Competition and Quality Choice in Hospital Markets

Hospital markets have undergone an unprecedented wave of consolidation that has substantially altered the competitive landscape. The impact of these changes on hospital prices has been well studied in the literature; however, their impact on the quality of hospital services is much less understood. The majority of the literature has focused on clinical outcomes and found mixed effects (e.g., Gowrisankaran and Town, 2003; Propper, Burgess, and Green, 2004; Mutter, Wong, and Goldfarb, 2008). One reason for these mixed findings is because managed care organizations (MCOs) generate incentives for hospitals to both keep costs low while also making themselves as valuable as possible to patients to secure higher reimbursements.

We seek to identify the degree to which hospitals alter their demand-shifting quality in response to competitive pressures and examine the relationship between these quality choices and clinical outcomes. We estimate the relative utility that patients receive from hospitals as a function of the level of market competition and managed care penetration using a panel of discharges for California from 2000 to 2010. We perform our estimation using all discharges for patients enrolled in traditional Medicare as well as for patients enrolled in a private HMO or PPO plan as the incentives generated by insurer type may vary. We also perform the analysis utilizing discharges belonging to each of the top three diagnostic categories to assess how the incentives may vary for different diagnoses groups.  Lastly, consistent with much of the previous literature, we use the Herfindahl-Hirschman Index (HHI) as the measure of market competition.  However, the HHI is endogenous as it includes a hospital’s own market share, so we develop several exogenous instruments for HHI.

The results of our approach provide strong evidence that hospitals compete directly for patients over quality and that the different types of insurer generate important spill-over effects for all patients. For example, a one standard deviation increase in market competitiveness as measured by the HHI causes hospitals to increase their quality by a tenth of a standard deviation for Medicare and HMO patients and about a sixth of a standard deviation for PPO patients, increasing the probability that a patient chooses a hospital by 10 to 15 percent when evaluated at the mean.  Consistent with previous research we also find that hospitals decrease their quality in response to increases in HMO and Medicaid penetration. Higher rates of Medicare enrollment also tend to lower quality, however, the effect is typically small.  In contrast to demand-shifting quality, we find that the effects on clinical outcomes of competition over Medicare and privately insured MCO patients generally work in opposite directions, consistent with some previous literature (Gowrisankaran and Town, 2003).  We conclude that hospitals compete for patients directly through their choice of quality and that these demand-shifting dimensions of quality do not necessarily result in better clinical outcomes.