Find and Replace: R&D Investment Following the Erosion of Existing Products

How do R&D-intensive firms react to negative shocks to their existing products? We explore this question using detailed project-level data from drug development firms. Using FDA Public Health Advisories as an exogenous and idiosyncratic negative shock to approved drugs, we examine how firms and their competitors react in terms of their R&D investment and financing decisions. We document that these negative shocks lead affected firms to increase R&D expenditures, financing this with debt. In terms of investment behavior, these shocks increase the likelihood of affected firms acquiring drugs projects from other firms, rather than developing new projects internally. We also find evidence of spillover effects, indicating that other firms in the industry learn about their own project prospects after competitors experience advisory shocks. Rather than turning to external acquisitions, these competing firms appear to re-shuffle their own drug portfolios--moving resources away from the affected therapeutic area and into more exploratory projects.