Optimal Conditional Drug Approval

Two contentious issues in the pharmaceutical industry are the early regulatory approval of drugs based on limited evidence and the question of whether drug testing costs are as high as firms claim. We show how regulators can optimize conditional drug approval when faced with private information about testing costs. Conditional drug approval grants early access but requires subsequent testing before final approval. Patients get early access, and firms get early revenue. Besides the short-term patient benefit, there is a long-term patient benefit if the early revenue makes a marginally unprofitable drug profitable. The main risk is that the drug will prove ineffective, so spending on the drug is wasted. In some cases, the regulator should conditionally approve a drug that is unlikely to be efficacious, but only for enough patients to make the testing profitable. Also, regulators should sometimes commit to final approval for drugs narrowly missing efficacy thresholds if firms test otherwise unprofitable drugs. Conditional approval is especially effective if drug revenue rises over time.