Executive Summary:
How Should Professionals Be Paid? Physician Compensation Offers Lessons
How should firms, particularly member-owned firms, compensate their partners? In many cases the goals of principal and agent are not perfectly aligned, thus the need to use compensation contracts inducing the agent into operating in the principal’s best interest. Physician practices present a fairly clear picture about how compensation should be structured, and offer interesting insights regarding the state of physician compensation within the health care industry. New research by Mina Pizzini of SMU Cox, Christopher Ittner of Wharton, and David Larker of Stanford reveals how and under what circumstances compensation contracts should be structured. The findings have implications for the design of compensation contracts for “lawyers, consulting firms, architects, other professionals, and even mid-level managers not currently using the performance measures that are available today,” Pizzini noted.
The Study and Results
Data was collected on more than 9,851 physicians in 596 practices in 1999. The average yearly total compensation for physicians in the study was $251,789. Sixty-five percent received at least half of their compensation in the form of productivity-based bonuses and 15 percent received no performance-based pay. Following are the key findings of the study. Practices deriving a larger proportion of group revenues from capitated contracts (of insurers or managed-care organizations) relied less on performance-based pay versus fee-for-service arrangements. According to Pizzini, “The problem with capitation is that it does not encourage the performance you would wish of a physician. In essence, it encourages the physician to minimize the number of times a patient comes to see him as well as the number of procedures, and encourages the physician to see more patients by being paid per member per month.” Time spent with capitation patients also reduces available time for more potentially profitable fee-for-service patients. Conversely, physicians paid on a fee-for-service basis (e.g., productivity) have incentives to over-provide services to boost compensation. Productivity-based bonuses are less utilized relative to a fixed salary when the physician spends a greater amount of time on non-clinical activities, teaching, in the case of groups staffing hospitals, or when quality outcomes are considered in compensation decisions. Quality of care is rarely used in the computation of performance-based bonuses as outcomes are difficult to measure. Productivity measures would prove difficult in a hospital setting; many factors are beyond the control of the physician such as workflow driven by hospital volume or other tasks performed such as administration and training. Salary would be a more optimal arrangement than productivity in this case as the physician would bear too much risk otherwise. It is important to note that just prior to the study, the trend of hospitals purchasing physician practices took off. Subsequently, physicians, now on salary, began seeing fewer patients. Performance-based pay is not the best solution in a multi-tasked environment or when clear measures of performance (or productivity) do not exist. Physicians with colleagues in the same specialty or those working in smaller practices utilized productivity-based pay less. Physicians in the same specialty, such as primary care or surgical specialties, are able to monitor each other better because of the known standards of performance. Mutual monitoring is more effective when other physicians practice the same specialty, and thus the compensation risk imposed on the physician may be reduced. However, greater group size makes monitoring more difficult and thus performance-based compensation more optimal. Pizzini remarked, “In more complex medical specialties where peer monitoring is less likely, you can incentivize physicians towards certain goals by either providing the incentive or by monitoring them. If it’s difficult to monitor a person such as a neurosurgeon, then pay him based on performance or his client base instead of monitoring him.” Practices using outside management firms used performance-based compensation to a greater extent. Management companies may improve the informativeness of performance-based measures through greater reliability, timeliness, and/or accuracy of performance data. Physicians may also be enabled to devote more time to enhancing clinical skills and building the practice, also translating into greater productivity. Compensation based on performance gradually increases for physicians with greater experience. Additionally, labor market conditions, such as concentration and competition, play a role in the choice of compensation mix.
Health Care Dynamics
Is the way physicians are paid a factor in escalating health care costs? The fee-for-service structure encourages more volume and therefore utilization. “Historically, we have created this situation in health care, where more is better—people are used to getting whatever care they want,” Pizzini explained. There have not been the incentives for people to economize, but insurance firms and employers are now giving the incentives through higher co-pays and deductibles. She mused repeating a quote of another scholar, “There are no bad people, just poorly designed incentive systems.” In a Health Maintenance Organization (HMO) or a restrictive managed care plan the doctor carries more of the financial risk of patients. Pizzini believes this is the wrong way around—the insurer should be the one to bear the risk. The balance for physician actions or oversight is that the insurer might say a procedure is unnecessary when reviewing a case. Pizzini concluded, “It’s clearly a fair way to pay physicians for what they perform, but you need to have the insurer perform the watchdog function. That is coming more into play. In the end, I think quality of care will go down slightly in terms of care, but the cost of care will go down a lot in health care overall.”
Implications for Other Professionals
The lessons of physician compensation can be generalized to other professional services settings. This study offers some guidelines as to how other professional services firms should structure their contracts when they hire. If a specialty exists within a firm, then compensate that group or individual appropriately. Pizzini suggests that if you give a professional the incentive to do the right thing, if she does what she is supposed to do, the outcome or performance will be higher (or lower by making the wrong choices). By imposing the risk on the professional to make the right choice, you also have to pay for that type of contract and risk as well. By taking the first look at professionals’ compensation contracts, this study helps shed light on how performance, motivations, and results are linked. The results offer guidelines regarding how compensation contracts should be designed for those in professional services. By taking the first look at professionals’ compensation contracts, this study helps shed light on how performance, motivations, and results are linked. The results offer guidelines regarding how compensation contracts should be designed for those in professional services. |
