On quality standards and the timing of pharmaceutical investment

This study analyzes how a health authority's quality standard influences a pharmaceutical firm's R&D investment timing, comparing this decentralized process with a social planner's integrated approach.

Drug quality evolves as a geometric Brownian motion, accelerating after irreversible investment. Using real options and optimal stopping theory, we model a sequential game between the regulator and firm, and a social planner who jointly sets both the investment threshold and quality standard.

The social planner invests earlier and achieves a higher total value than the combined payoff in the decentralized setting. Increasing the firm's remuneration can accelerate investment, but may delay commercialization if quality standards are set too high.

Decentralization creates inefficiencies through constrained optimization, whereas the social planner's unconstrained approach maximizes welfare. Remuneration design is a key policy tool for aligning incentives, particularly for neglected diseases that require timely solutions.