Hospital-Physician Integration and Hospital Ownership

Employment of physicians by hospitals – typically referred to as vertical integration – has increased significantly. Received theories fail to explain a key fact: The extent of vertical integration in not-for-profit (NFP) hospitals is substantially higher than in for-profit (FP) hospitals. We develop a model in which vertical externalities in the joint provision of complementary health care services by independent hospitals and physicians cause total prices and cost to be higher, and quantity, quality and profits to be lower, relative to a vertically integrated organization. This establishes an incentive for hospitals to integrate. We show that these externalities impact NFP hospitals more than they do FPs, so that NFPs have stronger incentives to integrate. Using data on US hospitals from 2000-2015 and with controls for other covariates including state-level “corporate-practice-of-medicine” regulations, we find support for our predictions. Our model not only explains patterns of vertical integration observed in the US hospital industry, but also has surprising implications for the effects of such integration on hospital and physician prices, and hence, for antitrust policy and empirical studies of pricing