Interfirm Collaboration, Ownership Stakes, and Incomplete Contracts: Evidence from the Pharmaceutical Industry

Part of the Lubar Research Seminar Series

Speaker:  Yianni Floros, Lubar College of Business, University of Wisconsin – Milwaukee

If contracts are incomplete, ownership stakes between collaborating firms can help align incentives and mitigate the costs of potential future conflicts. Using the unique institutional setting of the pharmaceutical industry, we construct hypotheses that relate the complexity of the contracting environment to the use of equity stakes. Using a sample of collaborations between pharmaceutical firms and detailed drug (project) and firm-level data, we find overwhelming support for our hypothesis. We construct precise drug level measures of competition and find equity stakes are more likely when competition is greater. We explore the contract features of the equity stake agreements and find frequent use of control terms. Last, we document that stock market reactions to the announcements of contracts with equity average 8% compared to 3% for those without equity.