Melissa Newham reviews how investors can alter the incentives and behavior of pharmaceutical companies to reduce competition and consumer welfare through common ownership and “rollup” deals.
This article is part of a series that explores how private equity reduces competition in the United States healthcare sector and the ways in which enforcers can respond. You can read the rest of the series as it is published here.
Access to affordable medicines is essential for the well-being of society. The pharmaceutical industry, alongside academic institutions and non-profit organizations, plays a crucial role in undertaking research and development (R&D) that yields innovative new treatments. Through drug discovery, manufacturing and price-setting, the industry drives accessibility to both branded and generic drugs. A well-functioning pharmaceutical industry is thus a key priority for many governments.
However, most major pharmaceutical firms are not state-owned (exceptions include the China National Pharmaceutical Group). Instead, they are structured as corporations owned by shareholders. The largest shareholders in public pharmaceutical companies, as in all public companies, are typically institutional investors, including pension funds, asset managers, and sovereign wealth funds. Private companies are owned by a smaller group of shareholders, which may include founders, venture capitalist firms and private equity firms.
While investors differ along dimensions, such as their risk appetite, management style, investment time horizon and industry knowledge, they all provide capital with the expectation of financial returns. Investors often influence corporate decision-making—driving managers to maximize shareholder value, which in turn affects business decisions, such as which drugs to develop, where and how to manufacture drugs, and how to set prices.
Given that investors and governments sometimes have conflicting objectives when it comes to the provision of medications, regulation plays a crucial role in this industry. One way in which governments intervene is through antitrust policies designed to maintain competitive markets. However, investors’ acquisitions of pharmaceutical firms often escape regulatory review due to the government’s focus on horizontal mergers between competitors, filing thresholds, complex deal structures and legal exemptions.
As this article argues, changes to a firm’s financial ownership structure have the potential to undermine competition, which in turn reduces consumer welfare. In particular, common ownership among rivals and “rollup” deals of smaller pharmaceutical firms by private equity provide strong reasons for antitrust authorities to increase their scrutiny of changes to firms’ ownership structures.
The pharmaceutical industry attracts a diverse set of financial investors
The pharmaceutical industry attracts a diverse set of financial investors who provide capital at different stages of the drug-development lifecycle—from early-stage R&D through clinical trials and regulatory approval, to product launch and commercialization.
In the early stages of drug development, venture capitalists (VCs), often armed with deep industry expertise, make high-risk investments in biotech startups and emerging pharmaceutical companies. According to one study, VCs make up 10% ($30 billion in 2020) of total global investments in R&D in the pharmaceutical industry. As products progress beyond the early phases and their risk uncertainty begins to diminish, private equity (PE) and other institutional investors come into the picture.
Historically, private equity has focused on acquiring more mature companies with launched branded or generic products rather than firms focused on R&D. However, PE firms are increasingly investing in small biotech firms and/or partnering with big biopharma to develop specific drug candidates. Royalty financing schemes, in which an investor provides an upfront fixed payment in return for percentage of future returns, allow PE firms to selectively invest in promising late-stage drug development projects rather than acquiring entire firms.
Unlike mergers between pharmaceutical companies, deals involving financial investors often escape regulatory scrutiny
While mergers between pharmaceutical firms routinely undergo regulatory scrutiny, for multiple reasons, acquisitions by large financial investors often evade such review. Competition policy primarily targets horizontal mergers that combine direct competitors—an approach justified by the fact that such mergers necessarily remove an independent rival from the market. In contrast, when investors acquire stakes in a company, the target generally continues to operate, albeit under modified ownership. Additionally, competition authorities typically review deals that surpass certain thresholds based on firm revenues or transaction size, meaning that many smaller transactions—such as VC or PE investments in startups and many biotech companies, as well as non-controlling or minority stake acquisitions—fly under the radar of competition authorities.
Moreover, sophisticated investors may strategically structure their deals, for example by splitting acquisitions across different investment vehicles, to stay below the thresholds that would trigger an in-depth merger review. Opaque and layered holding structures (as is often the case in PE) make it difficult to know who the ultimate owner is and which other, potentially competing, corporations an investor owns stakes in. Finally, acquisitions made purely as a financial investment, which do not confer control, are generally exempt from merger control under the Hart-Scott-Rodino Act.
Acquisitions by financial investors that create common ownership links between firms can harm competition
Acquisitions by financial investors that create common ownership links can dampen firms’ incentives to compete.Common ownership occurs when investors hold (partial) stakes in multiple firms. Economic theory shows that if common ownership leads firms to maximize their shareholders’ portfolio values, then firms with the same investor (or set of investors) have weaker incentives to aggressively compete with each other.
Common ownership is particularly prevalent in the pharmaceutical industry. In early-stage drug development, VCs frequently create ownership links among small biotech startups. In fact, a recent study by Xuelin Li, Tong Liu, and Lucian Taylor documents that 39% of biopharma startups in their sample share a VC investor with a close competitor. Their study finds that when one VC-backed firm’s drug shows promise in clinical trials, competing projects at commonly held firms are more likely to be halted. While consolidation of resources into a single “winning” drug candidate may reduce duplicative R&D expenditures and improve innovation efficiency, it can also diminish product variety and lower market competition, ultimately driving up drug prices.
Common ownership is also prevalent between large, publicly listed pharmaceutical firms. However, in these firms ownership links are created by large institutional investors, such as BlackRock, Vanguard and State Street. Although these investors each typically own only 5–7% of a company, mounting evidence suggests that they actively engage with management and boards with a view to shape long-term strategies. Moreover, Miguel Antón, Florian Ederer, Mireia Giné, and Martin Schmalz show in their research that managerial compensation schemes can serve as a mechanism that connects common ownership to softer competition.
Focusing on pharmaceutical markets, my recent research with Jo Seldeslachts and Albert Banal-Estañol indicates that higher levels of common ownership between generic and brand firms can reduce generic entry. Relatedly, Jin Xie and Joseph Gerakos find that brand firms are more likely to pay generic firms to stay out of the market of their patent-protected drug (in what are called pay-for-delay settlements) when they share an institutional investor. Combined, this research provides evidence that common ownership links among rival firms can soften competition.
Rollup deals, often initiated by PE investors, create consolidated markets
Another way investors may harm competition is by orchestrating “rollup” deals. A rollup deal occurs when an entity acquires multiple small competitors—each transaction often falling below merger notification thresholds—with the goal of consolidating them into a single, dominant market player. The consolidated firm can then use its market power to raise prices, lower the quality of its product, or create other competitive harms. The pharmaceutical industry provides a particularly profitable setting in which to execute such a strategy as demand is inelastic (patients cannot easily substitute medications) and regulatory barriers to entry are high (patent protections and lengthy approval processes for new drugs limit competition).
While large corporations can also engage in rollup deals, this strategy is especially attractive to PE firms because it offers a lucrative opportunity to maximize short-term returns by exploiting market power, and deals can be structured to sidestep antitrust scrutiny. Additionally, the PE fund may be able to implement significant price hikes or reduce product quality with relatively less reputational damage than publicly traded companies.
PE firms often acquire companies using substantial debt (leveraged buyouts), which creates pressure for rapid operational changes. To ensure that management aligns with the fund’s objectives, top executives are incentivized with steep performance-based financial packages. Given the business model of PE firms—to increase a company’s value over a short timeframe and exit at a profit (via sale or IPO)—there is a risk that short-term financial gains will be prioritized over long-term investments. Indeed, a large and growing body of research evidences the harmful impacts of PE ownership on the quality of care and costs to patients and payers in the healthcare sector.
Regulation will need to balance investors’ pursuit of financial returns with the broader public interest in promoting an innovative and competitive pharmaceutical industry
In sum, while financial investors are an important source of capital in the pharmaceutical industry, their increasing influence in corporate decision making raises complex challenges for competition policy. This article highlights that common ownership—whether established by venture capitalists in early-stage biotech startups or by institutional investors in large, publicly traded firms—can soften competition. Similarly, rollup deals orchestrated by private equity firms can harm consumers through reductions in quality and increases in prices.
To tackle these concerns, policymakers should consider expanding the scope of antitrust enforcement beyond horizontal mergers to include financial ownership changes that risk undermining competition. This would require adjusting merger notification thresholds to capture acquisitions that contribute to rollup strategies or create significant common ownership links between competitors. In parallel, stronger disclosure requirements should be introduced to ensure greater visibility into the ownership structures of investment funds and their portfolio companies. Ultimately, regulating financial transactions will involve reconciling investors’ pursuit of financial returns with society’s interest in promoting a pharmaceutical industry that is both innovative and competitive.
Author’s Disclosures: The authors report no conflicts of interest. You can read our disclosure policy here.
Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.
