Malpractice Laws and Incentives to Shield Assets: Evidence from Nursing Homes

Competition among suppliers plays an ambiguous role in assuring quality in reputational markets. Applied theoretical work has identified two opposing effects of competition on reputational quality. First, competition-induced erosion in market share increases the penalty for poor product outcomes while reinforcing the incentives for maintaining a good reputation. Second, however, competition also reduces firms’ ability to appropriate the surplus that consumers enjoy from consuming high quality. The theoretical literature predicts monotonic (increasing), “U-shaped” and inverse “U-shaped” relationships between reputational quality and competition. In this study, we use the nursing home data to investigate the impact of competition on reputational quality. We find that quality follows a U-shaped relationship that nursing homes provide higher quality in markets with high or low level of competition than those with intermediate level of competition. More interestingly, homes in markets with intermediate level of competition are more likely to change their firm names than those in other market structures. In addition, we verify and measure both the substitution and surplus extraction effects of enhanced competition that account for the gross relationship that we obtain. Further tests show how the relationship is affected by the mix of third party and private payment. To conclude, this study shows that the relation between competition and reputational quality is non-monotonic, which is central to the “complexity” of anti-trust policy. To our knowledge, we are among the first to show that there is an “inflection point” in this relation. Second, we are able to identify the underlying mechanisms of market discipline and rent extraction that help to account for this relation. The findings are meaningful for anti-trust policies in general and entry regulations in healthcare.