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Regulatory Exploitation and the Market for Corporate Control
Dafny L., Dranove D.

Abstract: This paper evaluates the possibility that a failure to exploit regulatory loopholes could result in the ousting of management. 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 5 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 team subsequently upcoded more than a sample of similar hospitals that did not, as identified by propensity scores. These results suggest that managers that do not fully exploit regulatory loopholes are vulnerable to replacement.

Regulatory Exploitation and the Market for Corporate Control (PDF 176 KB)

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