Paper Spotlight: Sharing R&D Risk in Healthcare via FDA Hedges

Adam Jørring

Andrew W. Lo

Tomas J. Philipson

Manita Singh

Richard T. Thakor














Recent estimates suggest that the cost of developing a single new drug in the biopharmaceutical sector is $2.6 billion, confirming the very large amounts of money that medical companies invest to develop a new treatment. Biomedical companies also face the risk of very low rates of success, not only due to the inherent scientific risk of developing new drugs, but also due to the risk of the Food and Drug Administration’s (FDA) regulatory approval process. The question that ought to be asked is what financial markets can do to promote more efficient risk sharing in the healthcare and drug development areas from which our societies can benefit. This is the question investigated by Adam Jørring, Andrew Lo, Tomas Philipson, Manita Singh, and Richard Thakor in their paper “Sharing R&D Risk in Healthcare via FDA Hedges.” They address the problem highlighted by many in the medical fields that investors are unwilling to provide financing due to these risks, resulting in a “funding gap” and underinvestment in biomedical R&D that causes many potentially valuable drugs either not being realized or not pursued beyond a certain stage. The authors propose a new form of financial instrument, FDA hedges, which allow biomedical R&D investors to share the pipeline risk associated with the FDA approval process with capital markets. Such instruments are shown to avoid the market failure that leads to an R&D “funding gap.” Using FDA approval data, the authors discuss the pricing of FDA hedges and mechanisms by which they can be traded and use novel panel dataset of FDA approval probabilities to explore the risks inherent in these contracts. The paper finds evidence that the risk associated with FDA hedges is mostly idiosyncratic, and argue that these instruments are appealing to both investors and issuers. Ultimately, FDA hedges should accelerate the development of new biomedical products by providing the necessary funding to support such risky projects, and will undoubtedly improve the health of countless patients. The significant social welfare implications are very clear for all of us.

Spotlight by Andrew Ellul
Photos courtesy of Adam Jørring, Andrew W. Lo, Tomas J. Philipson, Manita Singh, and Richard T. Thakor
First published December 10, 2021

RCFS Award Winners at the Cavalcade

Photos from the SFS Cavalcade are now available on the conference website.

Paige Ouimet and Elena Simintzi, Best Paper winners, with Executive Editor Andrew Ellul

Paige Ouimet and Jesse Davis, Best Registered Report winners, with Editor Isil Erel

Ashleigh Eldemire, Best Registered Report winner, with Editor Camelia Kuhnen

Michael D. Wittry, Rising Scholar winner, with Editor Camelia Kuhnen

Jessica Jeffers, Referee of the Year, with Editor Isil Erel

Best Paper Awards at CSEF-RCFS Conference on Labor, Finance, and Inequality

The winners of the best paper awards at the CSEF-RCFS Conference on Finance, Labor, and Inequality are:

“Owner Culture and Pay Inequality within Firms,” by Jan Bena, Guangli Lu, and Iris Wang

“Can the Unemployed Borrow? Implications for Public Insurance,” by J. Carter Braxton, Gordon Phillips, and Kyle Herkenhoff

“Early exposure to entrepreneurship and the creation of female entrepreneurs,” by Mikkel Baggesgaard Mertz, Maddalena Ronchi, and Viola Salvestrini

The program is available here. Congratulations to the winners!

Paper Spotlight: Optimal Capital Structure with Imperfect Competition

Alexei Zhdanov

Egor Matveyev

Why do firms in the same industry often have different leverage levels? In their paper “Optimal Capital Structure with Imperfect Competition,” Egor Matveyev and Alexei Zhdanov show that strategic interaction alone can generate this difference. The authors first exhibit a theoretical model in which two ex ante identical firms are deciding when to enter an industry and also how much debt to issue. The product price depends both on the aggregate quantity and on a stochastic shock to the demand curve. In the overall equilibrium of the model, one firm (which becomes an incumbent) enters in a relatively low demand state with a correspondingly low amount of debt. The second firm, the new entrant, enters the industry in a high demand state, and with more debt than the incumbent. Thus, not only do ex ante identical firms in the industry have different leverage levels, but a sharper prediction emerges: Younger firms are more levered than older ones. As a result, younger firms are more likely to fall into financial distress. Further, the dispersion in leverage naturally relates to industry features such as cash flow volatility, tax rate, and bankruptcy costs. The authors then test these predictions on U.S. public firms. Indeed, as predicted by the model, leverage is negatively correlated with firm age, and firms that go bankrupt tend to be younger. To study leverage dispersion, they construct pairs of firms that are close rivals within each industry, and find that leverage dispersion is positively related to cash flow volatility, and negatively to tax rates and asset tangibility. Overall, the empirical results support the idea that strategic interaction is an important driver of differences in leverage.

Spotlight by Uday Rajan
Photos courtesy of Egor Matveyev and Alexei Zhdanov
First published February 4, 2022

Tiered Submission Fees

As part of our continued effort to increase access for authors worldwide, the SFS is implementing tiered submission fees for our journals. Authors who reside in middle-income economies will be eligible to pay a reduced submission fee and authors who reside in low-income economies will be eligible for a fee waiver. While our journals have always offered some waivers for economic hardship, we have now formally defined the waiver options to increase transparency.