Strategic Cost Management and Institutional Changes in Hospitals

untitled Strategic Cost Management and Institutional Changes in Hospitals SYLVIA H HSU∗ and SANDY Q QU ∗Schulich School of Business, York University, Toronto, Canada (Received July 2010; accepted Nove.

European Accounting Review Vol 21, No 3, 499– 531, September 2012 Strategic Cost Management and Institutional Changes in Hospitals SYLVIA H HSU∗ and SANDY Q QU ∗ Schulich School of Business, York University, Toronto, Canada (Received: July 2010; accepted November 2011) ABSTRACT Accounting research raises the concern that firms in the health care and defence contracting industries, when facing a dual payment system with both cost-based and fixed-rate payments, have an incentive to reallocate overhead costs through increasing inputs used in cost-based operations However, prior literature reports contradictory empirical evidence regarding such real activity manipulation Drawing on the institutional perspective, we hypothesise that firms’ market power and interorganisational dependence affect their cost-management strategies and choice of overhead allocation in response to dual payment systems Analysing the data of California hospitals from 1980 to 1991, we find that when facing a dual payment system, dominant (strong market position) hospitals adopt a cost-revenue-enhancing strategy, increasing direct costs for cost-based services without containing costs in fixed-rate services In contrast, nondominant hospitals choose a cost-reduction strategy and improve operation efficiency on fixed-rate services We also find that nondominant hospitals shift more overhead costs away from fixed-rate services to cost-based services by reclassifying the allocation bases across services; combining this cost shifting with the cost-reduction strategy, nondominant hospitals demonstrate the compliance with the regulation expectation of cost containment Introduction This study examines how firms strategically manage operation costs and overhead allocation under a dual payment system that incorporates both cost-based and fixed-rate payments Various industries, such as defence contracting, health care and telecommunications, use a dual payment system, whereby Correspondence Address: Sylvia Hsu, Schulich School of Business, York University, 4700 Keele Street, Toronto, Ontario, Canada M3J 1P3 Email: shsu@schulich.yorku.ca Paper accepted by Salvador Carmona 0963-8180 Print/1468-4497 Online/12/030499–33 # 2012 European Accounting Association http://dx.doi.org/10.1080/09638180.2012.658152 Published by Routledge Journals, Taylor & Francis Ltd on behalf of the EAA 500 S.H Hsu and S.Q Qu some products of a multi-product firm are subject to cost-based payments, and some are produced for a commercial market and subject to fixed-rate payments As firms’ common costs are used by multiple products, such a system creates arbitrage opportunities for firms to shift costs from fixed-rate to cost-based products, since the increase in the costs of cost-based products will be reimbursed (Demski and Magee, 1992; Rogerson, 1992) Using data from defence contracting firms, hospitals and the US Federal Reserve, accounting research empirically finds that firms manipulate cost-allocation procedures and reallocate common costs (Cavalluzzo et al., 1998; Eldenburg and Kallapur, 1997; Thomas and Tung, 1992) Cost shifting can be achieved by various means, from reassigning common costs to distorting input decisions (Demski and Magee, 1992; Rogerson, 1992) Reassigning common costs without involving real activities changes reported costs, but has no economic impact on cash flow Per the overhead allocation procedure, inputs are usually used as allocation bases to determine allocated amounts across products; the allocation procedure motivates firms to shift costs by modifying underlying economic activities For example, firms hire excess staff and increase direct costs used in cost-based products Hence, accounting scholars have expressed concerns about cost increases arising from such cost-shifting strategies (Demski and Magee, 1992; Rogerson, 1992) To address this concern, empirical research has investigated how firms under a dual payment system manage direct costs and overhead allocation among products/services; the results have been inconclusive (Cavalluzzo et al., 1998; Eldenburg and Kallapur, 2000) For example, Eldenburg and Kallapur (2000) find that direct costs of fixed services increase when hospitals encounter a dual payment system, suggesting that hospitals have less incentive to contain costs because of the benefit of cost shifting In contrast, Cavalluzzo et al (1998) show that after facing dual markets, the US Federal Reserve, in addition to reassigning overhead costs, improves operation efficiency and controls the direct cost in competitive services The mixed evidence suggests that firms under a dual payment system might take different cost-management strategies: a costrevenue-enhancing strategy in which firms increase the resource use in costbased products, or a cost-reduction strategy in which firms reduce the direct costs of fixed-rate products Institutional theory suggests that organisations strategically react in response to their environmental changes, because their capacity to influence the external environment and their dependence on other organisations vary (e.g Goodrick and Salancik, 1996; Greening and Gray, 1994; Modell, 2002; Oliver, 1991; Sherer and Lee, 2002) Emphasising actors’ intentionality, Oliver (1991) demonstrates how agents with different levels of interorganisational dependence and market power adopt different strategies in pursuit of their own interests; the strategies vary from active manipulation to passive compliance Drawing on institutional perspectives, this paper empirically examines firms’ strategic cost management in response to a dual payment system The Strategic Cost Management and Institutional Changes in Hospitals 501 cost-revenue-enhancing strategy leads to an increase in total costs of cost-based products When a firm has market power to charge a high price for cost-based products to recover the increased costs, it is able to increase profits by adopting the cost-revenue-enhancing strategy In contrast, when a firm is more dependent on external resources or has weak negotiating power in a competitive market, it is unlikely to adopt the cost-revenue-enhancing strategy, because it cannot charge a higher price Hence, we hypothesise that when facing a dual payment system, a firm with weak negotiating power is likely to adopt the cost-reduction strategy, while a firm with strong market power is likely to adopt the cost-revenue-enhancing strategy.1 The California hospitals provide a good setting for us to test our hypotheses Prior to 1983, US hospitals were paid according to costs, and had strong power to determine service prices (Mayes, 2007) In 1983, Medicare, a public insurance programme for seniors, changed its payment system for inpatient services from a cost-based, retrospective payment to the Prospective Payment System (PPS) in order to reduce health care expenses The PPS reimburses hospitals a fixed rate based on diagnosis-related groups (DRGs) (Department of Health and Human Services, 1983), and provides an incentive for hospitals to control costs The payment for Medicare outpatient services and patients from other payers were still based on reported costs Since then, hospitals in the USA have operated under a dual payment system In addition, California enacted the selective contracting legislation in 1982, which enabled payers to negotiate with hospitals and led to price competition in the California hospital industry (Meltzer et al., 2002) Thus, not all hospitals have the power to set service prices, because interorganisational dependence between hospitals and payers varies Classifying hospitals into dominant and nondominant hospitals on the basis of market share, we analyse how California hospitals responded to the introduction of Medicare’s PPS Consistent with our hypotheses, the results show that during the post-PPS period (1984 – 91), hospitals adopted different cost-management strategies Nondominant hospitals adopted the cost-reduction strategy, reducing the costs of fixed-rate services and complying with the financial constraints imposed by the PPS; in contrast, dominant hospitals applied the cost-revenueenhancing strategy, manipulating cost allocation through strong bargaining power over cost-based payers Furthermore, we examine how interorganisational dependence affects the extent of reassigning reported overhead costs between services.2 The economics literature suggests that cost shifting disappears when markets become competitive (Dranove, 1988; Morrisey, 1996) However, empirical evidence shows a positive correlation between the intensity of market competition and the extent of cost shifting (Cavalluzzo et al., 1998) Krishnan and Yetman (2011) suggest that institutional factors drive organisations’ cost-shifting behaviour The higher the institutional pressures to conform, the more likely it is that organisations strive to conform to these expectations imposed by their environment (DiMaggio and Powell, 1983; Meyer and Rowan, 1977) Therefore, we expect 502 S.H Hsu and S.Q Qu that under the increased institutional pressures from Medicare to be more efficient in delivering services, nondominant hospitals shift more costs away from fixedrate services than the dominant hospitals This study contributes to accounting literature in the following ways First, we demonstrate differential cost-management strategies and real activity manipulation Prior studies show that depending on the contract arrangements between an organisation and its client or payer, the organisation exploits accounting practices to increase its own interests – for example, by providing a biased budgetary estimate (Blanchard et al., 1986; Eldenburg and Soderstrom, 1996); reclassifying cost (Eldenburg and Kallapur, 1997; Eldenburg and Vines, 2004); or misreporting expenses (Krishnan et al., 2006) This stream of accounting literature emphasises homogeneous opportunistic behaviour in accounting practices Our study shows variations across organisations in their cost-allocation strategy Second, our results highlight that the interorganisational dependence between payers and hospitals affects a hospital’s choices in terms of operation strategies and accounting practices Fields et al (2001) call for research analysing the cost/ benefits of accounting choices, to determine whether self-interested attempts at accounting manipulation are always successful Krishnan and Yetman (2011) encourage further empirical studies to examine the combined effect of institutional and economic factors in driving organisations’ strategic reporting behaviour Building on these studies, our study responds to recent concerns regarding real activity manipulation (e.g Bushee, 1998; Roychowdhury, 2006), exploring the effects of a firm’s relation with its buyers/payers on strategies of real operation management Third, our findings have broader implications for policymakers A dual payment arrangement exists in the health care, defence contracting and telecommunications industries (Majumdar and Chang, 2010; Rogerson, 1994; Thomas and Tung, 1992) Researchers and policymakers express the concern that these industries manipulate cost allocation with inefficient operation and attain high profitability (Demski and Magee, 1992; Fonfria and Correa-Burrows, 2010; Rogerson, 1992) Our results demonstrate that because of variations in interorganisational dependence and negotiating power with cost-based buyers, firms not necessarily arbitrage cost-allocation procedures and increase operation costs of cost-based products/services Firms with weak negotiating power enhance their operation efficiency to maintain profitability Thus, it is crucial for regulatory institutions to maintain competition in the suppliers’ market and to secure the relative bargaining power of cost-based buyers Fourth, by analysing strategic cost-management responses to the PPS system in the US hospital industry, our study provides implications for the health care industry in European countries where DRG or case-mix payment systems were recently introduced (Busse et al., 2006; Pettersen, 2001; Schreyoăgg et al., 2006) Our findings show that hospitals adopt different operation strategies and reallocate overhead costs among services when some services are not subject to a fixed-rate payment When the DRG reimbursement system is applied only Strategic Cost Management and Institutional Changes in Hospitals 503 to inpatient services, hospitals may adapt their operations in outpatient services and shift costs to these services The paper is organised into six sections The next section introduces the regulation and payment system in the California hospital industry Section reviews the literature on cost-management strategies under a dual payment system and develops our hypotheses The fourth and fifth sections introduce the research design and the tests, and discuss the empirical results The final section discusses the implications for accounting research and policymaking Institutional Background of the US Hospital Industry The Regulation and Payment System in the Hospital Industry before 1983 The USA does not provide universal health care coverage for its citizens; there are various private health insurance plans, and public programmes such as Medicare for seniors and Medicaid for low-income families Before 1983, state insurance laws prohibited most payers from shifting patients to low-cost hospitals and also from using economic incentives – such as decreased co-payments – to influence patient choice of providers (Dranove et al., 1993) Because of the regulation, health care payers were unable to negotiate prices Payers paid hospital services on a cost-based, retrospective reimbursement payment system according to ‘a customary, prevailing, and reasonable basis’ (Starr, 1982, p 385); they ‘had little to no means of questioning either the legitimacy or the necessity of the care that patients received’ (Mayes, 2007, p 23) Consequently, ‘professional power was cemented through a reimbursement system that neither imposed limits nor required outside approval’ (Mayes, 2007, p 24) Facing the costbased reimbursement system, hospitals expanded their operations and increased costs in order to receive more revenues Hospitals competed on quality; hence, hospitals’ operation costs and service prices were higher in a competitive market (Krishnan, 2005; Robinson and Luft, 1985) Regulatory Changes of the Hospital Industry in California in the Early 1980s In the early 1980s, ‘a shift in the balance of political and economic power’ (Mayes, 2007, p 21) incurred between the providers of medical care and those who pay for it In 1983, Medicare changed the reimbursement system for its inpatient services from the cost-based system to the PPS, under which hospitals were paid a fixed amount based on the patient’s diagnosis.3 The PPS is perceived to provide an incentive for hospitals to reduce and control costs, because hospitals incur a loss if their costs are higher than the reimbursement, and gain if their costs are lower (Sheingold, 1986) While Medicare adopted the PPS for its inpatient services only, both Medicaid and private payers still use a cost-based payment scheme In 1982, California enacted selective contracting legislation,4 which allowed insurance payers to negotiate payments with hospitals Both the PPS 504 S.H Hsu and S.Q Qu and the selective contracting legislation significantly shifted the interorganisational dependence and power relationship between payers and hospitals Under the PPS, hospitals cannot negotiate prices on Medicare inpatient services The selective legislation meant that hospitals no longer had negotiating power over Medicaid and private payers (Dranove et al., 1993), and thus some hospitals could be paid lower prices for services After the selective contracting legislation was passed, one type of private payer – managed care organisations – grew rapidly in California In 1980, the US national enrolment rate of managed care organisations was as low as 4% (Tarlov, 1986) By the early 1990s, California became the nation’s managed care leader; 32.7% of the state’s population participated in an Health Maintenance Organizations (HMO) plan in 1991 (Currie and Fahr, 2004) These organisations place a strong emphasis on cost containment within health plans (Baker, 1999; Baker and Shankarkumar, 1997; Noether, 1988) With the tremendous growth of managed care organisations, hospitals experience intensifying pressures to reduce costs After 1986, the revenues of California hospitals declined at a greater rate than their costs (Zwanziger et al., 2000), implying that the bargaining power of the hospital industry in relation to its payers deteriorated Prices paid by private insurers are directly influenced by the competitiveness of the hospital market and a hospital’s relative bargaining position (Melnick et al., 1992) Literature Review and Hypothesis Development Cost-Management Strategies under a Dual Payment System A multiple-product firm under a dual payment scheme has an incentive to reclassify overhead allocation and to increase reported costs of cost-based operations (Cavalluzzo et al., 1998; Eldenburg and Kallapur, 1997; Thomas and Tung, 1992) Since revenues from cost-based operations are cost sensitive, reassigning overhead costs results in an increase in revenues from these operations without increasing actual expenses Firms usually use direct cost to allocate overhead costs; they can incur higher direct costs of cost-based services (e.g labour padding) to reallocate costs between services (Christensen and Demski, 2003; Rogerson, 1992) Such cost-shifting strategy has a real economic impact on cash flow Rogerson (1992) maintains that it is profitable for firms to increase direct costs of the cost-based products and then pass on more overhead costs to these products, since both increased direct costs and overhead costs in costbased products will be reimbursed at a margin Hence, within a dual payment system, firms have an incentive to impair operation efficiency because of the benefit from manipulation in cost-allocation procedures (Demski and Magee, 1992) Against this backdrop, empirical evidence shows that while reallocating costs across products, some firms not adopt the cost-revenue-enhancing strategy Although Eldenburg and Kallapur (2000) find no cost containment in hospitals Strategic Cost Management and Institutional Changes in Hospitals 505 following the introduction of a dual payment system, suggesting the profitability of the cost-revenue-enhancing strategy, other empirical evidence suggests that firms choose to contain costs (Cavalluzzo et al., 1998) To illustrate and compare the profitability and other outcomes of cost-management strategies under a dual payment system, a numerical example is provided in the Appendix The numerical example shows that after the reimbursement system changes from a single cost-based system to a dual system, the cost-revenueenhancing and cost-reduction strategies both increase the firm’s profit when compared with the status quo strategy, which does not change costs in both products When the firm chooses the cost-revenue-enhancing strategy, the total costs of the cost-based products will increase radically; consequently, the prices of the costbased products considerably inflate A necessary condition for making the costrevenue-enhancing strategy profitable is that the firm be able to charge a high price for cost-based products When a firm does not have the negotiating power to charge higher prices, the firm is unable to increase profits by adopting the cost-revenue-enhancing strategy Dominant Market Position and Cost-Revenue-Enhancing Strategy Applying the convergent insights of institutional and resource dependence theories, Oliver (1991) theorises how organisations exercise strategic choices within the constraints imposed by institutional environments She suggests that variation in the capacity to exercise power explains the divergence of organisations’ responses to the environment, which vary from passive conformity to active manipulation We argue that interorganisational dependence and power between hospitals and payers influences what strategy a hospital is likely to adopt under a dual payment system The ability to charge a high price assures the profitability of the cost-revenue-enhancing strategy Dranove (1988, p 56) finds that when a hospital has market power, it charges a higher price to private payers in response to price cuts from public payers Although the selective contracting legislation enabled payers to negotiate prices, dominant hospitals might still maintain their bargaining power over payers, charging a high price for cost-based services In response to the financial constraints of the fixed payment, these hospitals were likely to employ the cost-revenue-enhancing strategy by incurring additional costs, as this strategy was easy to implement Their strong negotiating power ensures high prices to recover the extra costs incurred and makes this strategy profitable We hypothesise: H1: Dominant hospitals adopt the cost-revenue-enhancing strategy under a dual payment system, that is, increase direct costs related to cost-based services, in the early post-PPS period As stated earlier, the power relationship between hospitals and payers started to alter after the selective contracting legislation was implemented Zwanziger 506 S.H Hsu and S.Q Qu et al (2000) find that after 1986, the revenues of California hospitals decreased at a greater rate than their costs, suggesting a considerable decline in hospitals’ negotiating power with payers in the late post-PPS period When hospitals are less likely to negotiate a high price for cost-based operations, the cost-revenueenhancing strategy will not be a sustainable strategy for maintaining profitability We expect that because of the weakened negotiating power, the likelihood of dominant hospitals maintaining the cost-revenue-enhancing strategy, if observed, wanes over time We state H2 in a null form: H2: Dominant hospitals not adopt the cost-revenue-enhancing strategy under a dual payment system in the late post-PPS period Nondominant Market Position and Cost-Reduction Strategy The selective contracting legislation enhanced payers’ negotiating power and led the growth of managed care organisations and price competition among hospitals The cost-revenue-enhancing strategy might not be appropriate for hospitals with a weak position in the market since they were unable to charge a high price In response to regulatory changes, a firm with weak power or high interorganisational dependence chooses to conform to what is deemed as appropriate in order to gain legitimacy and secure its survival (DiMaggio and Powell, 1983; Meyer and Rowan, 1977; Oliver, 1991) Using an institutional perspective, Covaleski et al (1993) find that by adopting case-mix accounting systems to measure production efficiency of the DRG services, hospitals reflect their ‘need to conform to societal expectations of acceptable practice [and] the technical imperative of fostering rationality’ (p 65) Hospitals with weak power conform to Medicare’s expectations of reducing health expenses; they control the costs of and improve the operation efficiency of Medicare inpatient services We thus hypothesise the following: H3: Nondominant hospitals adopt a cost-reduction strategy under a dual payment system, that is, reduce direct costs related to fixed-rate services, in the post-PPS period Market Position and Reallocation of Overhead Costs between Fixed-Rate and Cost-Based Services5 In addition to adaptation of operation strategies, changes in accounting practices serve as another convenient means for reallocating overhead costs internally (Covaleski and Dirsmith, 1991) Under the increased institutional pressures from Medicare to be more efficient in delivering services, nondominant hospitals can reallocate overhead costs away from fixed-rate services to demonstrate compliance with external expectations of efficient operations and cost reduction in Strategic Cost Management and Institutional Changes in Hospitals 507 these services In an analysis of cost shifting across expense categories, Krishnan and Yetman (2011) find that hospitals facing higher normative pressures to demonstrate efficiency shift costs to a greater extent Thus, ‘by providing an appearance or pretext of acceptance of normative expectations, hospitals can project conformity to such norms’ (p 1007) Shifting overhead costs away from fixed-rate services also generates economic benefits Prior accounting literature shows that firms reallocate overhead to cost-based services to increase profits (Cavalluzzo et al., 1998; Eldenburg and Kallapur, 1997) Because of their weak negotiating power, nondominant hospitals are unable to adopt the cost-revenue-enhancing strategy to increase revenues as dominant hospitals However, shifting more overheads to cost-based services increases reported costs in these services and may lead to an increase in revenues from these services Because such shifting does not have a real economic impact on service costs, the increase in revenues, if any, will improve a hospital’s profit We expect that because of economic benefits, institutional pressures and the need for legitimacy, nondominant hospitals shift reported overhead costs away from fixed-rate services to a greater extent H4: Nondominant hospitals shift reported overhead costs away from fixed-rate services to a greater extent than dominant hospitals in the post-PPS period Methodology Research Sample We use a sample of California hospitals from 1980 to 1991 to examine our hypotheses California hospitals started to face a dual system when the PPS was introduced in 1983 The service costs before 1983, when hospitals faced homogeneous cost-based contracts, serve as a control group to neutralise all other influences; hence, this context provides a powerful natural experiment setting We include California acute care hospitals in the sample, excluding long-term care facilities or specialised service providers, because these services are usually not paid by Medicare, and therefore are not affected by the changes in the payment scheme The data are publicly available through the Office of Statewide Health Planning and Development (OSHPD) Research Design and Variable Definitions California hospitals submit an annual financial report to the California Hospital Commission.6 Hospitals follow the guidelines of the Commission to assign costs and report direct costs and allocated costs according to department Hospital departments are categorised into revenue-producing departments that provide 508 S.H Hsu and S.Q Qu patient services7 and non-revenue-producing departments (e.g administration services and housekeeping) that provide supporting services Costs that are traceable to a particular department are assigned to that department as direct costs Direct costs of non-revenue-producing departments are allocated to revenue-producing departments through a variety of allocation bases.8 Hospitals compute the service charges billed to patients according to the sum of allocated costs and the direct costs of revenue-producing departments We classify departments into two types: fixed-rate service departments that are primarily paid by the Medicare PPS and cost-based service departments that mainly provide non-Medicare-inpatient services Because the PPS was implemented in October 1983, we calculate the proportions of departmental Medicare inpatient services for the years 1980 – 82 to represent the proportion of fixed-rate services provided by each department We also compute the ratio of hospital revenues from Medicare inpatient services to total hospital revenues We average the ratios of each department and of each hospital for these three years Departments with a ratio higher than their hospital ratio are defined as fixed-rate departments and those with ratios lower than their hospital ratio are defined as cost-based departments.9 To examine hospitals’ cost-management strategies, we sum up the direct costs and service quantities of the fixed-rate and cost-based departments, respectively, and calculate the average direct cost per service There is no consistent unit measure of service quantities among departments For example, the medical acute centre uses patient days as a measure of service quantities, while a clinic uses the number of visits We choose patient days of the medical acute centre as the basis of the quantity measure, and use the gross charge per service – which is determined by case complexity and technical level of services – to adjust the relative complexity of services produced by patient service departments (Clement, 1997; Eldenburg and Kallapur, 1997, 2000).10 To illustrate, the gross charge per patient day of the medical acute centre is $100, and the gross charge per clinical visit is $20 Therefore, one clinical visit equals 0.2 adjusted patient days We classify hospitals into hospitals with strong and weak negotiating power (dominant vs nondominant hospitals) by their market share, which is defined here as the ratio of the number of hospital discharges to the total discharges in a county.11 Market share has generally been accepted as a measure of a firm’s market position (e.g Caves and Porter, 1978; Davies and Geroski, 1997) Hospitals with a larger market share wield their market power to negotiate a higher price with insurers (Brooks et al., 1997; Krishnan, 2000; Melnick et al., 1992) However, to the best of our knowledge, no literature defines the specific level of market share that must be attained by a dominant hospital (White, 1983, p 16) A dominant position might be undertaken with a market share of between 20 and 40% (Commission of the European Communities, 1980, p 28) We define hospitals owning at least 20% of market share as dominant hospitals.12 518 S.H Hsu and S.Q Qu the dependent variable as direct costs of cost-based departments We find significant DOMINANCE (p ¼ 0.056), TEACHING STATUS (p ¼ 0.027), LOCATION (p ¼ 0.007), YEAR (p , 0.001) main fixed effects; the interaction of YEAR and DOMINANCE are also significant (p ¼ 0.043) Panel B of Table shows that main fixed effects of TEACHING STATUS (p , 0.001), YEAR (p , 0.001) and Occup% (p ¼ 0.005) are significant in the model where the dependent variable is direct costs of fixed-rate departments Panel C of Table presents the result of H1 and H2, comparing the least squares means of Cost, which are adjusted by hospitals’ characteristics, occupancy rate and patient mix The direct cost of cost-based services is $115.94 in the pre-PPS period and increases to $123.01 in the early post-PPS period; the difference is significant from zero (F-value ¼ 9.22, p ¼ 0.002) H1 is supported; that is, dominant hospitals adopted the cost-revenue-enhancing strategy in the early post-PPS period H2 hypothesises that dominant hospitals not continue the cost-revenue-enhancing strategy in the late post-PPS period We find no significant difference between the costs of cost-based departments in the pre-PPS period and those in the late post-PPS period (F-value ¼ 0.01, p ¼ 0.904) To understand how nondominant hospitals adapt their operations in cost-based services in response to the introduction of the PPS, we construct planned contrasts of the least squares mean Cost for cost-based departments of nondominant hospitals Panel C of Table shows that nondominant hospitals moderately increase the costs of cost-based services from $123.67 in the pre-PPS period to $125.52 in the early post-PPS period, and significantly reduce the costs of cost-based services to $120.24 in the late post-PPS period This finding indicates that because of their weak negotiating power with cost-based payers, nondominant hospitals not choose the cost-revenue-enhancing strategy We graphically present the results in Figure In order to maintain viability, nondominant hospitals reduce the costs of fixedrate departments, conforming to the constraints imposed by the PPS, as stated in H3 Table 2, Panel D shows that the direct cost of fixed-rate services in the prePPS period is $120.90, and it significantly reduces to $116.27 in the early postPPS period (F-value ¼ 18.16, p , 0.001) and to $110.81 in the late post-PPS period (F-value ¼ 41.10, p , 0.001) In contrast, dominant hospitals not reduce the costs of fixed-rate services in the early post-PPS period despite the financial constraints of the PPS However, they significantly reduce the costs of fixed-rate services in the late post-PPS period.15 Results on Overhead Allocations (H4) H4 hypothesises that compared to dominant hospitals, nondominant hospitals shift more overhead costs away from fixed-rate departments to demonstrate their compliance with Medicare’s expectation of cost containment Such shifting may increase the revenues and profits from cost-based services because of the increased reported costs Table summarises the results of the repeated-measures Strategic Cost Management and Institutional Changes in Hospitals 519 Figure Comparison of service costs in pre-PPS, early post-PPS and late post-PPS periods Notes: Planned contrasts of least squares mean Cost in the pre-PPS, early postPPS and late post-PPS periods is obtained from the model Costjklmh ¼ m + Hh + Di + Oj + Tl + Lm + Yk + YDjk + Sizeh + Occup%h + Mcare%h + Mcaid%h + 1jklmh (see Table for the definitions of variables) The mean Costs expressed in parentheses are least squares mean estimates conditional on DOMINANCE, OWNERSHIP, TEACHING STATUS, LOCATION, YEAR, YEAR × DOMINANCE, and the means of Size, Occup%, Mcare% and Mcaid% The pre-PPS period refers to the years 1980–83; the early post-PPS period refers to the years 1984–87; the late post-PPS period refers to the years 1988–91 ∗ , ∗ ∗ , ∗ ∗ ∗ Significance levels of 0.1, 0.05 and 0.01, respectively ANCOVA model of Equation (3) Consistent with H4, the result shows a signifiC C cant difference between (OHR sqftnondominant,post − OHR sqftnondominant,pre ) and C C (OHR sqftdominant,post − OHR sqftdominant,pre ) (F-value ¼ 5.84, p ¼ 0.016) Discussion of Hospitals’ Strategic Cost Management in Response to Regulation Changes As shown in Figure and Table 2, nondominant hospitals adopt the costreduction strategy in response to the financial constraints of the fixed-rate services They also shift overhead costs away from the fixed-rate services Although such shifting increases the reported overhead costs of cost-based services, nondominant hospitals significantly reduce the direct costs of these services in the late post-PPS period That the cost reimbursement rates from the cost-based services, especially Medicaid services, decrease significantly in the late post-PPS period 520 S.H Hsu and S.Q Qu Table Summary statistics, estimated conditional means and planned contrasts from a repeated-measures analysis of covariance of overhead allocation C ¼ m + Hh + Di + Oj + Tl + Lm + Yk + YDjk + Sizeh + Occup%h + OHR sqfthijklm Mcare%h + Mcaid%h + 1hijklm Panel A: summary of the fixed effects for the full model of OHR_sqftCa DOMINANCE OWNERSHIP TEACHING STATUS LOCATION YEAR YEAR ì DOMINANCE Size Occup% Mcare% Mcaid% N ẳ 3686, R2 ¼ 9.54%, F-value ¼ 12.4, p-value , 0.001 Panel B: planned contrasts of least squares mean OHR_sqftCb Nondominant, post-PPS (1.021) Nondominant, pre-PPS (0.924) Dominant, post-PPS (0.980) Dominant, pre-PPS (0.941) (H4)c F-value p-value 1.43 1.09 7.03 1.43 5.23 1.33 5.31 3.43 7.27 1.26 0.233 0.335 0.008 0.231 ,0.001 0.203 0.021 0.064 0.007 0.262 F-value p-value 5.84 0.016 OHR_sqftC is calculated as (OH sqftC /UnitC ) (TOH sqft/UnitTOT ) where OH_sqftC ¼ overhead costs allocated to cost-based departments via square footage; TOH_sqft ¼ total overhead costs allocated via square footage; UnitC ¼ total adjusted patient days in cost-based departments; and UnitTOT ¼ total hospital adjusted patient days Cost-based departments have the proportion of Medicare inpatient services lower than the proportion of hospital Medicare inpatient services See Table for the definitions of other variables b Test statistics reflect contrasts of least square means c The mean values of OHR_sqftC expressed in parentheses are least squares mean estimates conditional on DOMINANCE, OWNERSHIP, TEACHING STATUS, LOCATION, YEAR, YEAR × DOMINANCE, and the means of Size, Occup%, Mcare% and Mcaid% The pre-PPS period refers to the years 1980–83; the early post-PPS period refers to the years 1984–87; the late post-PPS period refers to the years 1988– 91 a implies that nondominant hospitals not have the capacity to exercise power with cost-based payers ‘When an organisation anticipates that conformity will enhance social or economic fitness, acquiescence will be the most probable response to institutional pressures’ (Oliver, 1991, p 161) Following the expectations of Medicare and HMOs in terms of cost control in health care expenses, nondominant hospitals seem to accept the norm of cost containment as a given They enhance operation efficiency and control costs for both fixed-rate and costbased services to maintain their economic fitness They comply with institutional pressures ‘in anticipation of specific self-serving benefits that may range from social support to resources or predictability’ (p 153) Dominant hospitals adopted a different strategy Because of their strong market position in the early post-PPS period, they exercised their power and actively reshaped resources used in cost-based services, following Oliver’s manipulation Strategic Cost Management and Institutional Changes in Hospitals 521 strategy (1991) Dominant hospitals adopted the cost-revenue-enhancing strategy; that is, they increased operation costs in cost-based services and shifted overhead costs to these services; they did not contain the costs used in fixed-rate services However, in the late post-PPS period, they experienced growing pressures in negotiating with Medicaid and were not able to bargain for high prices As a result, they did not continue the cost-revenue-enhancing strategy; they chose to compromise to the financial constraints imposed by the PPS and started to control the costs of fixed-rate services in the late post-PPS period In sum, our findings, consistent with Oliver (1991), show that the variation in the capacity to exercise power is an important dimension in explaining the divergence of organisations’ cost-shifting and strategic cost management in response to a dual payment system Hospitals react to the change in the Medicare payment system by adopting a cost-management strategy that suits their own interests; they comply with the constraints, compromise or manipulate accounting practices and adapt operations Robustness Tests In the main test, we define dominant hospitals as those having a 20% market share We apply different definitions of dominant hospitals in the robustness tests The intensity of market competition also affects hospitals’ market position; hospitals have little market power in a competitive market The Federal Trade Commission defines a highly concentrated market as a market with a Herfindahl – Hirschman Index (HHI) larger than 0.18, and a moderately concentrated market as one with an HHI between 0.1 and 0.18 Hence, in a moderately or highly concentrated market (i.e HHI 0.1), we rank hospitals according to their market share and define the top two hospitals as the market leaders, since they have stronger negotiating power (Kwoka, 1977).16 We re-estimate Equation (1) and present the result in Table 4, which is qualitatively similar to that shown in Table Porter’s five forces framework suggests that buyers’ negotiating power is one of the determinants of rivalry within an industry (Porter, 1980) As discussed earlier, the selective contracting legislation led to rapid growth of managed care organisations, which imposed financial pressures on hospitals to operate efficiently (Baker, 1999; Baker and Shankarkumar, 1997; Noether, 1988) Empirical evidence shows that in the areas with a high HMO penetration rate, hospitals compete on prices and reduce their expenses (Morrisey, 2001; Robinson, 1991) Hospitals’ profitability decreases as the HMO penetration rate increases (Zwanziger et al., 2000) These findings suggest that in areas with high HMO penetration, hospitals have weak negotiating power Hence, we define hospitals in the area with high HMO enrolment as nondominant hospitals Obtaining the HMO enrolment rate of each county in California from Currie and Fahr (2004), we define nondominant hospitals as those in the counties with the HMO enrolment rate above the median (i.e 16.7%) Table shows the results of the re-estimation of Equation (1), which support H1 – H3 522 S.H Hsu and S.Q Qu Table Summary statistics, estimated conditional means and planned contrasts from a repeated-measures analysis of covariance (ANCOVA) of hospital cost-management strategies (with dominant hospitals defined as the top two hospitals in a moderately or highly concentrated market)a Costhijklm ¼ m + Hh + Di + Oj + Tl + Lm + Yk + YDjk + Sizeh + Occup%h + Mcare%h + Mcaid%h + 1hijklm Panel A: summary of the fixed effects for the full model of cost-based departments DOMINANCE OWNERSHIP TEACHING STATUS LOCATION YEAR YEAR × DOMINANCE Size Occup% Mcare% Mcaid% N ¼ 3686, R2 ¼ 15.14%, F-value ¼ 21.03, p-value , 0.001 Panel B: summary of the fixed effects for the full model of fixed-rate departments DOMINANCE OWNERSHIP TEACHING STATUS LOCATION YEAR YEAR × DOMINANCE Size Occup% Mcare% Mcaid% N ¼ 3686, R2 ¼ 14.26%, F-value ¼ 19.62, p-value , 0.001 Panel C: planned contrasts of least squares mean Cost of cost-based departments (cost-revenue-enhancing strategy) Dominant, early post-PPS (127.99) Dominant, pre-PPS (121.46) (H1) Dominant, late post-PPS (119.80) ¼ Dominant, pre-PPS (121.46) (H2) Nondominant, early post-PPS (124.17) ¼ Nondominant, pre-PPS (122.47) Nondominant, late post-PPS (119.43) ¼ Nondominant, pre-PPS (122.47) Panel D: planned contrasts of least squares mean Cost of fixed rate departments (cost-reduction strategy) Nondominant, early post-PPS (114.86) , Nondominant, pre-PPS (119.18) (H3) Nondominant, late post-PPS (109.45) , Nondominant, pre-PPS (1119.18) (H3) Dominant, early post-PPS (118.67) ¼ Dominant, pre-PPS (120.61) Dominant, late post-PPS (113.31) ¼ Dominant, pre-PPS (120.61) a See Table for variable definitions and test statistics F-value p-value 0.32 0.99 4.86 12.21 8.46 2.35 0.00 0.00 0.94 0.90 0.569 0.370 0.028 ,0.001 ,0.001 0.007 0.988 0.974 0.332 0.344 F-value p-value 4.76 0.35 11.67 1.71 11.88 1.33 1.60 9.22 2.36 0.05 0.029 0.706 ,0.001 0.191 ,0.001 0.199 2.063 0.002 0.125 0.825 F-value p-value 11.56 0.50 2.08 ,0.001 0.904 0.149 3.83 0.050 F-value p-value 29.82 ,0.001 72.72 ,0.001 0.88 5.98 0.349 0.015 Strategic Cost Management and Institutional Changes in Hospitals 523 Table Summary statistics, estimated conditional means and planned contrasts from a repeated-measures analysis of covariance (ANCOVA) of hospital cost-management strategies (with dominant hospitals defined as hospitals in a market with low HMO penetration)a Costhijklm ¼ m +Hh + Di + Oj + Tl + Lm + Yk + YDjk + Sizeh + Occup%h + Mcare%h + Mcaid%h + 1hijklm Panel A: summary of the fixed effects for the full model of cost-based F-value departments p-value DOMINANCE OWNERSHIP TEACHING STATUS LOCATION YEAR YEAR × DOMINANCE Size Occup% Mcare% Mcaid% N ¼ 3686, R2 ¼ 15.14%, F-value ¼ 21.03, p-value , 0.001 2.86 0.95 4.87 10.01 6.11 1.19 0.01 0.00 1.04 0.88 0.091 0.385 0.027 0.002 ,0.001 0.286 0.908 0.993 0.308 0.348 F-value p-value 0.00 0.38 11.87 0.99 11.70 1.33 1.52 8.34 2.56 0.16 0.962 0.686 ,0.001 0.319 ,0.001 0.202 0.218 0.004 0.109 0.690 F-value p-value Panel B: summary of the fixed effects for the full model of fixed-rate departments DOMINANCE OWNERSHIP TEACHING STATUS LOCATION YEAR YEAR × DOMINANCE Size Occup% Mcare% Mcaid% N ¼ 3686, R2 ¼ 14.26%, F-value ¼ 19.62, p-value , 0.001 Panel C: planned contrasts of least squares mean Cost of cost-based departments (cost-revenue-enhancing strategy) Dominant, early post-PPS (122.98) Dominant, pre-PPS (116.23) (H1) Dominant, late post-PPS (118.55) ¼ Dominant, pre-PPS (116.23) (H2) Nondominant, early post-PPS (127.23) ¼ Nondominant, pre-PPS (125.48) Nondominant, late post-PPS (121.36) ¼ Nondominant, pre-PPS (125.48) Panel D: planned contrasts of least squares mean Cost of fixed rate departments (cost-reduction strategy) Nondominant, early post-PPS (115.92) , Nondominant, pre-PPS (120.40) (H3) Nondominant, late post-PPS (110.11) , Nondominant, pre-PPS (120.40) (H3) Dominant, early post-PPS (116.5) ¼ Dominant, pre-PPS (117.58) Dominant, late post-PPS (112.80) ¼ Dominant, pre-PPS (117.58) a See Table for variable definitions and test statistics 9.14 0.82 2.13 7.05 0.003 0.364 0.144 0.008 F-value p-value 24.95 ,0.001 75.85 ,0.001 0.03 1.88 0.581 0.170 524 S.H Hsu and S.Q Qu We also apply a dynamic panel estimation approach that includes lagged dependent variables as instrument variables to address the issue of the correlation between error components with some independent variables (Ahn and Schmidt, 1995; Arellano and Bover, 1995) The result is qualitatively similar (unreported) Conclusion Prior literature has raised concerns that when firms face a dual payment system in which products or services are paid by cost-based or fixed-rate systems, firms opportunistically manipulate cost shifting and choose the cost-revenue-enhancing strategy to increase their profit (Demski and Magee, 1992; Rogerson, 1992) A dual payment system commonly exists in the health care, military contracting and telecommunications industries (Majumdar and Chang, 2010; Rogerson, 1994; Thomas and Tung, 1992), which account for a large amount of GDP in many countries It is thus important to empirically examine whether such a system motivates firms to exploit accounting allocation and impair operation efficiency Drawing upon an institutional perspective, we suggest that when operating under a dual payment system, hospitals adopt different cost-management strategies and real activity manipulation depending on their market position and interorganisational dependence The cost-revenue-enhancing strategy is adopted by hospitals with lower interorganisational dependence with payers; with strong market power, these hospitals can charge a high price to recover the increased costs, which renders the cost-revenue-enhancing strategy profitable Nondominant hospitals adopt the cost-reduction strategy, complying with the institutional expectation of cost containment Furthermore, we find that both types of hospitals reassign overhead costs and report more costs used by cost-based services Because of economic benefits and institutional pressures, nondominant hospitals shift costs away from fixed-based services to a greater extent than dominant hospitals Our study provides broader implications on firms’ strategic choices in managing operation costs and overhead allocations in response to similar regulatory environments with dual payments in different industries or countries With the objectives of containing costs and improving operation efficiency, some European countries have introduced DRG or case-mix payment systems to their health systems (Busse et al., 2006; Pettersen, 2001) We find that in response to the DRG system, hospitals may choose the cost-revenue-enhancing strategy and reallocate overhead costs when the regulations and the institutional environment enable them to so This evidence highlights the importance of maintaining market competition and negotiating power of payers to enhance hospitals’ operation efficiency We acknowledge the limitations of the study The change in direct costs might be due not to real activity manipulation but to the change in quality; after the PPS, dominant hospitals might increase the direct costs to improve their quality We Strategic Cost Management and Institutional Changes in Hospitals 525 not have quality data to address this issue Furthermore, it is difficult to attribute the decreased service costs in nondominant hospitals to lower service quality Research on health care management suggests that better quality care often lower costs because of the efficiency of experienced medical teams and fewer complications (Showstack et al., 1987; Winkelman et al., 1991) While interorganisational dependence is well documented as a determinant of firms’ strategies in the industrial management literature (e.g Oliver, 1991; Pfeffer and Salancik, 1978), few studies in the accounting literature have examined how interorganisational dependence can influence firms’ accounting practices and cost management Our research demonstrates that even when firms have the opportunity to exploit overhead allocation, because of variation in firms’ interorganisational dependence and market power, some firms may be constrained by the consequences of cost manipulation on price and cash flow Future research into the effect of market positions on other real activity manipulation will advance our understanding of firms’ accounting choices and cost-management strategies Acknowledgements The authors acknowledge the helpful comments of Marcia Annisette, Mark Covaleski, Dean Neu, Alan Richardson, and workshop participants at the Annual Alternative Accounts Workshop in Toronto and the International Symposium of Management Accounting and Controls in Beijing The authors are especially grateful to two anonymous reviewers for their constructive and insightful comments and suggestions, and for the advice of the editor, Salvador Carmona Appendix: An Example of Cost-Management Strategies in Response to a Dual Payment System Table A1 provides a numerical example to demonstrate how the cost-revenueenhancing and cost-reduction strategies affect total costs of the cost-based and fixed-rate products, in comparison with the status quo strategy.17 This example also shows the profitability of these strategies For ease of demonstration, we assume that a firm originally faced a single cost-based payment system and provides one unit of products F and C The firm allocates overhead costs based on direct costs Assume that both products use the same amount of direct costs ($2000), and thus, overhead ($3000) is evenly allocated to the two products Total cost of both products is $3500 The reimbursement is 110% of total cost; the price for both products is $3850 When the payment for product F changes to a fixed-rate system (assuming the fixed amount is $3600), net income of the status quo decreases from $700 to $450 if the firm does not adopt any cost-management strategies (Table A1, Panel B) The firm can choose the cost-revenue-enhancing strategy to boost the revenues from product C Assume that the firm increases direct cost by $100 and 526 S.H Hsu and S.Q Qu Table A1 Numerical example of cost-management strategies in response to a dual payment system Panel A: under a single cost-based payment system Total overhead costs Product F Service quantity Direct costs/unit Overhead costs allocated/unit Total costs/unit Cost-based payment rate Payment/unit Total income $3000 Product C $2000 $1500 $3500 1.1 $3850 $2000 $1500 $3500 1.1 $3850 $700 Panel B: under a dual payment system Status quo Direct costs/unit Overhead costs allocated/unit Total costs/unit Cost-based payment rate Payment/unit Total income Cost-revenue-enhancing strategy Direct costs/unit Overhead costs allocated/unit Total costs/unit Cost-based payment rate Payment/unit Total income Cost-reduction strategy Direct costs/unit Overhead costs allocated/unit Total costs/unit Cost-based payment rate Payment/unit Total income Product F Product C $2000 1500 $3500 $2000 1500 $3500 1.1 $3850 $3600 $450 $2000 1464 $3464 $2100 1536 $3636 1.1 $3999 $3600 $499 $1900 1462 $3362 $2000 1538 $3538 1.1 $3892 $3600 $592 Note: Overhead costs are allocated to products F and C based on the direct cost In the single costbased payment arrangement, the reimbursement is based on 110% of the total cost In a dual payment system, product F is paid at a fixed rate of $3600 and product C is still paid 110% of the total cost reallocates overhead costs between the two products Overhead cost $1536 is allocated to product C (¼ 3000 ∗ 2100/(2100 + 2000)) and $1464 to product F (¼ 3000 1536) Because of the increase in direct costs and the reallocation of overhead costs, the total cost of product C is increased from $3500 to $3636 (¼ (2100 + 1536)) Hence, there is a large increase in the price, $3999 (¼ 3636 ∗ 1.1) As predicted in prior research (Christensen and Demski, 2003; Rogerson, 1992), the cost-revenue-enhancing strategy increases revenues and profit, compared with the status quo That is, with a $100 increase in direct costs, the Strategic Cost Management and Institutional Changes in Hospitals 527 revenue-enhancing strategy yields an increase in profit than the status quo strategy ($499 vs $450) On the other hand, the cost-reduction strategy reduces the costs of fixed-rate products The firm decreases direct cost by $100 in product F This strategy will also lead to overhead reallocation The firm allocates $1538 overhead cost to product C (¼ 3000 ∗ 2000/(2000 + 1900)) and $1462 to product F (¼ 3000 1538) Although there is no increase in the direct costs of the costbased product, the reallocated overhead costs increase the total cost from $3500 to $3538, with the final price set at $3892 (¼ 3538 ∗ 1.1) By choosing this cost-reducing strategy, the firm earns $592 profit (¼ 3538 ∗ 1.1 + 3600 2000 1900 3000), which is higher than the profit earned in the status quo strategy.18 In comparison with the status quo strategy, a $100 decrease in direct cost leads to $142 increase in profit because of the benefit from cost reallocation Both the cost-revenue-enhancing and cost-reduction strategies lead to an increase in profit and overhead shifted to the cost-based product Notes To increase profitability, a firm with market power might also choose to adopt the costreduction strategy by reducing the cost of fixed-based services However, cost containment is not an easy practice, as it needs time and effort to achieve If a firm is able to adopt the cost-revenue-enhancing strategy to maintain or even increase its profits, it might have less incentive to minimise costs We appreciate the suggestion of one of the reviewers We examine the intention of firms’ strategic reporting of overhead allocation We exclude overhead costs that are allocated via the allocation base of direct costs because both the costrevenue-enhancing strategy and the cost-reduction strategy change direct costs used in services and reallocate overhead costs Under the PPS, the inpatient fee is computed by multiplying a standard rate by a weight factor that depends on the complexity of the diagnoses and is categorised by DRGs The standard rate is determined by the average costs of hospitals in the same market, and is revised every year; it includes both labour-related (e.g wage index) and nonlabour shares (e.g cost of living adjustment) California was one of the leaders in implementing selective contracting (Zwanziger et al., 2000) The cost-revenue-enhancing strategy and the cost-reduction strategy lead to a shift of overhead costs When using direct costs as an allocation base, both strategies change the ratio of the allocation base among products because of the mechanism of cost allocation, and as a result, reallocate overhead costs This section examines how market position affects hospitals to reallocate overhead costs that are not allocated on the basis of direct costs On January 1986, the California Hospital Commission transferred its functions to the Office of Statewide Health Planning and Development (OSHPD, 2003) Revenue-producing departments include daily hospital centres, which provide inpatient services with routine nursing care and room accommodation (e.g intensive care unit and medical acute centre); and ancillary service centres, which perform outpatient services (e.g clinics) or diagnostic and therapeutic services for both outpatients and inpatients (e.g diagnostic radiology) Allocation bases include accumulated costs, costs of supplies, department full-time equivalents (FTE)s, gross patient revenues, number of square feet, etc As a sensitivity test, the median of the hospital ratios is used as a cut-off point to define fixedrate and cost-based departments The results are quantitatively similar (not reported) 528 S.H Hsu and S.Q Qu 10 There are three reasons that we choose the patient day of the medical acute centre as the basis of the service unit First, adjusted patient days are a common measure used in the health economics literature (e.g Clement, 1997); furthermore, interviews with senior managers in the health care industry indicate that the price per patient day of the medical acute centre is commonly used as a basis for evaluating the prices of other services Second, services provided in the medical acute centre are relatively consistent over time in comparison with other services (e.g cardiac catheterisation centre, intensive care centre) Therefore, we can control, at least partly, the effect of technological progress on the costs of services in the years 1980–91 Third, inpatient services of the medical acute centre are provided by all acute care hospitals Basing the quantity measure on patient days of the medical acute centre allows us to avoid unnecessary deletion of observations due to missing data 11 In the ‘Robustness Tests’ section, we examine our hypotheses using different classifications of dominant hospitals 12 We use less strict criteria to define a firm with a dominant position; hence, the definition might be against us to find a significant result of dominant hospitals’ responses 13 We replace year dummies with two dummy variables (early post-PPS and late post-PPS) in Equation (1) and estimate the coefficients of early post-PPS and of late post-PPS Results are qualitatively similar 14 The means of direct cost per adjusted patient day are the unconditional means Dollar values are deflated using the average consumer price index data from the Bureau of Labor Statistics (http:// www.bls.gov) and expressed in 1983 dollars 15 We also analyse how hospitals manage their overhead costs Both dominant and nondominant hospitals reduced hospital overhead costs over the sample period: dominant hospitals spent $71.6 per adjusted patient day in 1980 and $64.9 in 1991; nondominant hospitals spent $75.6 per adjusted patient day in 1980 and $67.9 in 1991 16 We choose top two hospitals, instead of the leading one, to increase the number of observations of dominant hospitals The less strict criteria for defining dominance (moderately concentrated vs highly 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