitigate information asymmetry impact alliance performance?performance?

How do social ties matter for alliance performance?How do social ties matter for alliance performance?

How do different levels of uncertainty matter for How do different levels of uncertainty matter for alliance performance?alliance performance?

IntroductionIntroduction

Why biotechnology alliances?Why biotechnology alliances?

It is difficult to measure alliance performance, It is difficult to measure alliance performance, particularly in R&D alliancesparticularly in R&D alliances

Biotechnology alliances provides an empirical Biotechnology alliances provides an empirical context where a fairly objective indicator of alliance context where a fairly objective indicator of alliance performance exists:performance exists: Because of FDA regulations, information about Because of FDA regulations, information about

intermediate stages in drug development are made intermediate stages in drug development are made publicpublic

Biotechnology industryBiotechnology industry

The empirical contextThe empirical context

Small biotechnology R&D firms usually have Small biotechnology R&D firms usually have capabilities in product R&D activities (upstream capabilities in product R&D activities (upstream activities)activities)

Larger pharmaceutical firms (and some established Larger pharmaceutical firms (and some established biotechnology firms) supply capabilities in biotechnology firms) supply capabilities in commercialization activities (downstream activities, commercialization activities (downstream activities, i.e., manage the regulatory process, large-scale i.e., manage the regulatory process, large-scale manufacturing, marketing & distribution, etc.)manufacturing, marketing & distribution, etc.)

Lengthy and uncertain regulatory (FDA) approval Lengthy and uncertain regulatory (FDA) approval processprocess

Biotechnology industryBiotechnology industry

Key milestones in the drug development Key milestones in the drug development processprocess

PreclinicalPreclinical development: animal testing development: animal testing

Phase IPhase I clinical trials: human testing (for toxicity) clinical trials: human testing (for toxicity)

Phase IIIPhase III clinical trials: large-scale controlled clinical trials: large-scale controlled experiments on potential patients experiments on potential patients (most expensive and time-consuming, 33-42% of total (most expensive and time-consuming, 33-42% of total

cost)cost)

IntroductionIntroduction

Strategic alliancesStrategic alliances

Firms enter alliances to pool complementary Firms enter alliances to pool complementary resources to achieve common goals, but at the resources to achieve common goals, but at the same time, partner firms are seeking access to same time, partner firms are seeking access to types of resources not available to themtypes of resources not available to them

Information asymmetry problems for firms acquiring Information asymmetry problems for firms acquiring R&D on the part of client firms (usually R&D on the part of client firms (usually pharmaceutical firms or larger biotechnology firms)pharmaceutical firms or larger biotechnology firms)

The level of information asymmetry and overall The level of information asymmetry and overall uncertainty of the drug development project uncertainty of the drug development project changes as the drug development process changes as the drug development process progressesprogresses

Strategic alliancesStrategic alliances

Informal responses to information asymmetryInformal responses to information asymmetry

Social ties (i.e., reputation and repeated ties) Social ties (i.e., reputation and repeated ties) (Granovetter, 1985; Gulati, 1995; Powell, Koput, & (Granovetter, 1985; Gulati, 1995; Powell, Koput, & Smith-Doerr, 1996; Shane & Cable, 2002)Smith-Doerr, 1996; Shane & Cable, 2002)

Formal responses to information asymmetryFormal responses to information asymmetry

Direct oversight through participation in R&D firm’s Direct oversight through participation in R&D firm’s management or through formal contractsmanagement or through formal contracts

Client firms can invest in stages by setting up Client firms can invest in stages by setting up intermediate milestones (Noldeke & Schmidt, 1995; intermediate milestones (Noldeke & Schmidt, 1995; Sahlman, 1990)Sahlman, 1990)

Theory development & hypothesesTheory development & hypotheses

Repeated tiesRepeated ties

Information asymmetry problems in alliance formation Information asymmetry problems in alliance formation are more severe in the early stages of developmentare more severe in the early stages of development The client firm cannot accurately ascertain the potential The client firm cannot accurately ascertain the potential

economic value of an R&D firm’s research outputeconomic value of an R&D firm’s research output

Repeated ties between the client firm and the R&D Repeated ties between the client firm and the R&D firm is an indication of the R&D firm’s product quality firm is an indication of the R&D firm’s product quality

H1: All else held constant, alliances with partner firms H1: All else held constant, alliances with partner firms who had prior alliances with one another will more who had prior alliances with one another will more likely reach Phase I clinical trialslikely reach Phase I clinical trials

Theory development & hypothesesTheory development & hypotheses

Reputation effectsReputation effects

Reputation effects (past alliances by the R&D firm) Reputation effects (past alliances by the R&D firm) may also signal the R&D firm’s product quality may also signal the R&D firm’s product quality

H2a: All else held constant, the greater the number H2a: All else held constant, the greater the number of prior alliances that the R&D firm had been of prior alliances that the R&D firm had been involved in, the more likely the alliance is to reach involved in, the more likely the alliance is to reach Phase I clinical trials.Phase I clinical trials.

Theory development & hypothesesTheory development & hypotheses

Reputation effectsReputation effects

There may be negative effects of prior alliance There may be negative effects of prior alliance experience of R&D firms: R&D firms may exploit experience of R&D firms: R&D firms may exploit asymmetric information by out-licensing less-asymmetric information by out-licensing less-promising drug compounds (Pisano, 1997; “lemons” promising drug compounds (Pisano, 1997; “lemons” hypothesis)hypothesis)

H2b: All else held constant, the greater the number H2b: All else held constant, the greater the number of prior alliances that the R&D firm had been of prior alliances that the R&D firm had been involved in, the less likely the alliance is to reach involved in, the less likely the alliance is to reach Phase I clinical trials.Phase I clinical trials.

Theory development & hypothesesTheory development & hypotheses

Deal sizeDeal size

Alliances where the expected payoff is relatively Alliances where the expected payoff is relatively large will lead to greater commitment by alliance large will lead to greater commitment by alliance partnerspartners

In particular, greater commitment suggests that the In particular, greater commitment suggests that the client firm is more likely to continue funding such an client firm is more likely to continue funding such an alliance alliance The initial commitment to maintain relationship can be The initial commitment to maintain relationship can be

viewed as a real option (Kogut, 1991; Mahoney, 2005)viewed as a real option (Kogut, 1991; Mahoney, 2005)

H3: All else held constant, larger the amount of H3: All else held constant, larger the amount of funds committed to the alliance, the more likely the funds committed to the alliance, the more likely the alliance is to reach Phase I clinical trials.alliance is to reach Phase I clinical trials.

Theory development & hypothesesTheory development & hypotheses OversightOversight

R&D firms may be tempted to use research funds from R&D firms may be tempted to use research funds from the client firm to fund projects other than the specified the client firm to fund projects other than the specified ones (Pisano, 1990; Lerner & Malmendier, 2005)ones (Pisano, 1990; Lerner & Malmendier, 2005)

R&D firms may derive private benefits from carrying R&D firms may derive private benefits from carrying marginally beneficial trials forward in early stages (Guedj marginally beneficial trials forward in early stages (Guedj & Scharfstein, 2004)& Scharfstein, 2004)

Direct oversight by the client firm should reduce such Direct oversight by the client firm should reduce such alliances from going forwardalliances from going forward

H4a: All else held constant, oversight by the client firm H4a: All else held constant, oversight by the client firm over the development process will decrease the over the development process will decrease the likelihood of the alliance reaching Phase I clinical trials.likelihood of the alliance reaching Phase I clinical trials.

Theory development & hypothesesTheory development & hypotheses

Milestone paymentsMilestone payments

Client firms fund R&D projects in stages so that Client firms fund R&D projects in stages so that future funding is contingent on performance by the future funding is contingent on performance by the R&D firm (Sahlman, 1990; Noldeke & Schmidt, R&D firm (Sahlman, 1990; Noldeke & Schmidt, 1995; Kaplan & Stromberg, 2004)1995; Kaplan & Stromberg, 2004)

H4b: All else held constant, the presence of H4b: All else held constant, the presence of milestone payments will increase the likelihood of milestone payments will increase the likelihood of the alliance reaching Phase I clinical trials.the alliance reaching Phase I clinical trials.

H4c: All else held constant, the presence of H4c: All else held constant, the presence of milestone payments will increase the likelihood of milestone payments will increase the likelihood of the alliance reaching Phase III clinical trials.the alliance reaching Phase III clinical trials.

Theory development & hypothesesTheory development & hypotheses

Control rights – intellectual propertyControl rights – intellectual property

Well-defined intellectual property rights (i.e., Well-defined intellectual property rights (i.e., property rights on publication of research findings, property rights on publication of research findings, patents, etc.) will make clearer each partner’s gains patents, etc.) will make clearer each partner’s gains from the alliancefrom the alliance

Intellectual property rights become more important Intellectual property rights become more important in the later stages of development (information in the later stages of development (information asymmetry dominates in early stage)asymmetry dominates in early stage)

H5a: All else held constant, well-defined intellectual H5a: All else held constant, well-defined intellectual property rights will increase the likelihood the property rights will increase the likelihood the alliance reaching Phase III clinical trialsalliance reaching Phase III clinical trials

Theory development & hypothesesTheory development & hypotheses

Control rights – manufacturingControl rights – manufacturing

The client firm is a pharmaceutical firm or an The client firm is a pharmaceutical firm or an established biotechnology firm that is fully-integrated established biotechnology firm that is fully-integrated into manufacturing and distributioninto manufacturing and distribution

Manufacturing is an especially critical control right Manufacturing is an especially critical control right because of strict FDA regulations (Lerner & Merges, because of strict FDA regulations (Lerner & Merges, 1998)1998)

Efficient division of innovative labor suggests that the Efficient division of innovative labor suggests that the client firm should control this aspect of the allianceclient firm should control this aspect of the alliance

H5b: All else held constant, the client firm’s control H5b: All else held constant, the client firm’s control over manufacturing will increase the likelihood of the over manufacturing will increase the likelihood of the alliance reaching Phase III clinical trials.alliance reaching Phase III clinical trials.

Theory development & hypothesesTheory development & hypotheses

Alliance managementAlliance management

Compared to early stages of the development process, Compared to early stages of the development process, the financial stakes for later stages are higher (33-42% of the financial stakes for later stages are higher (33-42% of total cost of drug development is spent on Phase III total cost of drug development is spent on Phase III trials), but the technological uncertainty decreasestrials), but the technological uncertainty decreases

The client firm’s capabilities in managing the alliance The client firm’s capabilities in managing the alliance process (collaborating with the R&D firm, dealing with process (collaborating with the R&D firm, dealing with regulatory agencies, etc.) matter more for performance regulatory agencies, etc.) matter more for performance in the later stagesin the later stages

H6: All else held constant, the client firm’s capabilities in H6: All else held constant, the client firm’s capabilities in managing the development process will increase the managing the development process will increase the likelihood of the alliance reaching Phase III clinical trials.likelihood of the alliance reaching Phase III clinical trials.

Empirical resultsEmpirical results DataData

rDNArDNA database (Recombinant Capital) database (Recombinant Capital) SEC filings (10-K, 10-Q, etc.)SEC filings (10-K, 10-Q, etc.) NN = 169, research alliances (dyads only, 1990-1999) that = 169, research alliances (dyads only, 1990-1999) that

were analyzed by Recombinant Capital (contract analyses)were analyzed by Recombinant Capital (contract analyses)

Dependent variables: Dependent variables:

Technological performance (early stage)Technological performance (early stage): conditional on the : conditional on the drug compound having reached drug compound having reached preclinicalpreclinical trials, whether it trials, whether it reached reached Phase IPhase I trials (“success” if Phase I within 3 years) trials (“success” if Phase I within 3 years)

Technological performance (later stage)Technological performance (later stage): conditional on the : conditional on the drug compound having reached drug compound having reached Phase IPhase I trials, whether it trials, whether it reached reached Phase IIIPhase III trials (“success” if Phase III within 5 years) trials (“success” if Phase III within 5 years)

Empirical resultsEmpirical results Independent variables (and control variables)Independent variables (and control variables)

Repeated tiesRepeated ties: number of prior alliances between the two : number of prior alliances between the two alliance partnersalliance partners

Reputation effectsReputation effects: number of prior alliances by the R&D : number of prior alliances by the R&D firmsfirms

Deal sizeDeal size: total estimated dollar amount (including : total estimated dollar amount (including upfront payments, equity investments, loans, milestone upfront payments, equity investments, loans, milestone payments, etc.) that the client firm as agreed to transfer payments, etc.) that the client firm as agreed to transfer to the R&D firmto the R&D firm

MilestonesMilestones: dummy variable of whether the alliance has : dummy variable of whether the alliance has milestone payments specified in the agreementmilestone payments specified in the agreement

OversightOversight: whether : whether board seatsboard seats (on R&D firm’s board) (on R&D firm’s board) and/or and/or joint committeesjoint committees are specified in the agreement are specified in the agreement

Intellectual property rights: Intellectual property rights: whether whether patent rightspatent rights and/or and/or publication policiespublication policies are specified in the agreement are specified in the agreement

Control variables: client firm Control variables: client firm sizesize (sales), (sales), biotech-biotechbiotech-biotech alliance, functional alliance, functional scopescope of alliance of alliance

Early Stages: Preclinical – Phase I Early Stages: Preclinical – Phase I (Panel probit, (Panel probit, NN = 99) = 99)

(1)(1) (2)(2) (3)(3) (4)(4) (5)(5)

Deal sizeDeal size 0.4269*0.4269*

(0.2188) (0.2188) 0.4463*0.4463*

(0.2327) (0.2327) 0.4422*0.4422*

(0.2373) (0.2373) 0.7408*0.7408*

(0.3913) (0.3913) 0.8839*0.8839*

(0.4813) (0.4813)

Reputation Reputation effectseffects

-0.3254*-0.3254*

(0.1701) (0.1701) -0.4112**-0.4112**

(0.2080) (0.2080) -0.4276**-0.4276**

(0.2127) (0.2127) -0.5661*-0.5661*

(0.2950) (0.2950) -0.7424*-0.7424*

(0.4048) (0.4048)

Repeated Repeated tiesties

0.91710.9171

(0.5681) (0.5681) 0.93150.9315

(0.5690) (0.5690) 1.2464*1.2464*

(0.6669) (0.6669) 1.30211.3021

(0.7814) (0.7814)

MilestonesMilestones 0.23660.2366

(0.4024) (0.4024) 0.32380.3238

(0.4720) (0.4720) 0.28380.2838

(0.5217) (0.5217)

Joint Joint committeecommittee

-1.3009*-1.3009*

(0.7024) (0.7024) -1.2853*-1.2853*

(0.7512) (0.7512)

Board Board seatsseats

-1.9612-1.9612

(1.5535) (1.5535)

RhoRho 0.27910.2791

(0.3722) (0.3722) 0.44120.4412

(0.3366) (0.3366) 0.44040.4404

(0.3421) (0.3421) 0.5959**0.5959**

(0.3210) (0.3210) 0.7045**0.7045**

(0.2630) (0.2630)

Log Log LL -58.2820 -58.2820 -56.6391 -56.6391 -56.4626 -56.4626 -53.3178 -53.3178 -51.7303 -51.7303

Wald chi-sqWald chi-sq 5.66 5.66 6.19 6.19 6.14 6.14 5.78 5.78 4.80 4.80

Later Stages: Phase I – Phase III Later Stages: Phase I – Phase III (Panel probit, (Panel probit, NN = 70)= 70)

(1)(1) (2)(2) (3)(3)

Publication policyPublication policy 0.8899*0.8899*

(0.5133) (0.5133)

PatentsPatents 0.45260.4526

(0.7103) (0.7103)

Client Client manufacturingmanufacturing

1.0207*1.0207*

(0.6033) (0.6033) 1.0284*1.0284*

(0.5651) (0.5651)

MilestonesMilestones 1.0498*1.0498*

(0.5832) (0.5832)

RhoRho 0.6563**0.6563**

(0.2468) (0.2468) 0.6911***0.6911***

(0.2095) (0.2095) 0.6350***0.6350***

(0.2187) (0.2187)

Log LLog L -42.7177 -42.7177 -42.0969 -42.0969 -40.62994 -40.62994

Wald chi-sqWald chi-sq 4.10 4.10 4.39 4.39 6.23 6.23

*p < 0.10, **p <0.05, ***p < 0.01*p < 0.10, **p <0.05, ***p < 0.01

Empirical resultsEmpirical results First model (early stages): Preclinical to Phase IFirst model (early stages): Preclinical to Phase I

Repeated ties: Repeated ties: inconclusiveinconclusive

Reputation effects: Reputation effects: negative negative impact on performanceimpact on performance Consistent with Pisano’s (1997) “lemons” hypothesisConsistent with Pisano’s (1997) “lemons” hypothesis Different specifications (past alliances in same technology area only, Different specifications (past alliances in same technology area only,

past research alliances only) are also negativepast research alliances only) are also negative

Deal size: Deal size: positivepositive (supported) impact on performance (supported) impact on performance

Direct oversight: Direct oversight: partially supported partially supported Only joint committees negatively impacts performanceOnly joint committees negatively impacts performance

Unobservable attributes of client firm (Unobservable attributes of client firm (rhorho) from panel probit ) from panel probit model: model: mixedmixed results results Mixed results of the impact of unobserved individual client firm Mixed results of the impact of unobserved individual client firm

characteristics on performancecharacteristics on performance Client-firm effects seem to be weak, but presentClient-firm effects seem to be weak, but present

Empirical resultsEmpirical results Second model (later stages): Phase I to Phase IIISecond model (later stages): Phase I to Phase III

Milestones: positive (supported) impact on performanceMilestones: positive (supported) impact on performance Incentives in the form of milestone paymentsIncentives in the form of milestone payments

Property rights: partial supportProperty rights: partial support Publication policy clause has positive impact on performance, Publication policy clause has positive impact on performance,

but patent clause is not supportedbut patent clause is not supported

Control over manufacturing by client firm: positive Control over manufacturing by client firm: positive (supported) impact on performance(supported) impact on performance Division of innovative labor where the client firm has more Division of innovative labor where the client firm has more

expertiseexpertise

Unobservable attributes of client firm (Unobservable attributes of client firm (rhorho) from panel ) from panel probit model: supportedprobit model: supported Stronger support in second model of unobservable client firm-Stronger support in second model of unobservable client firm-

effects, suggesting the importance of alliance management effects, suggesting the importance of alliance management capabilities on the part of the client firmcapabilities on the part of the client firm

ConclusionsConclusions

Overall, as level of uncertainty inherent in the Overall, as level of uncertainty inherent in the alliance setting changes, different variables alliance setting changes, different variables seem to impact performance in different waysseem to impact performance in different ways

Data suggest information asymmetry as key Data suggest information asymmetry as key driver in early stagesdriver in early stages

R&D firms are inherently optimistic about the R&D firms are inherently optimistic about the prospects of their products and client firms that are prospects of their products and client firms that are able to best mitigate possible opportunism resulting able to best mitigate possible opportunism resulting from asymmetric information seem to have better from asymmetric information seem to have better alliance performancealliance performance

ConclusionsConclusions

In later stages where alliances are in Phase I In later stages where alliances are in Phase I clinical trials, how the alliance is managed clinical trials, how the alliance is managed seems to be more importantseems to be more important

Data suggests well-defined property rights and Data suggests well-defined property rights and division of innovative labor, which are aspects of division of innovative labor, which are aspects of alliance management, are important for alliance management, are important for performanceperformance

Also, unobservable client firm effects are strong in Also, unobservable client firm effects are strong in later stages suggests that client firm heterogeneity later stages suggests that client firm heterogeneity (which may include alliance management (which may include alliance management capabilities) also partially account for variations in capabilities) also partially account for variations in alliance performancealliance performance