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Review of Finance Vol. 30 No. 4 2026

Paying off the competition: contracting, market power, and innovation incentives

Xuelin Li1; Andrew W. Lo2,3,4; Richard T. Thakor3,5

1 Finance Division, Columbia Business School , 665 W 130th St , New York, NY, 10027, · 2 Finance Department, MIT Sloan School of Management , 100 Main St , Cambridge, MA, 02142, · 3 Laboratory for Financial Engineering, Massachusetts Institute of Technology, Cambridge, MA, 02142, · 4 Computer Science and Artificial Intelligence Laboratory, Massachusetts Institute of Technology, Cambridge, MA, 02142, · 5 Finance Department, University of Minnesota, 321 S 19th Ave S, Minneapolis, MN, 55455,

Abstract

This article explores the relationship between a firm’s legal contracting environment and its innovation incentives. Using granular data from the pharmaceutical industry, we examine a contracting mechanism through which incumbents maintain market power: “pay-for-delay” agreements to delay the market entry of competitors. Exploiting a shock where such contracts become legally tenuous, we find that affected incumbents subsequently increase their innovation activity across a variety of project-level measures. Exploring the nature of this innovation, we also find that it is more “impactful” from a scientific and commercial standpoint. The results provide novel evidence that restricting the contracting space can boost innovation at the firm level. However, at the extensive margin we find a reduction in innovation by new entrants in response to increased competition, suggesting a nuanced effect on aggregate innovation.

DOI
10.1093/rof/rfaf030
Volume
30
Issue
4
Pages
1261-1293
Language
en
Sources
openalex crossref

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