This document summarizes a presentation on modeling internal decision-making processes in hospitals and how they impact hospital behavior. It discusses four potential decision-making processes (DP1 to DP4) involving interactions between hospital management, chief physicians, patients, and sponsors. The key findings are: 1) DP1, DP2, and DP4 could result in the same optimal reporting strategy if certain conditions are met; 2) DP3 could lead to information rents for physicians and less favorable efficiency-rent extraction tradeoffs for sponsors; 3) Considering internal hospital decision-making is important for structuring optimal payment systems.

1. Swiss Health Economics Workshop
September 13, 2013
Internal decision-making processes and hospital
behavior
Hierarchical principal-agent vs. bargaining
models
Simon Spika, University Hospital Zurich, Finance Department
Peter Zweifel, Emeritus, University of Zurich, Department of Economics, Switzerland

2. 16.09.2013Seite 1S. Spika, P. Zweifel, Internal decision-making processes and hospital behavior
Motivation and objective
Typical hospital objective functions in PA models
Ma (1994)
Journal of Economics &
Management Strategy, Vol.
3, No. 1, 93 - 111
Chalkley/Malcomson (1998)
The Economic Journal, No. 108,
1093 - 1110
Ellis (1998)
Journal of Health Economics,
No. 17, 537 - 555
Hospital profit net of disutility of
providing service
Linear combination of patient benefit
and hospital profit
Sum of hospital profit and patient
benefit net of disutility

3. 16.09.2013Seite 2S. Spika, P. Zweifel, Internal decision-making processes and hospital behavior
Motivation and objective (cont'd)
Derive the objective function as the outcome of an internal decision-
making process
„We assume that some final solution is obtained among the tastes of the
administrator, the trustees, and the medical staff, so that we can speak of the
tastes of the hospital's decision maker.“ [Newhouse (1970)]
What does that
solution looks like?
What do I need to
know about the
internal decision-
making process?
Hospital
Management
Physicians
Nursing
personnel
Support
Sponsor
?

4. 16.09.2013Seite 3S. Spika, P. Zweifel, Internal decision-making processes and hospital behavior
Modeling
General setup
Sponsor (government agency, social insurer):
− Delegates treatment of patients to a hospital
− Designs payment system
Relevant decision-makers in the hospital
− Management:
− Responsible for financial viability of hospital
− Chief physician:
− Decides on treatment
− Establishes case severity

5. 16.09.2013Seite 4S. Spika, P. Zweifel, Internal decision-making processes and hospital behavior
Modeling (cont'd)
Model overview
payment /
cost ceiling
Hospital
Sponsor
Chief
Physician
Patient
Management
Panel A: PA mechanism
payment /
cost ceiling
treatment true case
severity
report case
sev.
report case
sev.
Panel B: Nash bargaining
Hospital
Chief
Physician
Patient
Management
Sponsor
payment /
cost ceiling
report case
sev.
payment /
cost ceiling
report case
sev.
treatment true case
severity

6. 16.09.2013Seite 5S. Spika, P. Zweifel, Internal decision-making processes and hospital behavior
Modeling (cont'd)
Model overview
Hospital
Sponsor
Chief
Physician
Patient
Management
Hospital
Chief
Physician
Patient
Management
Sponsor
Panel A: PA mechanism Panel B: Nash bargaining
Cost ceiling for
management /
chief physician
defined by
sponsor/manage-
ment
Transfer from
sponsor/manage-
ment to
management/chief
phyiscian
Case sevrity as
reported by
management/ chief
physician to
sponsor/manage-
ment
True case severity

7. 16.09.2013Seite 6S. Spika, P. Zweifel, Internal decision-making processes and hospital behavior
Modeling (cont'd)
The four decision-making processes
PA mechanism
Nash bargaining
solution
Full information
(internal)*
DP1 DP2
Asymmetric
information (internal)**
DP3 DP4
*) Chief physician always reports truthfully
**) Chief physician only reports truthfully, if this is the dominant strategy

8. 16.09.2013Seite 7S. Spika, P. Zweifel, Internal decision-making processes and hospital behavior
Modeling (cont’d)
Objectives of players and participation constraints I
• Chief physician
− Utility depends on patient benefit and payment received
− Treats patient only if
• Sponsor
− Maximizes severity weighted patients benefit net of expenditure

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Modeling (cont’d)
Objectives of players and participation constraints II
• Management
− Focuses on hospital’s profit (transfer received minus payment to chief
physician)
− Accepts arrangement with the chief physician only if
− Accepts sponsor's offer only if
(internal participation constraint)
(external participation constraint)

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Results
Proposition
If management and chief physician are both risk neutral and both
putting equal weight of one on tp, all solutions, which are Pareto
efficient (for management and physician), maximize surplus S and
have the same opitmal report strategy in common.

11. 16.09.2013Seite 10S. Spika, P. Zweifel, Internal decision-making processes and hospital behavior
If management and chief physician are both risk neutral and both
putting equal weight of one on tp, all solutions, which are Pareto
efficient (for management and physician), maximize surplus S and
have the same opitmal report strategy in common.
Results
Proposition
Utility physician
Profit
(>g)
(>g)

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Results (cont’d)
Objective functions as the outcome of decision-making processes
• DP1, DP2, DP4 (given chief physician's bargaining power not too small) all
result in
PA mechanism
Nash bargaining
solution
Full information
(internal)
DP1 DP2
Asymmetric
information (internal)
DP3 DP4

13. 16.09.2013Seite 12S. Spika, P. Zweifel, Internal decision-making processes and hospital behavior
Results (cont’d)
Objective functions as the outcome of decision-making processes
• DP1, DP2, DP4 (given chief physician's bargaining power not too small) all
result in
− No distortion due to internal asymmetry of information between chief
physician and management
− DP4: Chief physician’s information rent absorbed in his/her bargained
surplus
− Rent extraction – efficiency trade-off as in “traditional” PA-models with
two-tier hierarchy subject to adverse selection

14. 16.09.2013Seite 13S. Spika, P. Zweifel, Internal decision-making processes and hospital behavior
Results (cont’d)
Objective functions as the outcome of decision-making processes
• Decision-making process 3
PA mechanism
Nash bargaining
solution
Full information
(internal)
DP1 DP2
Asymmetric
information (internal)
DP3 DP4

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Results (cont’d)
Objective functions as the outcome of decision-making processes
• Decision-making process 3
− Information rent for chief pyhsician is not internalized
− Management takes into account 'virtual expense’
− Sponsor must “pay twice” for truthful reporting
− Rent-extraction – efficiency trade-off less favorable than in the case of
DP1, DP2, DP4

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Conclusion
Information on the hospital’s internal decision process is relevant for the
sponsor
Sponsor needs to structure hospital payment differently, if DP3 obtains
Limitations:
• Equivalence of DP1, DP2 and DP4 conditional on
− Risk neutrality of management and chief physician
− No restrictions on payment tp
• In real hospitals, decision-making processes are likely to be more
complex
Crucial insight: Consideration of internal decision processes is necessary
for developing “optimal” hospital payment systems.

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References
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University Press, 2002.
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(84):219–249, 2002.
• R. P. McAfee and J. McMillan. “Organizational diseconomies of scale”,
Journal of Economics & Management Strategy, 4(3):399–426, 1995.
• R. Boadway, M. Marchand, and M. Sato. “An optimal contract approach to
hospital financing”. Journal of Health Economics, (23):85–110, 2004.