Title: Contracting on Product-Development in the Biotech Industry 

Abstract:  So-called "co-development" partnerships are common in the biotech industry. In 
these partnerships, a (typically small) biotech company agrees to split profits, from the 
eventual sale of a product it is developing, with a (typically large) pharmaceutical company 
in return for "milestone" payments made as the development project progresses. A defining 
feature of the biotech industry is that such projects need not result in a viable product; 
there is a significant random component to success.  In this paper we propose a model for 
the dynamics of such co-development partnerships. Our model builds on a continuous-time 
principal-agent model developed by Sannikov. We incorporate a random success component in 
the model. We are able to reduce the analysis of this model to a problem in differential 
equations that can be solved numerically. Using this approach, we obtain not only descriptive 
results, such explaining which biotechs prefer such partnerships, but also prescriptive 
results, such as the optimal contract from the pharmaceutical company's perspective.    

  

Joint work with Xingwen Zhang, Graduate School of Business, Stanford University