Nursing homes play important roles in providing necessary care to institutionalized elderly and adults with impaired functionality. However, such important roles Healthcare Financing Essay
can be compromised if the homes are financially constrained. Nursing facilities have
several characteristics that mark them as likely to be financially constrained. Whited
and Wu(2006) conclude that the firms that are smaller, have low or no research coverage by equity analysts, and do not have corporate bond ratings are more likely to be
financially constrained. Most nursing homes satisfy these criteria. In addition, Jaffee
and Russell (1976), Keeton(1979), Stiglitz and Weiss (1987), and Whited (1992) view
information asymmetry between the lenders and the borrowers as a primary cause of
financial constraints and credit rationing. Asymmetric quality information between
nursing facilities and creditors can hinder the creditors’ willingness to provide inexpensive and long-term capital to the nursing facilities. Asymmetric information reinforces the effects of unfavorable firm characteristics and subsequently causes nursing
homes to face stricter limitations to external capital. Asymmetric quality information
has another impact on the product market. As noted by Arrow (1963), information
asymmetry is the prominent characteristic of the medical care market and often leads
to loss of consumer welfare. Information asymmetry can distort the incentives of
financially constrained nursing homes to provide socially optimal quality. The effects of asymmetric information on both credit and product markets make nursing
homes more vulnerable to financial constraints, but the negative consequences and
welfare losses as a result of financial constraints may be even more serious than those
encountered in other industries.
To motivate the empirical analysis, I construct a theoretical model to formalize Healthcare Financing Essay
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the complex relationships among financial constraints, asymmetric information, and
nursing home quality. Based on the work by Klemperer (1995) and Chevalier and
Scharfstein (1996), the model has the flexibility to explain counter-cyclical quality
fluctuations. This model is also the first to provide a theoretical foundation for research of financial conditions and quality of care. To empirically test the theoretical
predictions, I follow the approach used by Campello (2003), Khanna and Tice (2004),
and Zhu (2011). Regional and local business cycles are used to create the exogenous
cost shocks which nursing home managers do not fully expect when they make exante financial arrangements. Local business cycles are exogenous from the existing
financial leverage because it is impossible to perfectly forecast economic fluctuations.
Even if the managers can foretell the recessions and booms, the adjustments of capital structure are both expensive and time consuming; a significant adjustment of
capital structure often involves the redirection or restructuring of corporate strategies. Local business cycles also directly affect internal cash flows through impacts on
labor markets. The majority of the nursing home workforce is comprised of nurse
aides (about 65% of the nurse hours1
). They earn low hourly wages ($7.5; Yamada,Healthcare Financing Essay
2002) and have a lower skill set compared to other types of nurses. When the economy is booming and unemployment rates are low, outside employment options for
the nurse aides become more attractive. While nursing home wages might be more
rigid because of fixed public reimbursement rates, during economic booms nurse aides
can earn significantly higher wages at alternative work sites, such as restaurants and
department stores (Cawley et al., 2006). In addition, with their salaries, educational
attainments, and demographics (Yamada, 2002), nurse aides are more likely to be the
secondary source of their household incomes. Therefore, they may withdraw from the
nursing homes workforce during economic booms when their spouses or other family
members have stable jobs and earn promising incomes. Of course, such labor mar1My calculation based on nursing homes in the sample
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ket impacts are not equal across all nursing homes. Financially constrained nursing
homes may have particular difficulty keeping up with wages and retaining their nurse
aides. Ex-ante financial leverage serves as the primary proxy for financial constraints.
With different levels of financial leverage, the differential responses to exogenous cost
shocks are interpreted as causal impacts of financial constraints on quality.
To assess nursing home financial constraints at the facility leve