Financial Contracting in Biotech Strategic Alliances

We conduct a detailed, micro-level analysis of 126 strategic alliance contracts, all of which were written to sponsor early-stage, genomics-based biotechnology research at small R&D companies. All contracts prescribe staged investment decisions to capture the option value associated with the sequential resolution of uncertainty, but the contracts deal with agency problems differently. Among pre-IPO companies, many alliances resemble venture capital contracts: they involve convertible preferred equity and sometimes contain anti-dilution provisions, warrants, and board seats. Contracts contain explicit provisions linking equity participation to subsequent IPO activity, and contain clauses designed to insulate both parties from multi-tasking problems. Contrary to the standard assumptions of static contract theory, contracts often specify provisions that are unobservable or difficult to verify. Equity participation is positively correlated with the ambiguity of the contracting environment. JEL Classification Codes: G30, G34, G39, M13, O39 ∗ Corresponding author. Send correspondence to Uris Hall 414, Columbia University, 3022 Broadway, NY, NY 10027, or [email protected]. We would like to thank Mark Edwards at Recombinant Capital for generously making his data available to us. In addition, we are grateful to George Baker, Bernard Black, Alex Butler, Robert Gibbons, Bengt Holmström, Per Strömberg, Andy Wong and participants at the NBER Strategic Alliance Conference and the Batten Young Scholars conference for helpful comments. Sandhya Persad and Weigang Yuan provided expert research assistance. Any errors are solely our own. Article submitted to the 2002 Real Options Conference 10 June 2002