Conditional and Lenient Drug Approvals

Firms are often allowed to sell new drugs based on preliminary efficacy evidence, with final approval contingent on confirmatory testing. We characterize optimal approval policies for a government agency that maximizes consumer welfare while considering the firm’s incentives. We assume that firms have private information about testing costs and the government’s payoff depends on the drug’s expected efficacy. The optimal policy may include partial conditional approval for drugs with low expected efficacy, and leniency in granting final approval below conventional standards. Our calibration suggests these tools can generate hundreds of millions of dollars in annual social value.

This paper was accepted by Martin Bichler, market design, platform, and demand analytics.

Funding: The authors received no external funding for this research.

Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2025.03836.