The efficiency of professional malpractice laws under asymmetric information
Olsen, Reed Neil
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Permalink
https://hdl.handle.net/2142/21191
Description
Title
The efficiency of professional malpractice laws under asymmetric information
Author(s)
Olsen, Reed Neil
Issue Date
1989
Doctoral Committee Chair(s)
Ulen, Thomas S.
Department of Study
Economics
Discipline
Economics
Degree Granting Institution
University of Illinois at Urbana-Champaign
Degree Name
Ph.D.
Degree Level
Dissertation
Keyword(s)
Law
Economics, General
Language
eng
Abstract
Professional malpractice is currently treated as a tort in the U.S. Court system. However, cases of professional malpractice differ from other torts since they generally occur between parties with a pre-existing relationship. Such a pre-existing relationship allows for the possibility of contracts being used to allocate the risk of the professional relationship rather than using tort law.
Explicit contracting for risk between professional and client has been rejected as inefficient due to the informational advantage held by professionals. The inefficiency of contractual arrangements, it is argued, necessitates the use of malpractice laws to allocate risk and provide incentive to professionals to take adequate precaution. The present study models professional malpractice as a principal-agent problem and uses the medical industry as an example of the professional relationship. The theoretical model demonstrates that the use of explicit contracts to allocate risk is Pareto superior to the use of medical malpractice law even when the professional has an informational advantage.
Health Maintenance Organization (HMO) contracts are an example of explicit contracting to allocate risk while fee-for-service (FFS) contracts use malpractice laws as their sole risk allocation mechanism. The model predicts that HMO contracts would be more efficient than FFS contracts. HMO and FFS contracts are compared to the optimal contract and, as expected, the HMO contract is found to be more efficient.
This analysis suggests that HMOs should increase the net returns to the medical relationship. Net returns to the medical relationship would increase whenever: (1) HMOs increase health and decrease (or do not increase) medical expenditures or (2) HMOs decrease medical expenditures and increase (or do not decrease) health. The present study tests this hypothesis using a pooled cross-section/time-series data set for years 1980 to 1985 covering all states in the U.S. plus Washington, D.C. The death rate is used as a crude measure of health. HMOs are found to have a significant positive long-run impact on net returns. Thus, the empirical work supports the contention that explicit contracts (such as HMOs) can be used to efficiently allocate risk in professional relationships.
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