Hospital competition with soft budgets

Abstract

We study the incentives for quality provision and cost efficiency for hospitals with soft budgets, where the payer can cover deficits or confiscate surpluses. While a higher bailout probability reduces cost efficiency, the effect on quality is ambiguous. Profit confiscation reduces both quality and cost efficiency. First-best is achieved by a strict no-bailout and no-profit-confiscation policy when the regulated price is optimally set. However, for suboptimal prices, a more lenient bailout policy can be welfare-improving. When we allow for heterogeneity in costs and qualities, we also show that a softer budget can raise quality for high-cost patients.