Investment decisions in hospital technology when physicians are devoted workers

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Abstract:

This paper analyses the decision to invest in a new technology (as a way to increase quality) by a hospital using a real option framework. The environment is characterised by uncertainty on costs and returns of such investment and by the assumption that physicians are 'devoted workers'. We model the behaviour of three main actors: an agency purchasing hospital care (purchaser), a hospital (provider) and a representative hospital physician. The purchaser rewards the hospital at a fixed price for each patient treated and sets a quality-contingent long-term contract with the hospital according to a purchasing rule. First, we show that the presence of devoted physicians allows the hospital to reduce its investment while increasing the level of quality of care provided. We then analyse how the purchaser may influence the timing of the hospital's investment and the quality of care through strategic setting of the purchasing rule parameters. In particular, we show that if the purchaser aims at maximising overall quality of hospital care when physicians are devoted workers, it is not optimal to set a purchasing rule that cancels out the value of the option to defer the hospital's investment.

Keywords: Hospital technology; devoted worker; irreversible investment; quality; real options

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/10438590802547209

Affiliations: 1: Dipartimento di Scienze Economiche, University of Brescia, Brescia, Italy 2: Dipartimento di Scienze Economiche, Universita di Padova, Padova, Italy

Publication date: January 1, 2009

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