Abstract

Because of information asymmetry the purchaser is generally unable to verify the cost reducing effort and the true quality of health services. Thus the purchaser needs to negotiate appropriate contract terms to get the desired levels for the variables of interest. The trade off between quality and cost reducing effort has already been stated by a number of articles: a higher quality implies higher production costs and vice versa. This paper shows that if the principal (purchaser) can observe the quality provided by the agent, then the reputation based on the reliability of past behaviour gains a role. The proposed model, studying the hospital's profit function, uses reputation to overcome the asymmetric information in contracts for health care services. The goal is to show that reputation for past behaviour contract terms induces the provider to offer the target level for quality at the minimum cost. In particular the model highlights that, even if the purchaser is unable to observe perfectly the quality, a long-run first best equilibrium outcome is attainable, provided he sets, with a believable threat, the enforcement of fair conduct greater or, at least, equal to the temptation to cheat.