The Effect of Performance Pay Incentives on Market Frictions: Evidence from Medicare

Medicare has increased the use of performance pay incentives for hospitals, with the goal of increasing care coordination across providers, reducing market frictions, and ultimately to improve quality of care. This paper provides new empirical evidence by using novel operations and claims data from a large, independent home health care firm with the Hospital Readmissions Reduction Program (HRRP) penalty on hospitals providing identifying variation. We find that the penalty incentive to reduce re-hospitalizations passed through from hospitals to the firm at least for some types of patients, since it provided more care inputs for heart disease patients discharged from hospitals at greater penalty risk and that contributed more patients to the firm. This evidence suggests that HRRP helped increase coordination between hospitals and home health firms without formal integration. Greater home health effort does not appear to have led to lower patient readmissions.