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Revisiting Incentive-Based Contracts
No full textIncentive-based pay is rational, intuitive, and popular. Agency theory tells us that a principal seeking to align its incentives with an agent's should be able to simply pay the agent to achieve the principal's desired results. Indeed, this strategy has long been used across diverse industries-from executive compensation to education, professional sports to public service-but with mixed results. Now a new convert to incentive compensation has appeared on the scene: the United States' behemoth health-care industry. In many ways, the incentive mismatch story is the same. Insurance companies and employers are concerned about constraining the cost of care, and patients are concerned about quality of care. Physicians lack an adequate financial incentive to pay attention to either. Health care's recent move away from the traditional fee-for-service compensation model to incentive pay is perhaps unsurprising
Contract Theory and the Failures of Public-Private Contracting
Full text linkThe market for public-private contracting is huge and flawed. Public-private contracts for services such as prisons and welfare administration tend to result in cost savings at the sacrifice of quality service. For instance, to cut costs, private prisons skimp on security. Public law scholars have studied these problems for decades and have proposed various public law solutions. But the literature is incomplete because it does not approach the problem through a commercial lens. This Article fills that gap. It considers how economic analysis of contract law, in particular efficiency theory and agency theory, bear upon the unique problems of public-private contracting.
Public-private contracts are subject to systematic biases that cause the parties to impose a cost on service recipients in the form of low quality service. Because there is essentially no competitive market for these services, the contracting parties are not forced to internalize these costs. As a result, contracts tend to be underpriced. Thus, what appears to be a cost-saving mechanism is often, in fact, a systematic market failure.
This Article proposes two unconventional and counterintuitive solutions to force the parties to internalize the cost of poor service provision. First, it suggests reading into public-private contracts a mandatory duty to act in furtherance of the public interest. Although efficiency theory assumes that mandatory restrictions on contracting parties are inefficient, a mandatory rule is justified, here, because the law must protect non-parties to the contract who cannot adequately protect themselves. Second, this Article argues, based on behavioral economics studies, that these contracts should be less detailed. Although agency theory suggests that detailed tasks, performance incentives, and monitoring mitigate agency costs, those mechanisms do not work with public-private contracts. Studies indicate that less detailed contracts that rely on social norms such as reciprocity may better align incentives
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Price Transparency and Incomplete Contracts in Health Care
No full textMarket-based health care reform solutions, which have grown in popularity and possibility, suggest when patients act more like consumers, health care prices will decrease and unnecessary medical procedures will occur less frequently. This Article argues that these benefits of a market-based health care system cannot occur without price transparency in health care contracts. Through synthesizing theories of law and economics and behavioral science, this Article proposes that contract theory provides the most desirable solution: courts enforcing a penalty default of $0 when health care contracts do not provide a price and it would be reasonable to do so
Revisiting Incentive-Based Contracts
No full textIncentive-based pay is rational, intuitive, and popular. Agency theory tells usthat a principal seeking to align its incentives with an agent\u27s should be able to simply pay the agent to achieve the principal\u27s desired results. Indeed, this strategy has long been used across diverse industries-from executive compensation to education, professional sports to public service-but with mixed results. Now a new convert to incentive compensation has appeared on the scene: the United States\u27 behemoth health-care industry. In many ways, the incentive mismatch story is the same. Insurance companies and employers are concerned about constraining the cost of care, and patients are concerned about quality of care. Physicians lack an adequate financial incentive to pay attention to either. Health care\u27s recent move away from the traditional fee-for-service compensation model to incentive pay is perhaps unsurprising
Price Transparency and Incomplete Contracts in Health Care
Full text linkMarket-based health reform solutions dominate the post-Affordable Care Act landscape. Under these plans, competition is supposed to bring down ballooning prices, and patients are to act more like consumers, refusing low-value, medically unnecessary care. Whether one embraces these solutions, one thing is clear: they cannot work absent price transparency—which the U.S. system lacks. To the contrary, the law explicitly enforces open price term contracts between patients and providers.This Article is the first to synthesize theories of incomplete contracts from traditional law and economics and recent work in the behavioral sciences and to apply these theories to the price transparency problem. It argues that doctrine is out of step with theory, and proposes a contract law solution: an information-forcing penalty default rule. Courts should impose an undesirable default to force the parties to contract around the default. When providers fail to include a price, and it would have been reasonable to do so, courts should fill the gap with a price of $0. Rather than risk not being paid, providers will include a price in the patient contract. Legislative action has been both slow and ineffective in fixing the crucial price transparency problem. At no other time in recent memory has the importance of contract theory been put into such sharp relief and, remarkably, in an area of law that is at the very core of the emerging political economy.http://law.emory.edu/elj/content/volume-67/issue-1/index.htm
Facilitating Incomplete Contracts
Full text linkContract law abhors incompleteness. Although no contract can be entirely complete, the idea of a purposefully incomplete or underspecified contract is antithetical to lawyers’ ideals of certainty for the parties and for the law. Indeed, contract law is designed to incentivize parties to specifically articulate their intentions. Yet there is a growing body of interdisciplinary work in economics and cognitive psychology demonstrating that highly specified contracts tend to stifle intrinsic motivation and innovation, whereas less-specified contracts — particularly in public-private contracting, IP, and contracting for innovation — can induce higher effort levels and a more cooperative principal-agent relationship than the traditional approach. Nevertheless, there remain both entrenched doctrinal and sociolegal deterrents to drafting less-specified contracts.This Article argues that the existing doctrinal roadblocks to incomplete contracts are out of step with the normative goals of commercial contracting — promoting efficiency and incentivizing commercial activity. The indefiniteness doctrine and current approaches to contract interpretation, for instance, over-deter the use of incomplete contracting even when it would be efficient. Ultimately, this Article suggests a new doctrinal approach for those contracts where the law should incentivize incomplete contracting, borrowing from principles of constitutional interpretation: dynamic contextualist interpretation. Courts should look not only to party intent at the moment when the contract was formed but should consider how intentions developed during contract performance. Rather than punishing incompleteness, flexibility should guide determinations of validity and questions of interpretation
Nudging Patient Decision-Making
Full text linkRational choice theory once pervaded the law. But we now know that individuals often make decisions that are not in their best interests. Many areas of the law have responded accordingly. The law of health care decision-making, however, has not.With limited exception, patients have the right to make their own medical decisions about their treatment, even if they make bad decisions. And there is ample evidence from the behavioral sciences that they do make bad decisions. Patients lack the stable preferences that the law assumes they will draw upon in making decisions, and they suffer from a number of systematic decision-making biases. Bad decision-making negatively impacts the individual, but also the entire health care system that must bear the cost of poor decisions. Patient choice nonetheless remains a hallmark of legal doctrine.This Article challenges the myopic approach that solely values autonomy to the detriment of well-being. It proposes that both doctors and patients instead be nudged toward the welfare-maximizing treatment choice by the establishment of a treatment default. A right to opt-out still protects autonomy, but the default will move most patients toward better decisions—those that data suggest will most increase patient well-being. We should no longer accept a regime that delegates the complex task of decision-making to often vulnerable patients without regard to their well-being
Public-Private Contracting and the Reciprocity Norm
Full text linkWhen governments outsource work to private entities — running prisons and schools, administering state benefits, and the like — they tend to write extremely detailed contracts. The conventional thinking is that these private entities need to be constrained lest they act opportunistically. Therefore, governments write contracts that highly specify tasks, contain robust monitoring provisions, and financially reward task compliance. This detailed contracting approach, which views agents as selfish, profit-driven, and looking for opportunities to shirk, finds support in both the agency cost and public law literatures. This Article challenges the prevailing approach. It argues that control-based contracts are not only difficult and expensive to write and costly to monitor, but they stifle intrinsic motivation and innovation. Such detailed contracts frequently fail in practice, with serious negative implications for the public. Recent literature in behavioral economics suggests that the conventional approach is actually premised on a misunderstanding of human nature. Experiments on the positive reciprocity norm — meaning that people reward kind actions — have shown that less complete contracts induce higher effort levels and a more cooperative principal-agent relationship than the traditional approach. This Article incorporates this behavioral research and studies of real world behavior to present an interdisciplinary argument for why the traditional public-private contracting approach should be rethought both in theory and in practice
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