Pharmaceutical regulation and innovative performance: a decision-theoretic model

Tannista Banerjee and Stephen Martin ()

No auwp2013-21, Auburn Economics Working Paper Series from Department of Economics, Auburn University

Abstract: In this paper we develop a model of the impact of the drug approval process on the terms of a contract between a pharmaceutical company that requires the services of a contract research organization (CRO) to carry out testing of new drug molecules. Results show that if the equilibrium contract includes a variable payment (royalty), the CRO gives more effort to create a more accurate result, the more strict the FDA approval process. We also find that given the royalty shares in the contract if the FDA demands more accuracy in results as a condition of approval, then the CRO will generate more accurate results from late stage tests. However, greater FDA stringency in the approval process benefits pharmaceutical companies because the greater is FDA stringency, the less is the risk of a drug recall. We also find that in order to employ a CRO in the testing process, the pharmaceutical company's prior probability that the drug is of high quality must be very high.

Keywords: Pharmaceutical regulation; Food and Drug Administration; R&D outsourcing; contract research (search for similar items in EconPapers)
JEL-codes: L24 L65 (search for similar items in EconPapers)
Date: 2013-11
New Economics Papers: this item is included in nep-com, nep-hea, nep-ind and nep-ino
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