Moral Hazard and Risk Spreading in Partnerships

A unique dataset on medical group practice is used to investigate the degree to which firms choose to spread risk and sacrifice efficiency incentive s depends upon risk preferences, for which data are typically unavailable.

Abstract

Partnerships provide a classic example of the tradeoff between risk spreading and moral hazard. The degree to which firms choose to spread risk and sacrifice efficiency incentives depends upon risk preferences, for which data are typically unavailable. We use a unique dataset on medical group practice to investigate this tradeoff. Risk aversion leads to compensation arrangements, which spread risk through greater sharing of revenues. We find that compensation arrangements with greater degrees of revenue sharing significantly reduce physician effort. The results imply that changing the method of physician payment from fee-for-service to capitation will dramatically reduce physician effort.