Regulation, Financial Incentives, and the Production of Quality

Abstract

An economic model for the production of health care quality is presented, encompassing financial and altruistic returns, penalties and rewards, and transaction costs. After maximizing returns from quality and service volume, the role of regulatory policies and pay-for-performance proposals in producing quality is examined. The tension between the production of quantity and quality is demonstrated. Specifically, the model shows that increasing the costs of a quality improvement program reduces program effectiveness, sanctions for low quality will not improve the performance of high-quality providers, noncompliance with regulation can be a rational decision, and some pay-for-performance programs will not improve quality for low-quality providers. The model suggests incentive structures to improve quality for all providers. This model has application to a variety of social regulatory programs of importance in public health and health care, including health care quality (ie, regulation of nursing homes or medical laboratories) and environmental and food safety regulation.