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Disruptive innovation and R&D ownership structures

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Abstract

This paper provides a theoretical explanation as to why breakthrough innovations seem to be possible only within capitalist economies (Kornai in Dynamism, rivalry, and the surplus economy: Two essays on the nature of capitalism, Oxford University Press, Oxford, 2013). Specifically, our theory explains why disruptive innovations are discovered and financed by large numbers of independently owned small firms in capitalist economies rather than in socialist economies where state ownership is the only option. The key is that the ownership structure of the firm affects the ex-post selection of worthwhile discoveries, which determines the fate of disruptive innovation. Our paper also contributes to empirical work on disruptive innovation, which is missing in the literature. We use new molecular entities (NMEs) in the pharmaceutical industry as a proxy for disruptive innovation. Although pharmaceutical companies are often very large, their R&D projects greatly depend on forming alliances with much smaller independent firms. We find that the number of NMEs discovered by pharmaceutical companies is positively and significantly associated with the number of R&D alliances in which they participate. Our theory is supported by the empirical findings.

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Notes

  1. We adopt Kornai’s (1992) definition of socialism as an economy where state ownership dominates. Because the state is the sole owner and controls state firms, no clear boundary between the state and the firm exists in socialism. According to that definition, Western welfare states are not socialist.

  2. We are aware of the problems of the bureaucracy and deficiencies of the FDA, which affect the quality of the drugs approved by them. For example, Klein and Tabarrok (2002) report inefficiencies and delays caused by the FDA. Lasser et al. (2002) document other deficiencies of the FDA. The inefficiency and inaccuracy of the FDA is equivalent to introducing type I and type II errors into our variable and lower the accuracy of NMEs as a proxy of disruptive innovation in drug R&D. However, these problems do not substantially affect disruptive innovation of new drugs in the US (to be discussed in Sect. 4.1). We thank the editor and a referee for suggesting the related literature.

  3. Owing to their inability to invent NMEs, Russia and China rely heavily on the import of pharmaceuticals, and their domestically produced drugs typically are made from imported ingredients.

  4. The private benefit received by an entrepreneur at different project dates includes present and future material and nonmaterial gains, such as perks and reputation.

  5. In the very early stages, particularly with regard to basic research, high-tech R&D projects often are funded by the US government through the National Science Foundation (NSF), the National Aeronautics and Space Administration (NASA) and the National Institutes of Health (NIH). Regardless of the source of financing, selection mechanism, such as the one we study here, is a key factor determining R&D outcomes.

  6. The total number of patents granted to the class “Drug, bioaffecting, and body treating compositions” (i.e., CCL/424 or CCL/514) between 1 Jan 1998 and 31 Dec 2018 was 144,385 (https://www.uspto.gov/). That is, the average annual number of patents granted closely related to drug development during our study period was 6875. Some other CCLs, such as CCL/435 (Chemistry: molecular biology and microbiology) or CCL/436 (Chemistry: analytical and immunological testing), are not included because those categories sometimes cover things other than drug development. Hence, we understate the total number of drug development patents in general.

  7. https://www.fda.gov/drugs/new-drugs-fda-cders-new-molecular-entities-and-new-therapeutic-biological-products/new-drug-therapy-approvals-2019.

  8. All statistics are sorted based on the information from CapitalIQ, a financial database constructed by Standard and Poor’s.

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Acknowledgements

We thank Prof. Eric Maskin for his generous help on an early version of the present paper; Prof. William Shughart II and two anonymous referees for helpful comments and suggestions; and Mr. Zhongming Shi and Ms. Cindy Tian for their skilled research assistance. Chenggang Xu acknowledges support from the CKGSB and the hospitality of Corvinus University of Budapest, Imperial College London, and LSE. The views and errors are those of the authors, and they do not necessarily reflect those of their affiliated institutions.

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Authors and Affiliations

  1. Business School, Brunel University London, Kingston Lane, Uxbridge, UB8 3PH, UK

    Di Guo

  2. China International Capital Corporation, 25/F and 29/F One International Finance Centre, 1 Harbour View Street, Central Hong Kong, Hong Kong

    Haizhou Huang

  3. Business School, University of Nottingham, North Building, Jubilee Campus, Wollaton Road, Nottingham, NG8 1BB, UK

    Kun Jiang

  4. Cheung Kong Graduate School of Business, Oriental Plaza 2/F, Tower E2, 1 East Changan Ave., Beijing, 100738, China

    Chenggang Xu

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  1. Di Guo
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Correspondence to Chenggang Xu.

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Guo, D., Huang, H., Jiang, K. et al. Disruptive innovation and R&D ownership structures. Public Choice 187, 143–163 (2021). https://doi.org/10.1007/s11127-020-00850-1

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