Financial incentives and physician prescription behavior: Evidence from dispensing regulations

In many healthcare markets, physicians can influence the volume (volume response) and the composition of the services provided (substitution response). The goal and main contribution of this paper is to empirically assess the relative importance of these two behavioral channels. Our analysis is based on the market for ambulatory care in Switzerland in which different drug dispensing regimes (banned/allowed) co-exist at the regional level but many important other features are regulated at the federal level. Dispensing creates financial incentives for physicians to sell more drugs and to substitute towards more expensive drugs thus providing an ideal setup for our empirical analysis. We combine the regional variation in the dispensing regime with comprehensive physician-level prescription data to empirically disentangle the volume and the substitution response. The estimated average effects suggest that physician dispensing increases drug costs on the order of 25% for general practitioners and 15% for medical specialists. A decomposition of this overall effect indicates that the cost increase can mainly be attributed to a volume increase, while average drug prices are not or even negatively affected in some specifications. In addition, we document substantial effect heterogeneity along the outcome distributions.