Health-Insurer Bargaining Power and Firms' Incentives to Manage Earnings

Abstract

Health-insurance premiums account for a significant portion of the cost base of U.S. corporations. A recent study finds that health-insurance premiums increase for firms that experience positive profit shocks (Dafny 2010), suggesting that the U.S. health-insurance market is not perfectly competitive. Motivated by this finding and the economic importance of health-insurance premiums, this is the first study to examine firms’ earnings-management incentives in the face of insurance carriers with strong bargaining power. We use an innovative dataset for a large sample of U.S. firms with detailed information on insurance premiums and insurance-plan characteristics. Employing an economic shock to insurance firms’ bargaining power and difference-in-differences tests, we find that firms manage their reported earnings downward when insurance providers have strong bargaining power. We further show that this effect is more pronounced in settings in which there are ex-ante reasons to expect stronger incentives to manage earnings downward. We also provide preliminary evidence suggesting that downward earnings management has the intended effect of mitigating future increases in health-insurance premiums. Our analyses highlight an inefficient health-insurance market as an important determinant of firms’ financial reporting choices.