Exit from the Hospital Industry

By Ciliberto, Federico; Lindrooth, Richard C. | Economic Inquiry, January 2007 | Go to article overview

Exit from the Hospital Industry


Ciliberto, Federico, Lindrooth, Richard C., Economic Inquiry


I. INTRODUCTION

The hospital industry has experienced significant changes in both reimbursement and technology over the past 20 years. Changes in both the level and type (e.g., per diem versus prospective) of reimbursement have occurred with all major payers. In addition, the demand for inpatient care has declined due to utilization management by managed care organizations and technological advances that have facilitated a shift toward treatment in outpatient settings. At the same time the industry has experienced significant exit and consolidation. Over the time period of this study (1989-97) almost 350 short-term general hospitals exited the inpatient hospital industry. In this article, we examine the characteristics of closing hospitals and study whether the factors that influence closure have changed over the decade of the 1990s.

We expect the factors behind closure to change over the time period for several reasons. First, the relative generosity of payment from different payers shifted over the time period. In the late 1980s and early 1990s, reimbursement by Medicaid and Medicare was relatively less generous compared to private payers. Furthermore, the hospital industry was adapting to the shift from to prospective payment to cost-based reimbursement, which began with Medicare and spread to other insurers during this time period. However, by the mid- to late 1990s, after the market adjusted to changes in the way hospitals were reimbursed, managed care pushed reimbursement of privately insured patients to historically low levels in many markets. Thus, the relative generosity of Medicaid and Medicare payments increased in the latter half of the period. Second, managed care also shifted a larger portion of risk to mainly urban hospitals in the latter half of the 1990s through capitation. Under prospective payment, hospitals are reimbursed at a fixed rate based on a patient's diagnosis. In contrast, hospitals are reimbursed based on the number of enrollees in the managed care plan under capitation. Capitation shifts more risk onto hospitals, and those that are most effective at managing the risk are more likely to be successful. Finally, the technological substitutability between inpatient and outpatient care increased throughout the period. Thus the economic climate for hospitals that performed inpatient and outpatient surgeries was more favorable at the end of the period.

Several previous empirical studies of exit have tested Ghemawat and Nalebuff's (1985, 1990) prediction that in an oligopolistic market for a homogenous good whose demand is declining, survival is inversely related to size. (1) Deily (1991) found no evidence of a simple inverse relationship between a plant's size and exit. Rather, proxies of a plant's profitability were important in determining which plants survived the contraction of the steel industry, thus supporting the neoclassical theory that long-run expected profit determine whether a plant will exit. Gibson and Harris (1996) also find that larger, lower cost, and older plants are less likely to exit an industry. (2)

The focus of previous empirical studies of hospital exit, however, has not been on testing competing theories of exit but describing the characteristics of hospital that close. Most likely this is because hospitals, with their many unique features, are ill-suited to testing general theories of exit. For example, the hospital industry is populated by government, nonprofit, and for-profit firms. We expect for-profit hospitals to be more likely to exit because not only do they compare uses of capital across several industries but they are also unable to credibly commit to remaining in a market with excess capacity, as shown in Wedig et al. (1989). In contrast, non-federal government and many nonprofit hospitals have alternative sources of funding that can sustain them through a marketwide shakeout.

In their study of small hospitals between 1985 and 1988, Williams and colleagues (1992) found that financial variables (total margin, costs, and revenues) are significant determinants of hospital closure and that public hospitals are less likely to close than other hospitals. …

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