Cost Center or Profit Center? Hospital Behavior in a Conflicting Regulatory Environment

Abstract

We examine the interaction between two forms of hospital regulation and their effect on hospital behavior. Because reimbursement under federal Medicare regulation is a fixed fee per diagnosis, hospitals are encouraged to behave more like cost centers and reduce cost through shorter average lengths-of-stay. Under California Medicaid (MediCal) regulation, reimbursement is on a per diem basis, which encourages hospitals to behave more like profit centers and increase profit through longer average lengths-of-stay. The different regulatory authorities thereby force California hospitals to have conflicting identities. We find that hospitals operating more like cost centers tend to reduce cost (have shorter average length-of-stay) more than hospitals that operate more like profit centers. Hospitals operating more like profit centers have length-of-stay associated with per diem profit rather than per diem cost. Finally, we find that hospitals with a greater uncertainty about what is the appropriate length-of-stay are more likely to follow the conflicting regulatory incentives and have a greater difference in average length-of-stay between their Medicare and MediCal populations.

JEL Classification: D20, M40