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Authors:

• Mingshan Lu
  University of Calgary

• Ching-to Albert Ma
  Boston University

• Lasheng Yuan
  University of Calgary

This paper examines the incentive effects of Performance-Based Contracting (PBC) in a model of patient heterogeneity, provider horizontal differentiation and asymmetric information.  Treatment effectiveness is affected by the match between a patient's "type" (illness, severity) and a provider's practice style (speciality, treatment and intensity).  Before PBC, a provider's revenue is unrelated to treatment effectiveness; therefore, providers supply treatments even if their patients' types do not match their practice styles.  Under PBC, budget allocation is (positively) related to treatment performance; patient-provider mismatch is reduced because patients are referred more often.  Using PBC data from the state of Maine, we show that PBC leads to more efficient matching between patients and providers.  We conclude that the data support our hypothesis that PBC may lead to welfare gain.