Health care investors: Beware! A new study casts doubt on the potential to create value by adjusting doctors’ financial compensation.
Relevance
Investors often plan use compensation as a tool to create value at their portfolio companies. The basic economic principle is that compensation (e.g., bonuses and stock options) can be used to better align incentives between the organization, management, and employees by providing appropriate skin in the game. This may be especially important in situations where both the information and actions of decision makers are not perfectly observable to others.
Imperfect information and high costs? Health care sounds like the perfect case study. As health care investors consider deals and value creation plans that aim to create efficiencies by tinkering with the financial compensation of health care providers, the results of a newly-published economic study should give them pause.
Summary
A study recently published in the Journal of Political Economy, one of the top overall economics journals, examined the impact of linking doctors’ bonuses to health care costs in an attempt to reduce such costs.
The study found that the bonus scheme failed to achieve its goal – health care costs did not decrease, and yet doctors still found ways to game the system to get increased bonuses.
What makes this study particularly important?
The study is based on results from The New Jersey Gainsharing Demonstration – an experimental program designed by the New Jersey hospital lobby to reduce treatment costs. By offering providers financial bonuses to reduce overall patient treatment costs, hospitals hoped to better align provider and patient interests while minimizing unnecessary treatments.
To assess the effects of the bonus scheme, this study exploited the quasi-experimental design of the demonstration program: only some New Jersey hospitals were included in the program, and most New Jersey doctors have admitting privileges at more than one hospital. This allowed the authors to compare the program’s impact on a given doctor’s behavior (which patients were treated, where, and how) and compensation for treating patients at hospitals participating in the demonstration program vs. the same doctor’s behavior and compensation at non-participating hospitals.
This powerful “fixed effect” study design increases our confidence in the authors’ causal interpretation of the compensation scheme – i.e., that the new bonuses caused doctors to change their behavior in ways that allowed them to earn bonuses but that did not lead to lower health care costs for the patients they treated.
Upshot
There are legitimate reasons to think that this compensation scheme failed to lower costs due to its own details, rather than a more foundational flaw in the premise of achieving targeted changes in doctors’ behavior through financial incentives.
Nevertheless, the results of this study should encourage health care investors to think deeper about any adjustments they plan to make to health care providers’ compensation. Why didn’t the incentives provided achieve the outcomes targeted in this context? Do the details of your plan, and/or the conditions at your portfolio company, differ enough from those in this study that you’ll achieve your target where others have failed?
Link to the study: Published | Working paper (free)