Partnerships provide a classic example of the tradeoff between risk spreading and moral hazard. The degree to which firms choose to spread risk and sacrifice efficiency incentives depends upon risk preferences, for which data are typically unavailable. The authors use a unique data set on medical group practice to investigate the degree to which firms which report more risk aversion have greater departures from first-best organizational incentive structures and the consequences for physician productivity. Increased risk aversion leads to compensation arrangements which spread more risk through diminished incentives. The authors also find that compensation arrangements that have greater degrees of revenue sharing across physicians significantly reduce each physicians's productivity, whereas reductions in group size significantly increase productivity. The estimated efficiency loss associated with risk aversion accounts for over ten percent of gross income, comparing the most risk averse to the least risk averse physicians in the sample. The authors use the results to show that changing the way physicians are paid from fee-for-service to capitation will dramatically reduce physician productivity.
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