Regulatory Exploitation and the Market for Corporate Controls

   (284 K)

This paper investigates whether managers who fail to exploit regulatory loopholes are vulnerable to replacement. We use the U.S. hospital industry in 1985-1996 as a case study. A 1988 change in Medicare rules widened a pre-existing loophole in the Medicare payment system, presenting hospitals with an opportunity to increase operating margins by five or more percentage points simply by “upcoding” patients to more lucrative codes. We find that “room to upcode” is a statistically and economically significant predictor of whether a hospital replaces its management with a new team of for-profit managers. We also find that hospitals replacing their management subsequently upcode more than a sample of similar hospitals that did not, as identified by propensity scores.

Published: Leemore Dafny & David Dranove, 2009. "Regulatory Exploitation and Management Changes: Upcoding in the Hospital Industry," Journal of Law & Economics, University of Chicago Press, vol. 52(2), pages 223-250, 05.

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