EXPENSE PREFERENCE BEHAVIOR AND CONTRACT-MANAGEMENT - EVIDENCE FROM US HOSPITALS

This paper reports on a study of expense preference behavior in a cond itional sample of hospitals (before and after adoption of contract-man agement arrangements) using an extension of Mester's (1989) test. To i dentify expense preference parameters, input demand equations are cons idered in addition to the cost function and are estimated jointly with the cost function as a system of nonlinear equations. Based on this t est, contract managers do not appear to be cost minimizers, although t hey tend to exhibit lower expense preference behavior than salaried ma nagers. The importance of our results, however, goes beyond a single i ndustry because we have shown that estimates of expense preference dep end critically upon the particular input demand being studied. Studies that hitherto have relied on single input demand equations or on the cost function alone may have to be reinterpreted in this light.