Explain what the principal-agent problem is, and explain evidence of i

Explain what the principal-agent problem is, and explain evidence of its existence in hospitals in the United States.

What will be an ideal response?

ANSWER

The principal-agent problem is an example of asymmetric information in the market place. This problem occurs when one person’s welfare (the principal) depends upon what another person does (the agent).

The study of 725 hospitals from 14 major hospital chains by Herzlinger and Krosker found that the rate of return on investment and the average costs of two types of hospitals did differ. They found that for-profit hospitals earned an 11.6 percent return on investment, and nonprofit hospitals earned 8.8 percent return on investment in 1977. After differences in hospital functions were netted out, using regression analysis, the authors found that the average cost of a patient day in nonprofit hospitals was 8 percent higher than in for-profit hospitals.