Physician hospital integration and cost efficiency in US private hospitals in 1997

Abstract

Our research question is: How does physician hospital integration affect the quality adjusted cost efficiency in U.S. hospitals in 1997? We view the physician and the hospital manager as a team of agents. Technologically, the physician resides within the firm because he allocates resources in the production of medical services.Production uncertainty in the sense of Arrow (1963) implies variable quality in medical care. Legally, a physician can be an employee in a fully integrated organization (FIO), a partner in a network, or an independent professional in a segregate hospital. The hospital owner (principal) administers a salary cum bonus scheme, which Holmstrom (1982) defines as a budget breaking scheme, for the production team in the FIO. Holmstrom shows that such a scheme removes moral hazard in team agency (i.e. team members shirk when their effort cannot be observed) and leads to Pareto efficiency (which we proxy with quality-adjusted cost efficiency). Eswaran and Kotwal (1984) argue that a self interested principal faces a moral hazard problem herself and has the incentive to prevent the team achieving Pareto efficiency. Our result shows empirical evidence for this argument in U.S. hospitals: nonprofit FIOs are more cost efficient than nonprofit network or nonprofit segregate hospitals in our sample. However, the for-profit counterparts have similar (quality-adjusted) cost efficiency.The principal can monitor the agents if she cannot administer a budget breaking incentive scheme in network and segregate hospitals. When the principal is the residual claimant, monitoring is incentive compatible (Alchian and Demsetz, 1972). The property rights theory predicts that for-profit hospitals are more cost efficient than nonprofit ones because the former have well defined residual claimants. For network and segregate hospitals, we find that for-profit entities are more cost efficient than nonprofit ones. Our results show that for-profit and nonprofit FIOs have similar cost efficiency statistically. We argue that both budget-breaking incentive scheme and monitoring are active in the FIOs because firms that administer bonus scheme also monitor their employees. The mechanisms produce opposing forces and indeterminate end point in this subgroup.Our findings extend earlier debate on cost efficiency difference between for-profit and nonprofit hospital. Recent empirical research generally finds no cost efficiency difference in recent years, but this finding does not refute the property rights theory. By using the team agency theory, we show how physician incentives modify the effect of capital owner incentives to influence cost efficiency.