Cost Center or Profit Center? Hospital Behavior in a Conflicting Regulatory Environment

Posted: 24 Jul 1998

Date Written: October 1995


We examine the interaction between two forms of hospital regulation and their effect on hospital behavior. Because reimbursement under federal Medicare regulation is a fixed fee per diagnosis, hospitals are encouraged to behave more like cost centers and reduce cost through shorter average lengths-of-stay. Under California Medicaid (MediCal) regulation, reimbursement is on a per diem basis, which encourages hospitals to behave more like profit centers and increase profit through longer average lengths-of-stay. The different regulatory authorities thereby force California hospitals to have conflicting identities. We find that hospitals operating more like cost centers tend to reduce cost (have shorter average length-of-stay) more than hospitals that operate more like profit centers. Hospitals operating more like profit centers have length-of-stay associated with per diem profit rather than per diem cost. Finally, we find that hospitals with a greater uncertainty about what is the appropriate length-of-stay are more likely to follow the conflicting regulatory incentives and have a greater difference in average length-of-stay between their Medicare and MediCal populations.

JEL Classification: D20, M40

Suggested Citation

Balachandran, Bala and Soderstrom, Naomi S. and Hemmer, Thomas, Cost Center or Profit Center? Hospital Behavior in a Conflicting Regulatory Environment (October 1995). Available at SSRN:

Bala Balachandran

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States
847-491-2678 (Phone)
847-467-1202 (Fax)


Naomi S. Soderstrom (Contact Author)

University of Melbourne ( email )

Melbourne, 3010

Thomas Hemmer

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States

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