Many tertiary care hospitals (acquirers ) acquire non-tertiary care hospitals (targets), and some of these mergers lead to a significant increase in referrals from the target to the acquirer. This study examines the hospitals' motives for integration and for increasing referrals using hospital discharge data from the Pittsburgh area. I develop and estimate a model of referral choice based on a reputation mechanism. The results suggest that low- or average-quality acquirers exploit their targets' monopoly power to steer patients to the acquirers. Distinguished acquirers, on the other hand, seem to have motives other than patient steering, including the integrated delivery of care.
Since the 1990s, there have been many hospital merger cases in which a tertiary care hospital that provides specialized care (the acquirer) acquires a non-tertiary care hospital that does not offer such services (the target). (1) Several media reports note that mergers of this type could lead to an increase in referrals from the target to the acquirer (Bernstein 1996; Brown 2001). Because the number of tertiary care hospitals is limited, patients typically present themselves first at their local non-tertiary care hospital for diagnosis; patients then are referred to a tertiary care hospital when necessary. This makes referrals from hospitals not offering the service an important path for specialized services. (2) This is especially the case for cardiac surgery, as only a limited number of hospitals offer this service and the major source of admission is physician referrals (Mukamel, Weimer, and Mushlin 2006). Huckman (2006) reported that acquirers on average experience an increase in cardiac surgery admissions from the target's primary market. On the other hand, Nakamura, Capps, and Dranove (2007) found that in the majority of cases, there appears to be no change in referrals to the acquirers, although some acquisitions do lead to a significant increase in referrals for cardiac surgery as well as other specialized services.
This paper studies why some mergers are more successful in increasing cardiac referrals than others and, more importantly, what motivates this type of merger and the subsequent increase in referrals. The health economics literature offers two hypotheses that have completely different welfare and policy implications. The theory of transaction costs asserts that integration could enable the merging parties to resolve internal agency problems and to make relation-specific investments (Grossman and Hart 1986; Klein, Crawford, and Alchian 1978; Williamson 1979, 1985). Accordingly, hospital acquisitions could facilitate not only economies of scale and scope, but also joint investments in quality improvement and cost reduction--that
is, the integrated delivery of care (Burns and Pauly 2002). If this were the case, integration could produce an increase in referrals to the acquirers. Nevertheless, a completely different motivation is also possible. While referral laws prohibit hospitals from paying physicians for their referrals, the laws also exempt certain forms of payment between hospitals and their affiliated physicians. Thus, hospital acquisition can be used as a loophole for providing monetary or nonmonetary rewards to physicians who give referrals--a practice known as patient steering. While the integration of hospitals might not affect physicians' decisions regarding whether to refer a patient to a tertiary care hospital, hospitals could shift referral volume from nonaffiliated hospitals to affiliated hospitals. (3)
Because health care providers are imperfect agents for patients, a reputation mechanism plays a central role in disciplining health care providers. Consider a physician at a nontertiary care hospital choosing where to refer her patients for tertiary care. Suppose the non-tertiary care hospital is affiliated with a tertiary care hospital and that the physician is paid for referrals made to the acquirer hospital. …