Do Firms Skimp on Quality in Competitive Markets? Evidence from Drug Manufacturing

Policy makers generally support reducing competition in order to encourage innovation through intellectual property protection such as patents, but after patent expiration, policy makers generally promote intense competition. A simple model suggests that encouraging competition could reduce quality, if firms earning low margins are more willing to risk the regulatory penalties causing market exit. Using pharmaceutical industry data from 1999 to 2017, we find that manufacturers in competitive markets (i.e., generic manufacturers) have more regulatory warning letters than firms in less competitive markets (i.e., brand-name manufacturers). We also find that warning letters leapt after an exogenous increase in monitoring of foreign facilities. Foreign manufacturers of generic drugs were more likely to have a detected violation than others. Finally, we find evidence that if regulatory monitoring increases, entry decreases. We describe policies under consideration that would increase competitive pressure and advise that policy makers should reduce the competitive pressure and/or increase monitoring.