Why trash does not pass? Pharmaceutical licensing and safety performance of drugs

Objectives: This paper examines how asymmetric information in pharmaceutical licensing affects the quality of licensed drugs. Pharmaceutical companies often license potential drug molecules at different stages of drug development from other pharmaceutical or biotechnology companies and complete the remainder of the research stages before submitting the new drug application (NDA) to the Food and Drug Administration. The asymmetric information associated with the quality of the licensed molecules can result in a lesser number of good potential molecules being licensed out while those with greater potential, are developed internally.

Data: We identify the New drug applications (NDAs) submitted between 1993 and 2004 where the new molecular entities (NMEs) were acquired through licensing. Controlling for other drug area specific and applicant firm specific factors, we investigate whether the drugs developed with licensed molecules face a higher probability of safety based recall and ultimate withdrawal from the market than drugs developed internally.

Results: Results suggest the opposite of Akerlof’s (1970) lemons problem. Licensed molecules rather have a lower probability of facing safety based recalls and ultimate withdrawal from the market compared to internally developed drug molecules. This suggests that biotechnology and small pharmaceutical firms specializing in pharmaceutical research are more efficient in developing good potential molecules because of their concentrated research. These firms license out good potential molecules because it increases their market value and reputation.  In addition, results suggest that the number of previous approved drugs in the disease area and the applicant firms’ previously approved drugs reduce the probability that an additional approved drug in the same drug area will potentially be harmful.