Our next two hypotheses address the effect of external pressures for increased quality of care
and cost control on the use of nonfinancial performance measures. First, we examine the effect of
capitation contracts at the practice level the first-tier contract in Figure 1 on the choice of
performance measures at the second stage of contracting with the physician, thus establishing the
interrelationship between contracts in this hierarchical setting. Capitation contracts at the practice
level provide strong incentives for physician practices to control costs. Therefore, physician practices
are more likely to tie individual physician compensation to cost control when the practice’s
reliance on capitation revenue is greater. However, an emphasis on cost control also creates the
potential for physicians to provide too few services or lower quality of patient care in an effort to
reduce cost Dudley et al. 1998, 662; Ware et al. 1996; Evans et al. 2005. Responding to quality
concerns associated with capitation payments in the managed care system, government organizations
and health care plan buyers have required health insurance companies, the primary source of
capitation contracts, to implement quality assurance programs.10 Health insurance companies, in
turn, require that physician practices with whom they contract on a capitation basis implement
formal procedures to ensure quality of care and patient satisfaction O’Kane 2001.11 This suggests
that physician practices with greater reliance on capitation revenue from health care insurance
companies are more likely to use cost control, as well as quality of care and patient satisfaction, in
determining individual physician compensation: