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Organizing and Regulating Hospital and Physician Investment

50 Pages Posted: 23 Apr 2011  

Misja C. Mikkers

Dutch Healthcare Authority; Tilburg Law and Economics Center (TILEC)

Peter Bogetoft

University of Copenhagen - Department of Economics

Date Written: January 1, 2008


This paper considers the interaction between hospital and physician incentives to make investment in new technology or services. The investment costs are private information and we consider both the case of substitute and complementary investments. The focus is on the organization of the health sector and the regulation framework. We analyze centralized regulation, where a principal (the state or insurance company) contracts with the hospital and physicians directly, as well as decentralized (delegated) regulation where the principal contracts with the hospital and the hospital then contracts with the physicians. We compare the outcomes in terms of task allocation and information rents. Moreover, we consider as benchmarks a first best solution and a solution with a fully integrated hospital-physician entity. The choice of organizational and regulatory forms for the analysis in our paper stems from two major characteristics of hospital and doctor activities. A first important observation is that physician and hospital activities interact and that physician effort can both substitute and complement hospital investments depending on the type of service at stake. Advanced diagnostic equipment may for example substitute for time-consuming physician examinations while new operation treatment facilities may be worthless without the extra effort of devoted physicians. From a regulatory and organization perspective, this raises crucial questions about the costs of separate ownership of hospital and physician assets and the possibility for a regulator to coordinate the physician and hospital activities by individual regulation targeting the hospital and physicians respectively. The asymmetric information prohibits a first best solution in general. Investments are rationed to save information rents, and in most cases suboptimally coordinated across the providers. In the case of substitutes, the centralized solution is superior. This presumes however that there are no restrictions on the regulation. Common regulations limit the (yardstick) competition that can be introduced across provider types. This makes an integrated provider (multi-utility) preferable. Also, delegated contracting may be superior to centralized contracting since the hospital can use private information about its own cost, when contracting with the physician. In the case of perfect complements, the outcomes coincide. In particular, an integrated provider is as valuable as a centralized solution with no restrictions on the regulation.

Keywords: Health care markets, vertical relations, hospital, doctor

JEL Classification: D23, D82, I11, I18, L22

Suggested Citation

Mikkers, Misja C. and Bogetoft, Peter, Organizing and Regulating Hospital and Physician Investment (January 1, 2008). Available at SSRN: or

Misja C. Mikkers (Contact Author)

Dutch Healthcare Authority ( email )

Postbus 3017
Utrecht, 3502 GA

Tilburg Law and Economics Center (TILEC)

Warandelaan 2
Tilburg, 5000 LE

Peter Bogetoft

University of Copenhagen - Department of Economics ( email )

Ă˜ster Farimagsgade 5
Bygning 26
1353 Copenhagen K.

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