During the past three decades, the pharmaceutical industry has increased its reliance on incremental innovation to drive growth. This change in conduct reflects the industry’s response to a series of changes that has impacted negatively the return on its research and development investment. This dissertation examines the relationship between these changes in conduct and financial performance. First, the structure-conduct-performance paradigm and the resource-based theory of competitive advantage are referenced to establish the basis for the dynamics of change at industry and firm levels. Then, a value relevance model is defined to study the relationship between the change in innovative focus and the change in financial performance.
This research studies the brand-name pharmaceutical industry from 1980 to 2009. Data to study the relationship between innovative focus and performance are compiled from three sources. Financial data are drawn from Standard & Poor’s Compustat database and firms’ annual reports. Data to operationalize innovative focus are acquired from the United States Food and Drug Administration’s Drugs@FDA database. The value relevance model defined for this research is evaluated using time series and pooled time series approaches.
The results confirm the pharmaceutical industry’s innovative focus changes significantly during the period studied. The change in innovative focus significantly drives change in financial performance. Closer analysis of strategic change at the firm level reveals some firms increase their focus on incremental innovation while others do not. Financial performance changes only for the firms that increase their focus on incremental innovation. In the long run, the financial performance of the firms that change strategy by increasing their focus on incremental innovation exceeds that of the firms that do not.
This research contributes to the value-relevance literature by examining allocation of the research and development investment, rather than the magnitude of the investment, and its role in driving financial performance. The results from this research have important implications for managers as they set new-product portfolio strategy to drive superior financial performance for their firms.