Investment in hospital care technology under different purchasing rules: A real option approach

Quality of health care is the product of several factors as the literature has long recognized. In this paper we focus on the relationship between quality and investment in health technology by analysing the optimal investment decision in a new health care technology of a representative hospital that maximizes its surplus in an uncertain environment. The new technology allows the hospital to increase the quality level of the care provided, but the investment is irreversible. The paper uses the framework of the real option literature to show how the purchaser might influence the quality level by setting a quality-contingent long-term contract with the hospital. The investment in new technology is in fact best incentivated within a long-term contract where the number of treatments reimbursed depends on the level of investment made when the technology is new. In this way, asymmetry of information does not affect the outcome of the contract. In our model in fact the purchaser can verify the level of the investment only at the end of each period but the purchasing rule has an anticipating effect on the decision to invest.