Mergers and innovation in the Pharmaceutical Industry

Professor Carmine Ornaghi led research into the potential detrimental effects of mergers and acquisitions (M&As) on research and development expenditure and innovation output in the pharmaceutical industry. This has informed and shaped merger enforcement policies of the European Commission (EC), leading to a closer scrutiny of recent merger deals and the adoption of more stringent EC remedies.

Prof Ornaghi’s research challenges the widely-held claims that M&As can unlock knowledge synergies in research and development among the research teams of acquirers and targets and calls into question the benefit of such deals for consumers.

Research by pharmaceutical firms is a driver of medical advancements and well-being. Over the last three decades the pharma industry has been shaped by a substantial number of mergers and acquisitions. Many of the world’s biggest drug companies, such as Pfizer and GlaxoSmithKline, have been built through a succession of consolidations.

Prof Carmine Ornaghi started to investigate the effects of these acquisition deals on the innovation of pharmaceutical firms during his PhD thesis in 2004. The effects of these acquisition deals on R&D efforts and innovation output of the firms had received little attention by academics and competition authorities.

Matching financial data on R&D expenditure with patent data of pharmaceutical firms, Prof Ornaghi’s research aimed at assessing the causal effects of mergers on early-stage innovation. He compared the research of merged firms to a control group of non-merging firms. A robust finding from his research was that on average, mergers do not generate synergy of knowledge and innovation. Instead, such deals may even have a detrimental effect on incentives to innovate.

Further findings showed that acquirers are more likely to target firms with similar technology or drug portfolios, and higher technology relatedness of merging firms is negatively correlated with their post-merger R&D investments. As a result, several mergers may not only contribute to higher prices of marketed drugs, but also less incentives to develop new treatments. 

Prof Ornaghi is still doing active research on the effect of M&As on innovation in the Pharmaceutical sector. In his latest study based on inventor-level data, he finds that the post-merger decrease in patenting observed using firm-level data, is linked to two factors:

• There is a halt in the research activity of certain scientists, indicating a loss of human capital due to inventors' exits.
• There is also a migration of inventors from target firms to other research labs, indicating a reallocation of human capital to possibly less productive activities.

Prof Ornaghi’s findings were recognised by the European Commission (EC): the Chief Economist of the Directorate-General for Competition described his initial article as “one of the very few (if not the only) papers which were addressing the question of the effects of mergers on innovation”.

Over the last few years, the EC has taken a more rigorous stance on assessing the effects of mergers on innovation, in line with the findings by Prof Ornaghi’s research. Most notably, the 2017 Dow/Dupont merger and the 2018 Bayer/Monsanto merger, two of the largest deals within recent years, were cleared after imposing remedies worth billions of Euros to remove problematic overlapping between the parties

Based on his papers on mergers and innovation, Prof Ornaghi was asked by senior officials at the EC Directorate-General for Competition to act as an academic advisor for their 2017 feasibility study on the microeconomic impact of enforcement of competition policies on innovation. 

In this advisory capacity, Prof Ornaghi worked with a selected small group of economists to define a methodology in order to retrospectively evaluate the impact of mergers on innovation.

 Prof Ornaghi has also worked as academic advisor on a second EC research project between 2018 and 2019, “Study on the impact of mergers and acquisitions in the Pharmaceutical Industry”, the outputs from which were circulated widely within the relevant Directorates-General within the EC.

More recently, Prof Ornaghi was invited to the round table on "The Future of Pharmaceuticals: Examining the Analysis of Pharmaceutical Mergers" organized by the (US) Federal Trade Commission in collaboration with the (EU) Directorate General for Competition and the (UK) Competition and Markets Authority and he has also discussed and presented his work to economists working at the DG Comp and CMA.

Innovation is a key driver of firms’ productivity increase, product quality improvements and economic growth more generally. Mergers can play an important role in fostering or supressing innovation. Prof Ornaghi’s research shows that, in the pharmaceutical industry, mergers are often associated with a significant decrease in R&D expenditures and in patent output coupled with a significant reduction of human capital due to the exit and departure of scientists. These dynamics are responsible for a substantial loss in social welfare, to the extent that these scientists could have produced new knowledge instrumental for the development of more cost-effective treatments.