An optimal contract approach to hospital financing

Existing models of hospital financing advocate mixed schemes which include both lump-sum and cost-based payments. The doctor is generally the unique decision maker, which is unrealistic in a hospital setting where both managers and doctors are involved. This paper develops a model in which managers and doctors are responsible for different decisions within the hospital. In this model, public authorities who provide the financing, hospital managers who allocate resources within the hospital, and doctors who assign patients to either a low-tech or a high-tech therapy have information of increasing quality on the casemix of patients. The public authorities sign with hospital managers contracts specifying some lump-sum financing and some size of a high-tech equipment. In turn, managers, who know the broad mix of patients in the hospital, sign with hospital doctors contracts that specify the non-medical resources allocated to this facility as well as some remuneration. Doctors, who know each patient's illness severity, select the patients to be treated by the high-tech facility, and receive from public authorities some fee-for-service payment that is differenciated according to the low- or high-tech treatment used for curing their patients. What emerges is a two-stage agency problem in which contracts are designed to elicit information in the most efficient way