Portfolio Management in New Drug Development - Innovation and Marketing in the Pharmaceutical Industry - page 110

significant information about the drug portfolio of the target firm, and appropriately
value their worth thereby avoiding the “winner's curse.”

3.4.4 Incentive Design

Incentives affect how organizational strategies are carried out by the people tasked
with execution: managers and scientists. Most pharmaceutical firms have a hierar-
chical structure with a Chief Technology Officer reporting to the CEO, and a further
hierarchy within the R&D organization. Given the multilevel organization,
misaligned incentives can result between strategists designing R&D portfolios, and
the executors, or even for the strategists themselves.
Manso ( 2011 ) examines the problem of how to motivate riskier innovation proj-
ects using a principal-agent setting and finds that substantial tolerance (or even
reward) for early failure and reward for long-term success is needed for agents (such
as managers or scientists) to explore riskier options. If short-term success is
rewarded, then agents are more inclined to choose safer options (i.e., those which
can lead to incremental innovations). In publicly held firms, a real tension exists
between the short-term financial results expected by investors and the need for long-
term investment to provide future growth opportunities for the firm. Manso's work
suggests that incremental innovations could arise endogenously due to incentives.
Thus, firms need to ensure that those responsible for strategic choices and executing
on them are rewarded appropriately for their decision making, especially in the high
risk world of new drug portfolios.
Chao et al. ( 2009 ) examine the incentive problem for managers allocating
resources between incremental and radical innovation projects, as a function of
funding authority. When funding is variable (i.e., manager can use revenue from
existing product sales to fund NPD efforts), the manager is induced to focus on
incremental rather than radical innovation. However, variable funding results in
overall higher effort towards both types of innovation as compared to fixed funding.
These authors also point out a substitution effect between explicit incentives in the
form of compensation and implicit incentives (i.e., career concerns). Thus, pharma-
ceutical firms should carefully consider the implications of how R&D programs are
funded.
There is a growing body of work relating to incentives for portfolio managers.
Szydlowski ( 2012 ) focuses on a situation where a firm chooses how to allocate
funding for a portfolio of projects, and a manager is responsible for multitasking
across these projects. This is a commonly arising scenario in R&D departments
where a person may be responsible for multiple projects. Szydlowski ( 2012 ) sug-
gests that performance-related bonuses at the project level lead to more optimal
managerial behavior than issuing firm-level equity in the form of shares. Care is
therefore needed in designing incentives so that managers will undertake the right
amount of effort in the right projects at the right time.