A Road Untaken: What Makes Entrepreneurs Promote Breakthrough Innovation?

This paper examines the strategic conditions that drive entrepreneurial innovators to pursue novel innovation rather than innovation that is closer to existing technologies. To an increasing extent, startups commercialize innovation in a cooperative setup. Because radical breakthrough innovation is more difficult to communicate than its incremental counterpart, entrepreneurial innovators may avoid breakthrough innovation for which the cost of developing credible information is exceedingly high. In the context of the Orphan Drug Act (ODA), this study uses a difference-in-difference approach to measure whether entrepreneurs are more likely to bring novel innovations to the market when the policy change unexpectedly lowers the cost of obtaining information that will convince investors through a small market test. Using a new measure of the novelty of innovation and a detailed panel dataset of therapeutic molecules, this empirical study finds that biotech startups bring more breakthrough drugs to markets affected by ODA. This research also finds that in ODA-affected areas, entrepreneurs are more likely to make partnerships with pharmaceutical partners, but the timing of the partnership is delayed to the advanced development stage for startups to create credible evidence of novel drugs. Taken together, the results of this study suggest that the cost of convincing investors prevents entrepreneurs from marketing novel innovation and that a public policy can moderate inefficiency in the “market for ideas” by decreasing the information friction.