An empirical analysis of strategic contracts

Abstract

This article investigates the use of strategic contract clauses such as most-favored-customer clauses, rights of first refusal, rights of first offer, first negotiation rights in bio-tech R&D contracts between pharmaceutical firms and bio-tech agents. It is shown that these strategic rights are more likely adopted when potential entry threat from other pharmaceutical firms are larger. This result is consistent with the prediction from the literature: strategic contracts can increase the joint benefit of contracting parties by extracting rent from entrants and/or protect investments by contracting parties. Furthermore, strategic rights and termination rights held by pharmaceutical firms are shown to be substitutes, and the level of substitution is affected by the uncertainty of the R&D activities involved and the previous relationship between contracting parties. These results can be explained by a multi-task theory where bio-tech agents allocate effort between R&D activities specified in contracts and non-contracted R&D activities.