Health-Insurer Bargaining Power and Firms’ Incentives to Manage Earnings
Professor Ole-Kristian HOPE
Deloitte Professor of Accounting
Rotman School of Management
The University of Toronto
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. Using an innovative dataset for a large sample of U.S. firms with detailed information on insurance premiums and insurance-plan characteristics, we find that firms manage their reported earnings downward when insurance providers have strong bargaining power. This finding holds using both association tests and a natural experiment. 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 reducing future health-insurance premiums. Our analyses highlight an inefficient health-insurance market as an important determinant of firms’ accounting choices.