The Efficiency of Nursing Home Chains and the Implications of Non-Profit Status

By Andersen, Randy I.; Lewis, Danielle et al. | Journal of Real Estate Portfolio Management, January 1, 1999 | Go to article overview

The Efficiency of Nursing Home Chains and the Implications of Non-Profit Status


Andersen, Randy I., Lewis, Danielle, Webb, James R., Journal of Real Estate Portfolio Management


Executive Summary: In this article, we estimate Xefficiency levels in the nursing home industry and investigate the impact of their profit status and chain affiliation on performance. Using a Bayesian stochastic frontier approach and a nation-wide data set, we find that nursing homes are relatively cost inefficient. We also find strong evidence that chain affiliations and nonprofit status reduce a firm's operational cost efficiency. Finding that chain-affiliated homes are less cost efficient than independent homes casts concerns on the industry in light of the recent growth in chain affiliations.

Winner of the 1999 American Real Estate Society manuscript prize for the Seniors Housing category.

Introduction

Steadily increasing health care costs for the growing elderly population has prompted many debates about the likely culprits and possible solutions. Practitioner and academic research has examined senior housing issues such as over-insurance, supplier-induced demand, slow growth in productivity, increases in per capita real income and increases in technology costs (Newhouse, 1992). However, as Vitaliano and Toren (1994) point out, little attention has focussed on the operational inefficiency of nursing homes. Operational inefficiency is generally defined as managerial failure to use the optimal level and mix of firm inputs to produce a given level of output. If X-inefficiencies are present, nursing homes could not only reduce average costs by more efficiently using their available resources, but profitability could also be improved on. The economics and finance literature term these cost X-inefficiencies and they have found that it is a highly effective method in measuring performance at the firm and industry level.

In this study, we focus on X-efficiency in the nursing home industry by using a stochastic frontier analysis with Bayesian statistics. In an Xinefficiency context, firms operate sub-optimally for two reasons. First, inefficiency is the failure to optimally allocate resources. The second is the failure to utilize resources optimally given their allocation. In other words, two firms may have the exact same resource allocation, yet one firm produces less than the other. The difference between how a firm could best utilize its resources versus actual input utilization is termed X-inefficiency (Leibenstein,1966).

Leibenstein (1966) argues that the majority of Xinefficiency losses arise from inadequate motivation by firm management. X-efficiency measures how effectively management minimizes costs within the firm. This type of information can be relevant in making human resource type decisions. Leibenstein suggests, on a broader spectrum, that motivation levels link the structure and competitiveness of the market in which a firm operates. If the nursing home market is competitive, nursing home managers and/or workers would have to operate efficiently in order to compete and survive.1 In an inefficient market, managers may not have to manage as effectively. Hence, if we can understand how efficient the nursing home industry is, and what arrangements are associated with increases in efficiency, policy may be implemented to increase the competitiveness and efficiency of this sector. Ultimately the results of this study may be useful in identifying practices that could potentially reduce health care costs in nursing homes and at the same time, increase the quality of services for the elderly.

Research Motivation and Prior Efficiency Studies

The prior efficiency studies in the nursing home sector have spent considerable time examining how profit status impacts performance. Using agency theory as proposed by Jensen and Meckling (1976) and Scanlon (1980), Palmer and Vogel (1985) suggest that for-profit nursing homes will be more efficient than non-profit homes because the residual cash flows accrue to the owners who have incentives to ensure cost minimization. Researchers also suggest those non-profit firm managers would be more inclined to maximize their own utility. …

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