Which MBA?

How companies' good reputations help get them over regulatory hurdles

CONFRONTED with a sink suddenly spurting water many homeowners have neither the knowledge nor the materials to make the repair themselves. In choosing a plumber they generally have to rely on some sort of signal of quality. A recommendation from a stranger helps; a recommendation from a sensible neighbour can help even more; prior, direct experience is best of all. 

Government regulators can be said to be permanently in need of plumbers. Faced with a rapidly changing market and technological advances—of financial instruments, medical therapies, agricultural methods, software—the regulatory agencies have to make decisions quickly. It might then make sense that, as one would welcome a recommended plumber, regulators might be more willing to trust companies with stronger reputations.

Jerry Kim, an assistant professor of business at Columbia University, wanted to test the relationship between reputation and regulatory treatment at the Food and Drug Administration (FDA). He looked at 884 New Drug Applications (NDAs) submitted to the FDA for approval between 1990 and 2004. A firm’s reputation, in this case, depended not on its market share or the use of its drugs, but its generation of knowledge and innovation. Mr Kim’s hypothesis was that a firm with a longer track record of contributing to drug development would have its NDAs approved faster than would a developer less well known to the FDA. The more patent citations a firm had, the greater its knowledge reputation.

The hypothesis proved correct: the higher the firm’s reputation, the more likely that its drugs would speed through the approval process. Other factors influenced FDA approval as well. Drugs targeted at “underserved” illnesses (those that lack good treatments) were approved more quickly, for example, while any drug submitted after a product recall, regardless of whether or not it was related to the recalled drug, was more likely to spend additional time under review. A firm’s political contributions, meanwhile, were a non-factor.

Mr Kim also found a curious side effect of the drug-approval process. The FDA has a special “priority” rating for those drugs believed to be significantly better than existing treatments. (New drugs, or those first to treat a disease, are more likely to be designated priority.) There was no statistically significant relationship, however, between a firm’s reputation and the likelihood of its application receiving priority status. This suggests that established firms are not more likely to turn out innovative or especially useful drugs than their lesser-known peers. In separate research, Mr Kim found that the approved drugs from high-status firms were more likely to prompt product recalls or warnings. In short, the established firms may be coasting.

Mr Kim draws two lessons from his findings. One is practical: new biotech firms may want to partner with veterans to get their products to market more quickly and establish a strong reputation. The second is to adopt a healthy scepticism about the ability of regulators to protect the public. The biases he found were not the kind easily attributable to underhanded bribery, lobbying, or even more subtle political pressures; rather, they are the result of trying to process a great deal of information quickly. “These people...really are dedicated to serving public interest and they’re trying their best,” says Mr Kim of his talks with FDA researchers. “The problem is, their best is not always good enough.”