Outsourcing Intensity and Ownership: Theory and Evidence from California General Care Hospitals

For-profit hospitals in California contract out services much more intensely than either public hospitals or private nonprofit hospitals. To explain why, we build a model in which the outsourcing decision is a trade-off between net revenues and some nonmonetary benefit to the manager, which we call “bias” in the manner of production. Since nonprofit firms must consume profits indirectly, they trade off differently than for-profit firms. This difference is exaggerated in services where nonmonetary benefits are particularly important but minimized when the firm is hit with a fixed-cost shock. We test these predictions in a panel of California hospitals, finding evidence for each. These results suggest that a model of public or nonprofit make-or-buy decisions should be more than a simple relabeling of a model derived in the for-profit context.