As debates around drug prices heat up on the presidential campaign trail, the House of Representatives voted in December to pass Speaker Nancy Pelosi's drug bill, which contains key provisions allowing the government to negotiate lower prices on at least 50 drugs each year.
This would come as a welcome relief to Americans who pay more per capita for prescription drugs than our wealthy global peers. Yet many believe the Republican-controlled Senate is likely to bury the bill. Once again, lobbyists for the pharmaceutical industry are committed to blocking the way, arguing that prices must be kept high in order for firms to invest in new drugs through big research and development programs.
The industry’s claims that high prices are vital to fund innovation are demonstrably false, according to economists who research how drug companies allocate money.
However, the industry’s claims that high prices are vital to fund innovation are demonstrably false, according to economists who research how drug companies allocate money. The truth is that many of these companies use profits reaped from their exorbitant prices to wheel and deal with Wall Street instead of developing new and more effective medicines.
Pharmaceutical companies, economist William Lazonick and his colleagues show, have increasingly focused on manipulating their stock prices over the last few decades in order to line the pockets of executives, hedge-fund managers and bankers. The researchers reveal that some of the biggest drug companies often take on debt to distribute well in excess of 100 percent of profits to shareholders in the form of stock buybacks and cash dividends.
To understand how this happened, you have to go back to the 1980s, when an idea called “shareholder value theory” caught fire with business school programs and corporate titans like Jack Welch, the much heralded chief executive of General Electric from 1981 to 2001. Plainly stated, this theory holds that the primary function of corporations is to make shareholders rich, not to do things like produce useful goods and services. Under this business model, executives turn from focusing on the companies’ long-term health to their short-term profit-making — often with disastrous results.
In recent years, many critics have realized the problems created by the theory and denounced it. Harvard Business School professors Joseph L. Bower and Lynn S. Paine have called it “the error at the heart of corporate leadership.” The Economist magazine declared it “a license for bad conduct, including skimping on investment, exorbitant pay, high leverage, silly takeovers, accounting shenanigans and a craze for share buy-backs, which are running at $600 billion a year in America.”
This shareholder value theory is now also condemned by many prominent business leaders — from John Mackey of Whole Foods to Alibaba CEO Jack Ma. In August, close to 200 top CEOs issued a statement rejecting the theory and redefining the purpose of the corporation in terms of ethical responsibility and advancing the interests of society. In 2009, even Welch himself declared that shareholder value is “the dumbest idea in the world.”
Yet many of America’s most powerful companies — and the politicians they fund — still treat the discredited management theory as gospel.
Many of America’s most powerful companies — and the politicians they fund — still treat the discredited management theory as gospel.
Drug companies are some of the most zealous advocates of shareholder value, with a broken business model to show for it. Lazonick and his colleagues have found that companies that funnel the most money into distributions to shareholders are least productive per dollar spent on research and development.
Some are actually no longer in the business of developing drugs: Merck and Pfizer, the researchers note, have grown large by acquiring “blockbuster” medicines that other companies developed rather than researching new drugs themselves. Merck’s top cancer drug, Keytruda, for example, was initially developed by Dutch Organon International, which was acquired by Schering-Plough in 2007, which later merged with Merck in 2009.
Today, most of Big Pharma measures success by stock price and dividend yields. Profits seem to trump producing affordable medicines that Americans need.
Meanwhile, executives paid in stock are incentivized to use corporate cash to manipulate stock prices. The buyback is a favorite way to do this — a controversial practice in which a company buys its own stock in order to reduce the number of shares available and thus jack up the price of those that remain. Through this financial sleight-of-hand, executives basically take profits from high drug prices to pad their own paychecks.
This is especially scandalous given that U.S. taxpayers, in addition to ponying up for expensive drugs at the pharmacy, actually spend a tremendous amount on subsidies, patent and market protections for the benefit of drug companies. We also pay tens of billions each year in the form of government-funded basic and applied pharmaceutical research and drug development done at organizations like the National Institutes of Health (NIH) — all of which Big Pharma makes use of.
One study shows that from 2010 to 2016, NIH funding contributed to published research associated with every single one of the 210 new drugs approved by the Food and Drug Administration during those years. Yet in return for this largesse, American taxpayers still see drug prices climb each year.
The idea that the public must choose between innovation and high drug prices is a false one.
The idea that the public must choose between innovation and high drug prices is a false one: What is needed is a business model in which profits are invested in developing useful and affordable drugs, not funding executives’ super yachts and private jets.
Lazonick notes than while the Pelosi bill would be a step forward in asserting the federal government’s right to negotiate for lower drug prices, this kind of intervention still lacks a plan for pricing drugs that balances the need to fund drug development with the need to make drugs widely available and affordable. Regulating drug prices should be complemented, he writes, with policies that forbid corporate practices that undermine innovation — like, for example, funneling all the profits into shareholder distributions.
Remedies could include policies such as banning stock buybacks, eliminating stock-based executive pay and placing public interest members on corporate boards – including people who have expertise in medicines and understand the interests of taxpayers, drug customers and the scientists and other employees who contribute to making drugs. Such policies would treat the root of the problem: business models that create perverse profit incentives to keep drug prices high.
Some have lauded a new trade deal now proposed to replace the North American Free Trade Agreement in which pharmaceutical companies have failed to gain new patent protections for high-priced biologics (popular drugs made from living cells that treat everything from arthritis to breast cancer). Drugmakers work overtime to keep patents locked in for as long as possible because this allows them to discourage competition and keep prices high. In the United States, biologics currently enjoy 12 years of protection from competitors, and pharmaceutical companies sought 10-year patent protection in Mexico and Canada, where the protection periods are shorter. Though drug companies did not get what they wanted, critics note that even the new agreement will likely have little impact on U.S. drug prices, because it maintains the status quo in America.
Bottom line: The status quo is unhealthy for anyone except pharmaceutical company executives. Drug companies need a new business model that gets them back into the business of making the drugs Americans need at prices we can all afford to pay.