The Regulation of Direct‐to‐Consumer Advertising of Pharmaceuticals in a Managed Care Setting

• Author: RHEMA VAITHIANATHAN,MATTHEW RYAN
• DOI: http://doi.org/10.1111/jpet.12129
• Date: 01 December 2015
• Published date: 01 December 2015

THE REGULATION OF DIRECT-TO-CONSUMER ADVERTISING

OF PHARMACEUTICALS IN A MANAGED

CARE SETTING

MATTHEW RYAN

Auckland University of Technology

RHEMA VAITHIANATHAN

Auckland University of Technology and Singapore Management University

Abstract

We analyze direct-to-consumer advertising (DTCA) in the

prescription drug market, when a regulator imposes a fine

for misleading advertisements (truth-in-advertising regula-

tion) and doctors face pressure to contain prescribing costs.

The efficacy of a drug is based on scientific evidence as

well as on patient-specific characteristics. Patients do not

possess information on either dimension of efficacy. Phar-

maceutical firms observe the scientific data and use DTCA

to convey this information to patients. Doctors observe

both the scientific data and patient-specific characteristics,

and provide treatment recommendations. We develop a

model in which DTCA is followed by a doctor–patient sig-

nalling game. We show that truth-in-advertising regulation

Matthew Ryan, Department of Economics, Auckland University of Technology, Private Bag

92006, Auckland 1142, New Zealand (matthew.ryan@aut.ac.nz). Rhema Vaithianathan,

Department of Economics, Auckland University of Technology, Private Bag 92006, Auck-

land 1142, New Zealand, and School of Economics, Singapore Management University, 90

Stamford Road, Singapore 178903.

The authors warmly thank two anonymous referees for their suggestions, which have

materially improved the paper.They also thank the following for valuable feedback on ear-

lier drafts: Catherine de Fontenay, John Hillas, Albert Ma, and audiences at the Australian

Economic Theory Workshop (Massey University, Auckland), the European Health Eco-

nomics Workshop (Brescia, Italy), the University of Auckland, the University of Karlsruhe,

the University of Leicester,the University of Melbourne and the University of Queensland.

The usual disclaimer applies.

Received July 8, 2014; Accepted August 6, 2014.

C2014 Wiley Periodicals, Inc.

Journal of Public Economic Theory, 17 (6), 2015, pp. 986–1021.

986

The Regulation of Direct-to-Consumer Advertising 987

increases the credibility of DTCA and may increase both

doctor–patient conflict and prescriptions for an expensive

new drug—a market-stealing effect. Tighter regulation may

encourage more DTCA, and may even encourage more

false advertising.

1. Introduction

The marketing of ethical medicines is a highly regulated activity. In the

United States direct-to-consumer advertising (DTCA) must restrict state-

ments to verifiable facts and only promote the use of the drug for approved

indications (Danzon and Keuffel 2014). However, DTCA remains controver-

sial, and episodes such as the withdrawal of Vioxx have amplified calls for

tightening of the regulation of DTCA. Vioxx was among the most heavily

advertised products in the market (Bradford et al. 2006) but was later found

to have fatal side-effects leading to large-scale mortality (Vaithianathan et al.

2009). Its rapid take-up was partly blamed on intensive marketing campaigns,

prompting calls for tighter regulations and better enforcement of truth-in-

advertising rules (U.S. General Accounting Office 2002, Donohue, Cevasco,

and Rosenthal 2007, Shuchman 2007).

An open question is whether increased regulation or monitoring will

discipline advertisers as intended. Nelson (1974) pointed out that truth-

in-advertising regulation may have the perverse effect of encouraging more

advertising, since regulation enhances the credibility—and therefore the

value—of advertisements. Sauer and Leffler (1990) found some empirical

support for Nelson’s hypothesis. However,Nelson does not consider markets

with “learned intermediaries” who might contradict the advertised message.

The present paper develops a signalling model in which a patient con-

sults a physician about whether to take a new drug after observing DTCA.

The patient’s treatment decision is based on what they infer from DTCA as

well as the doctor’s recommendation. Drug advertising is randomly audited

for truthfulness.

We assume that physicians face pressure to limit prescribing of expensive

new drugs—as in a managed care environment—so physicians are imperfect

agents of their patients. Nevertheless, in the absence of DTCA, patients com-

ply with their physicians’ suggested treatments. Advertising changes equi-

librium behavior in the physician–patient consultation by encouraging the

patient to challenge a physician who recommends against the advertised

drug. In the model, DTCA distorts the physician’s recommendation toward

the advertised drug and also leads to greater levels of conflict with patients.

Our model therefore illustrates one possible mechanism by which DTCA

might facilitate market stealing—shifting demand to the advertised brand. It is

also consistent with empirical evidence on the detrimental effects of DTCA

on patient–physician trust, particularly in a managed care or health mainte-

nance organization (HMO) setting (Kravitz et al. 2005, Spence et al. 2005).

988 Journal of Public Economic Theory

We examine two types of market-stealing equilibria in detail: one in

which all advertising is truthful, and another in which some advertising

is false. Although we do not characterize all equilibria of the model, our

results are nevertheless general in the following sense: if DTCA is used in

equilibrium,1then the level of prescribing of the advertised drug will be

higher than under a scenario in which DTCA is banned.

There have been a number of empirical studies of the effects of DTCA

on prescribing (e.g., Berndt et al. 1995, 1997, Calfee, Winston, and Stempski

2002, Ling, Berndt, and Kyle 2002, Rosenthal et al. 2003, Iizuka 2004, Iizuka

and Jin 2005). The evidence suggests that DTCA can be effective in increas-

ing own-brand demand. Narayanan, Desiraju, and Chintagunta (2004) and

Kalyanaram (2008, 2009) find that DTCA increased the market share of the

advertised drug. Wosinska (2002) also finds a market-stealing effect of DTCA,

but only when the drug is subsidized for the patient.

There is also evidence that this market-stealing effect might work by

encouraging patients to request the advertised medicine. Liu and Gupta

(2011) analyze prescribing data for patients newly diagnosed with hyperlipi-

demia, and find that DTCA has a positive and statistically significant effect

on patient requests for the advertised brand. In Kravitz et al. (2005), actors

were randomly assigned to make 298 unannounced visits to physicians. They

found that 37% of patients requesting a named brand received a prescription

for the drug, compared to 10% of patients who made a general drug request

and none of the patients who did not request any drugs. They conclude that

as long as DTCA can persuade patients to mention a brand, physicians can

be induced to change their prescribing decisions.

Previous theoretical analyses of DTCA have tended to focus on market

expansion effects, rather than market stealing.

Brekke and Kuhn (2006) analyze the interaction between DTCA, price

setting, and detailing (marketing to physicians). They model DTCA as

directly informative: consumers do not question the truthfulness of adver-

tised messages, and are prompted to visit their physicians by learning the

advertised information. By contrast, we assume that patients visit their physi-

cians whether or not they see DTCA, but our patients do not unquestioningly

believe the content of DTCA. Our model explains why DTCA may persuade

consumers to switch drugs, despite their rational incredulity and the inter-

mediation by physicians. In Brekke and Kuhn, it is detailing that drives the

prescribing decision, which is made by the physician. There is no detailing

in our model (though this an obvious avenue for further research), and

patients have sovereignty over the prescribing decision. The exercise of this

sovereignty is limited, however, by the need to pay a “conflict cost” to reject

the physician’s recommendation.

1More precisely still, in any restricted equilibrium—as defined in the Supplementary

Material.