CASE STUDY PFIZER

ETfflCS AND INCENTIVES: AN EVALUATION AND DEVELOPMENT OF STAKEHOLDER

THEORY IN THE HEALTH CARE INDUSTRY

Heather Elms, Shawn Berman, and Andrew C. Wicks

Abstract: This paper utilizes a qualitative case study of the health care industry and a recent legal case to demonstrate that stakeholder theory's focus on ethics, without recognition of the effects of incen- tives, severely limits the theory's ability to provide trtanageriai direction and explain managerial behavior. While ethics provide a basis for stakeholder prioritization, incentives influence whether managerial action is consistent with that prioriti ration Ourhealth care examples highlight this and other limitations of stakeholder theory and demonstrate the explanatory and directive power added by the inclusion of the interactive effects of ethics and incentives in stake- holder ordering.

Introduction

Historically, the traditional ethic ofthe medical profession provided a sourceof order among health care's stakeholders: "The health of my patient will be my first consideration" (from the World Medical Association Declaration of Geneva, 1948; cited in Rodwin, 1993: 268).' Current forms of health care pro- vision, however, also explicitly acknowledge the importance of stakeholders other than patients (e.g., the interest of employers in cost containment) (Morreim, 1992). In addition, new incentive arrangements are commonly understood to encourage the recognition of this broader range of stakeholders (Morreim, 1992). As a theory that makes its greatest contribution to managerial scholarship by explicitly recognizing that organizations should satisfy multiple constituencies, stakeholder theory might well be the theory to which researchers tum in an attempt to understand the current dynamics of health care provision. In assert- ing the inherent value of all stakeholders, however, stakeholder theory does not explicitly prioritize specific stakeholders. Nor does the theory take into account the effect that managerial incentives may have on such a prioritization. Recent work has criticized stakeholder theory for the first of these limitations—its lack of stakeholder prioritization (e.g., Donaldson and Dunfee, 1994; Mitchell, Agle and Wood, 1997), but has not yet acknowledged the second—its silence with

© 2002. Business Ethics Quarterly. \^lume 12. Issue 4. ISSN 1052-150X. pp. 413-432

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respect to managerial incentives. We utilize an empirical study of the health care industry and a recent legal case highlighting the potential conflict between ethics and incentives in health care to consider both critiques of stakeholder theory. Our examples illustrate how stakeholder theory's deficiencies result in an inability to provide managerial direction and a lack of explanatory power, thus highlighting the need to incorporate both ethics and incentives in a stake- holder theorj' of managerial behavior.^

Without both ethics and an allowance for the effects of incentives, stake- holder theorjf remains unable to adequately direct or explain managerial action. Ethics both direct a prioritizadon of stakeholders—and to the extent that man- agers follow that directive, explain their behavior. Incentives at least partially explain managerial behavior with respect to that prioritization. Directing and explaining managerial action offers stakeholder theory the means to provide managerial relevance—one of the theory's central goals. The theory's current failings limit its ability to fulfill this purpose.

The health care iridustry provides an ideal context in which to examine stake- holder theory's current inability to direct and explain managerial behavior. Given stakeholder theory's emphasis on the role of normative values in managerial decision making, the theory ought to have its greatest explanatory power where a guiding ethic exists. Health care has historically been such a setting. We high- light our concerns with stakeholder theory by demonstrating that decision makers' behavior in the current health care environment is not well explained by current formulations of the theorj'.

Stakeholder Theory

Stakeholder theory emerged, in large part, as an outlet for normative ethi- cists to incorporate a concern for ethics into descriptions of the core operations of the firm. While recognizing the value of addressing isolated moral problems within organizations (e.g., sexual harassment, bribery), ethicists additionally sought a way to link ethics with both the day-to-day operations of the firm and strategic decision making (Freeman and Gilbert, 1988; Gilbert, 1992). Stake- holder theory represents an effort to create the latter link—between ethics and strategic decision making—by highlighting relationships between the firm and its stakeholders. These relationships are strategic because they affect the firm's long-term resource allocation decision-making processes. Research in stake- holder theory makes explicit the moral assumptions and implications of firms' relationships with stakeholders by asking two central questions: "What is the purpose of the firm?" and "To whom does the firm have responsibilities?" (Free- man, 1994). Ethicists argue that firms (or their managers) have choices about how they wish to answer both questions. Managers' moral frameworks, how- ever, at least partially determine their answers to these questions. If managers develop ethically compelling answers on the basis of strong moral frameworks, and implement these answers systematically, their firms' fundamental opera- tions are more likely to be morally sound.

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While the roots of modern stakeholder theory lie with R. Edward Freeman's Strategic Management: A Stakeholder Approach (1984), work in the area grew rapidly in the 1990s (Donaldson and Preston, 1995). This work has been both theoretical (e.g., Phillips, 1997), and increasingly empirical, as suggested by a recent special issue of The Academy of Management Journal (October, 1999) devoted entirely to empirical stakeholder research. An article by Jones and Wicks (1999) and accompanying dialogue pieces, however, demonstrate that there re- mains considerable debate about whether or not stakeholder theory is in fact a single theory, a genre of theories, or just an umbrella term for researchers using a common perspective (and hence not a theory at all). The discussion around the Jones and Wicks (1999) article also Identifies considerable disagreement about how closely the aormatii'e and insmamental elements of stEtkeholder theoiy are related (see the "Dialogue '̂ section of the April, 1999 issue of The Academy of Management Review). We contribute to this normative vs. instrumental dis- cussion by underscoring the relationship between ethics (normative) and incentives (instrumental).

In addition to dissatisfaction with the theoretical nature of stakeholder ap- proaches and the relationship between the streams of work identified by Donaldson and Preston (1995), researchers express discontent with stakeholder theory's in- ability to deal with problems of stakeholder prioritization—exemplified by Donaldson and Preston's (1995: 67) suggestion that "Stakeholder management requires, as its key attribute, simultaneous attention to tlie legitimate interests of aU appropriate stakeholders, both in the establishment of organizational struc- tures and general policies and in case-by-^case di^cision making" (emphasis added). In reality, managei s must necessarily order stakeholders' demands, given limited resources and, common conflict between various stakeholder interests. Mitchell, Agle. and Wood (1997) begin to confront the prioritization problem by presenting a heuristic for determining which stakeholders will be most sa- lient in managers' decision-making processes. The propositions offered by the Mitchell, Agle, Wood framex '̂ork are intuitively appealing and empirically trac- table (see Agle, Mitchell, and Sonnefield, 1999) The model remains descriptive, however, and does not address the fundamental problem of the relative values pf the heuristic's dimensions. Since these relative values influence the norma- tive ordering prescriptions of the framework, Mitchell, Agie, and Wood's contribution to the theorj' needs further specification before it provides a nor- mative basis for stakeholder prioritization. Additionally, the Mitchell, Agle, Wood fxamewotk does not address the role incentives play in managers' de facto prioiitization of stakeholders. Thus even with Mitcliell, Agle, and Wood's con- tribution, stakeholder theory currently fails to offer explicit direction for nianasjerial behavior, given a lack of guidance in prioritizing stakeholder claims ajid a lack of recognition of the role of incentives in motivating human behav- ior. We suggest that an explicit appreciation of the interaction between ethical standards and incentives provides ail essential development of the theory's ex- planatory power, and improves stakeholder theory's managerial relevance.

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Rationale for Qualitative Case Study

Our evaluation and development of stakeholder theory relies on an exami- nation of the history of U.S. health care provision and a recent legal case involving the relationship between physician incentive systems and the prac- tice of medicine. The case study stresses the ambiguous outcomes of situations in which normative guidelines and incentive systems conflict, suggesting the need to address both in a theory that proposes to describe managerial behavior. We use this case study to discuss and develop the managerial relevance and explanatory power of stakeholder theory, rather than creating or systematically testing specific formal hypotheses. We utilize this qualitative, inductive approach to discuss and develop stakeholder theory rather than subjecting the existing theory to more traditional hypothesis testing techniques precisely because cur- rent formulations of stakeholder theory do not easily lend themselves to the latter type of endeavor. In our discussion of the case, we elaborate how stake- holder theory might be able to address the theoretical shortcomings identified through the case study method^ both in the health care setting and more broadly. Developing stakeholder theorĵ along the guidelines we suggest would increase the theory's application to the world of practice and provide a basis for gener- ating future empirical work.

The dynamics of health care provision provide a particularly appealing arena in which to investigate the influence of ethics and incentives on tiie prioritization of stakeholder groups and thus the empirical import of stakeholder theory. Phy- sicians, health care's key decision makers, have been guided historically by a normative ethic that provided order among the industry's stakeholders, placing the patient's health concerns above any other concern (Angell, 1993). This clini- cal directive maintains an overtly moral stance akin to the managerial directive found within stakeholder theory. The growth of managed care has made par- ticularly salient, however, the additional influence of physician incentive arrangements on the provision of caie. The case study makes clear that incen- tive structures do not provide the only motivation for behavior. Instead, as stakeholder theory suggests, ethical standards and moral obligations also shape action. Physicians additionally face an increased number of stakeholders and a far more complex environment under managed care than they did under tradi- tional fee-for-service arrangements. Stakeholder theory explicitly addresses settings where managers are at the nexus of a multiple stakeholder interaction. The health care industry thus provides a prime setting to study the domain of the theory and the interactive effects of ethical mandates and incentive structures.

The rationale for utilizing qualitative case studies is well established in man- agement research (Morgan and Smircich, 1980; Yin, 1984; Eisenhardt, 1989; Sutton, 1997). There are, however, three important differences between our work and most of the previous qualitative work in management theory. First, we do not use qualitative data to generate new theory, which many authors suggest as a key strength of the case study approach (Eisenhardt, 1989; Sutton, 1997). We

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instead use qualitative data to evaluate and develop existing theory'. Similar to those authors utilizing qualitative work as a basis for theory generation, we thus avoid the case selection bias associated with qualitative research when used for formal hypothesis testing (Eisenhardt, 1989; Kieser, 1994). Second, qualitative work on organizations has traditionally focused analysis at the or- ganizational level, with the researcher investigating single firms in great depth (e.g., Selznick, 1949; Hargadon and iSutton. 1997), or multiple firms in some- what less depth (Eisenhardt and Bourgeois, 1988; Henderson and Clark, 1990). We instead conduct an industry-level analysis, reviewing the history of health care provision. As Miles' and Cameron's work on the tobacco industry shows, the industry approach can also lead to theoretical insights for organizations (Miles and Cameron, 1982; see also Miles, 1987), while Kieser (1994) notes that historical data is potentially useful for organizational theory development. Finally, the second part of the case study centers on a recent legal case that explicitly focused on the imf*act of alternative incentive structures on physi- cian decision making-—usin_g the incentive structures present in a particular organization. While economists commonly use legal cases to assess economic theoi7 (Stigler, 1963; Klein, Crawford, and Alchian, 1978; Kxattenmaker and Salop, 1986), this tactic is generally not eKiployed by organizational theorists.

Health care's contextual factors make die use of qualitative data particularly appealing. Health care providers emrently face a complex, unstable, and rap- idly changing environment (Fennell and Alexander, 1^93; Flood and Fennel, 199f*). As Morgan and Smircich (1980) suggest, these environmental character- istics create problems for more traditional quantitative methods, but are well suited for qualitative research. Historical analysis is also more conducive to assessing evolutionary processes (Kieser, ] 994), lilse those present in the health care industry.

We also acknowledge the limitations of our approach. Our use of a legal case and a historical overview of an incredibly complex industry may limit the generalizability of our conclusions. However, our purpose remains developing the managerial relevance aad explanatory power of stakeholder theor}'-—within health care and more broadly. Given the parallel between phj'sicians and man- agers, tliis work can only serve to extend the domain of stakeholder theorj', and thus provide a basis for future more generalizable studies.

Our analysis is based on extensive review of tlie literature on the histoiy of health care provision and the legal case, intensive field study by one of the authors in 17 managed care organizations over a three-year period, and exten- sive interviews with members of both the defense and prosecution teams in the legal case. Counsel from both sides additionally reviewed, provided input, and approved our account of the case.

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A Case Study ofthe Health Care Industry and Its Stakeholders

Angell (1993) divides the history of health care into three phases. Her analysis appears to be based primarily on the source of payment for medical services. We additionally examine the importance of the relationship between ethics, in- centives, and the salience of various stakeholder groups in each of these phases.

Angell identifies the first phase, that of the true market, as lasting until World War II. Medicine was practiced primarily by solo-practitioriers who owned and operated their own practices, and was paid for by patients out-of-pocket on a fee-for-service basis.^ Even those individuals who acquired health insurance, commencing primarily in the 1930s, paid for that insurance themselves. Physi- cians, then, did not find themselves as agents to practice owners, insurance companies, or employers. Instead, during this first phase of health care provi- sion, salient stakeholders remained limited to the patient, the profession, and communities exposed to a physician's patients—and the norniative ethic of the profession clearly ordered these constituents: "The health of my patient will be my first consideration" (from the World Medical Association Declaration of Geneva, 1948; cited in Rodwin, 1993: 268).

jSolo-practice, patient-^paid, fee-̂ for-service medicine remained consistent with this normative ethic. Fee-for-service compensation allowed physicians to act in the interests of their patients (and thus behave in ways consistent with the profession's normative ethic) while at the same time acting in their own inter- ests as sole owners of their practices.'* The more care a physician provided to patients, the more revenues he or she brought to the practice. Even the bias of fee-for-service compensation towards over-utilization of services complied with the patient-first ethic, given the greater comfort most of us share with having too much care relative to too little.

Angell ideritifies the beginning of a second phase with the onset of WWII, when employers began to offer health insurarice to employees—generally un- derstood as a ŷay to increase wages while avoiding the war's wage and price controls. When employers began to offer health insurance to employees, Angell and others have argued that patients became insulated from the costs of care, for the costs incurred by their use of services or those associated with increased premiums came out of somebody else's pocket. Patients' incentive to obtain more care than necessary thus increased. Physicians' incentives did not change, however, for although coming from an alternate source, fee-for-service remained the compensation arrangement of choice, and physicians remained in private, single-owner practices. Physicians.' incentives thus remained aligned with the industry's traditional ethic. Through contract, however, physicians did find themselves as agents to insurance companies and through them to employers, making insurers and employers more salient stakeholders in the health care pro- vision arena.

The realization by employers and other third party payers (most notably the government) that they could not afford to continue providing such benefits

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marked the beginning of the third phase—the one in which we currently re- main. Payers have responded with ever increasing pressure on insurers and providers to reduce the costs of health care insurance and provision, thus mak- ing payers and through them insurers ever more salient stakeholders. This pressure has forced the development of new organizational forms in the health care industry, including the increasing predominance of network-model health maintenance organizations (HMOs): of 77 million HMO enrollees in 1996, 69% were members of network-model plans (Hoechst Marion Roussel, 1997).

In these network-model HMOs, insurance administration remains with the HMO, while the provision of care occurs in independent, contracted, medical groups. The development of these contracting relationships has occurred in conjunction with changes in the structure of individual medical practices. The percent of practicing physicians in groups (as opposed to solo practice or part- nei'ships of two physicians) has increased by 361% since 1965 (only 26.5% of physicians were still in solo practice in 1995), and the average size of these medi- cal groups is increasing (American Medical Association, 1997; Bodenheimer, 1999; Emmons and Kletke, forthcoming). Contracts between these medical groups and HMOs (the latter essentially now just insurance conduits between employers and medical groups)- are increasingly characterized by capitation, especially in sophisticated managed care markets like Califoimia, Minnesota, Massachu- setts, and Texas (Kerr et al., 1995; Robinson and Casalino, 1995).

Under capitation, medical groups leceive a fixed pajfment, per member per month, to caj e for a pool of HMO patients. The amount of this payment depends on the t)'pes of medical services the medical group agrees to provide and on the demographic characteristics of tile pool of patients. The payment thus depends on the expected use of medical services by patients—^not on the actual use of mî dica] services. The medical group can typically pocket the difference between the sum of these fixed payments and the actual costs the medical group incurs, but the medical group is also at financial risk for any costs that exceed the sum of the fixed payments. Continued contracting, and therefore patients, depends oti medical groups' ability to offer their sen/ices to these insurers or employers at a competitive capitation rate.

While solo-practice, patient-paid, fee-for-service medicine remained com- patible with the profession's patient-first ethic, large-group-practice, insiHter-contiacted, employer-provided, capitated medicine potentially conflicts with this stliic. Group practice creates additional stakeholders, in the form of partners., for member physicians. While remaining key decision makers, they have become accountable to the owners of the medical groups in which they practice," The larger these groups become, the moie stakeholders member phj'- sicians face.^ In addition to impacting the health of their patients, these pliysicians' behavior influences tiot only their own income (through individual, organizational-performance, or ownership-based pay), but the incomes of these additional stakeholders (through organizational-performance or ownership- based pay).

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Under capitation, more care means more costs, but not more money, for capitated medical groups and their physicians. Proponents of capitation argue that patients benefit from the incentives provided by capitation for preventive care, given that preventive care is presumably less costly than acute care and lessens the need for the latter. This argument, however, presumes a long-run perspective on the behalf of providers, and that the providers of care in the current period will also be the providers of care in future periods and thus reap any benefits of preventive care. In reality, these assumptions remain unmet: employers can and do change insurers and providers thus cannot expect com- plete continuity in their patient populations (Robinson, 1995). Without expected payoffs to its provision, providers have little incentive to supply preventive care. More likely, incentives to provide minimal levels of caie dominate. For example, returns (in the form of reduced treatment costs) to an investment in the early detection of certain cancers (e.g., annual mammograms) might flow to a medical practice other than the one making the initial investment.

Patients' ability to assert their claims as stakeholders remain limited. They are no longer direct payers, and given the structure of employer provided health care insurance, have limited opportunities to exit from relationships with their physicians or from the insurers with whom their employers contract. Most em- ployees cannot simply walk away from their health plan and choose another. Given the costs to employers of negotiating multiple health insurance options for their employees, employers often offer only limited insurance choices to employees. Even if their employers offer a better plan, it is often more costly and requires a change of doctors. Other restrictions further limit employees ability to exit insurance relationships: workers who already have a chronic ill- ness in the family, for example, have historically found themselves captives of their existing plans, although these plans would be delighted if they switched. The sick generally do not easily disengage themselves from relations with their doctors, and neither they nor their healthier advisors even know when it is in their interest to do so (Starr, 1982). toUectively, the rewards to patients of col- lective action meant to chflinge the employer-provideci scenario remain particularly low precisely because the majority do not pay for medical services directly—and thus the costs incurred from such action cannot easily be com- pared to the costs of inaction.

Employers, on the other hand, use their ability to negotiate for large num- bers of patients (some even negotiate collectively with other employers) to win premium concessions from health maintenance organizations and Other insur- ers (Robinson, 1995). Insurers, in turn, use their ability to negotiate for large numt»ers of enrollees to secure reduced capitatioB payments from medical groups. Employers and insurers arguably suffer from lesser collective action problems than a diffused profession or citizenry. Medical groups' power to fight back (while seemingly greater than that of individual physicians) remains constrained by their own barriers to collective action, by their relative size and resources, by legislative restrictions on their ability to contract directly with employers in

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many states, by their inexperience in these and other activities elsewhere, and by an arguably too generous supply of physicians. The dominance of employers and insurers has seemingly precipitated organizational and financial arrange- ments that are no longer entirely consistent with an ethic that orders patients first. Large-group-practice, insurer-contracted, employer-provided, capitated medicine's incentives allow and potentially encourage a reordering of health care provision's stakeholders—away from patients and towards the now more salient insurers, employers, and practice owners.

An Examination of a Recent Legal Case

The first suit alleging breach of fiduciary duty under capitation serves as a specific example of the conflicts present in the current health care system (Ching V. GainesandEngeberg, 1995; Olmos. 1995; Palermo, 1996; Jacobi, 1997; Kwon, 1997; Picittic, 1997), In the past, suits against physicians have tended to remain limited to those claiming malpractice—^understood as the "bad, wrong, or inju- dicious treatment of a patient, resulting in inj ury, unnecessary suffering, or death to the patient, and proceeding from ignorance, carelessness, want of proper pro- fessional skill, disregard of established rules or principles, neglect, or a malicious or criminal intent" (Black's Law Dictionary, 1968; see also Rodwin, 1993). Malpractice charges thus addiess only the provision (or lack thereof) of patient care equaling or exceeding the so-called "standard of care"—the stan- dard of a competent jiractitioner's caje and skill under similar circumstances {Crits etal. v. Sylvester et ai.., 1956, cited ia Black's Law Dictionary, 1968). The focus of malpractice is thus technical, not motivational. In contrast, the plain- tiff in Ching v. Gaines and Engeberg (hereafter, Ching v. Gaines) explicitly charged the defendant physicians with acting in their own self-interest, rather than that of their patient's, and thus with lireaching their fiduciary duty to the patient (McGinley, 1997).s

Proponents of the plaintiff's theory in Ching v. Gaines argue that physicians may be said to act as agents for patients in giving advice about the appropriate level and charaicteristics of care. Under traditional agency law, the physician is a fiduciajry for these purposes (Hieplef, 1997a, 1997b; Jacobi, 1997). California case law has held that physicians do owe tlieir patients a fiduciary duty in cases of informed consent (Co&fe v. Grant, 1972; Moore v. Regents of the University of California, 1990; Wicklme v. State of Califomia, 1986; ail cited in Hiepler, 1997a, i997b). Act);ng in a fiduciary capacity requires putting the interests of patients above those of the fiduciary and those of any third party, and thus ad- dresses motivation (Davidson, Elnowles,, and Forsythe, 1996). In pursuing a breach of fiduciary dyty charge, plaintiffs ^patients) may transfer the burden of proof to the defendant (physician), aad thus increase their chances of winning the ca,se,, by first prodng that a fiduciary/ duty between physician and patient exists, and then proving that an incentive to breach that fiduciary duty exists. This incentive niight be an economic one, but it might also be simple meanness.

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stupidity, carelessness, or slothfulness. Once fiduciary duty and the incentive to breach are established, the burden of proof is transferred to the defendant to prove that he or she did not breach his or her fiduciary duty to the patient (McGinley, 1997).

There remains some debate about whether physicians are in fact fiduciaries (Rodwin, 1993; Gonzalez, 1997).̂ Without an expectation on the patient's part that the physician will put that patient's interests above the physician's own and those of any third party, a fiduciary relationship may not exist. Critics of the theory that physicians owe a fiduciary duty to the patient argue that patients realize the financial incentives faced by physicians, and so do not expect fidu- ciary behavior from them. Others argue that even if physicians do have a fiduciary duty, they fulfill that duty by explaining those incentives to patients and obtaining their informed consent (and legally, disclosure and informed con- sent fulfill fiduciary duty without admitting that a duty exists) (Gonzalez, 1997).

Past establishing whether or not physicians have a fiduciary duty, demon- strating the existence of an incentive to breach that duty has also proved difficult. Given that the incentives of fee-for-service medicine are to provide care (per- haps too much care), rather than restrict css:& (potentially leading to substandard care), suggestions that an incentive to breach existed under historical (fee-for- service) compensation regimes met with overwhelming skepticism (McGinley, 1997). With the increasing prevalence of capitation, however, the proposition that an incentive to breach exists has became more reasonable. Examining the proceedings of Ching v. Gaines provides an avetiue through which to demon- strate how incentive systems may affect physicians' ability to fulfill a normative (fiduciary) role—and thus how incentive systerns might impact the behavior of relationships between decision makers (eg., managers) and stakeholders.

According to testimony, Joyce Ching, then 34 years old and insured by MetLife (now MetraHealth), presented with persistent abdominal and pelvic pain and rectal bleeding (later described by the plaintiff's attorney as all the classic symptoms of colon cancer) when she visited ber primary care doctor. Elvin Gaines, oh August 14, 1992. Although Gaiiies noted an unexplained posterior (at the back of the uterus) mass, he apparently failed to appreciate its potential, and given Ching's history of fibroids, presumecl a pelvic explanation for her condition. He gave her a pelvic exam, a prescription for pain medication, and an ultrasoun:d that an expert later testified could not have detected the tumor she was eventually found to have. For the next several weeks, Ching continued to complain of pain and requested to have either more invasive testing com- pleted or to see a specialist. Another primary care doctor in Gaines' group. Dr. Dan Engeberg, ordered a series of blaod and stool tests and recommended a change in diet. The plaintiff's attorney claimed that both doctors refused Ching's pursuant telephone requests to see a specialist, while the defense argued that while Ching requested to see a specialist, she also delayed returning to Drs. Gaines' and Engeberg's office—although they requested her to do so. On Octo- ber 27, 1992, two and ahalf months after her initial visit, Ching and ber husband

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visited the doctors' office and, according to the plaintiff, refused to leave until she received a referral to a specialist. Instead, Dr. Gaines ordered a barium en- ema, which revealed a strictured area in her colon. Several days later, on Monday, November 2, 1992, Gaines referred Ching to a gastroenterologist who, by the following day, diagnosed a cancerous tumor. A surgeon removed the fist-sized grovrth two days later, but the tumor had already perforated her colon and metas- tasized. After seven operations and less than 2 years after her initial visit. Joyce Ching died in April, 1994, at the age of 35.

In December, 1995, attorney Mark O. Hiepler argued that capitation's finan- cial incentives had contributed substantially to Joyce Ching's inability to see a specialist until her cancer spread beyond the point where she could be helped. Colon cancer appears to be a treatable disease if detected early—with a five- year survival rate of 91% (although only 37% of colon cancer is found in an early stage) (American Cancer Society, 1998). Hiepler claimed that Ching's chances of survival dropped from 80% to 10-15% hecause of the delayed diag- nosis {Ching V. Gaines, 1996). Hiepler described the incentives to delay care faced hy the physicians by presenting details of the capitated contact that Drs. Gaines and Engeberg had signed with MetLife, Joyce Ching's HMO. Under that agreement, for every MetLife enrollee that signed up with the physicians' medi- cal group, Simi Valley Family Practice, the group received $27.94. This payment required the medical group to provide not only their own services hut also spe- cialist care, many diagnostic tests, and emergency room care. The medical group's purchase of stop-loss insurance (meant to insure the practice against the costs of patients' catastrophic illnesses), however, limiied the practice's obligation to the first $5,000 of specialist treatment before the insxirance kicked in. As partners in the group, Drs. Gaines and Engeberg botli received shares in the group's net income—that portion of pooled capitated fees left after the practice's expenses had been paid. Hiepler contended that these incentive arrangements encouraged the group's doctors to sign up more patients than they could respon- sibly care for and to spend no more than seven minutes per patient visit.

Capitated payments are guaranteed whether or not the patient visits or receives treatment, so an incentive exists for capitated medical practices to enroll as many patients as possible, and thus maximize the number of capitated payments received, while at the same time minimizing the care these patients receive, and thus the costs to the practice. On the day that Joyce Ching came for her first visit. Dr. Gaines saw 39 other patients. Defense attorney Michael Gonzalez ar- gued that this patient load simply reflected the fact that Gaines was the doctor on call the day Ching called for an appointment. Hiepler argued that the contract's incentives additionally encouraged the doctors to limit diagnostic tests (the tests the physicians did order for Joyce Ching exceeded the payments the practice had received from her HMO for her care during those months: the ultrasound alone cost $225) and to avoid sending Ching to a specialist, as the medical group remained liable for the costs of these services (up to the $5,000

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required by the medical practice's insurance contract). In total, the physicians' group spent instead $1,276 on Ching before her death.

The defense argued that capitated contracts cannot be evaluated by looking at only one patient: capitation's logic spreads risk across populations. Indi- vidual payments are pooled to provide a fund for the care of all patients, and if costs for one patient exceed that patient's individual payment, their care is funded by the payment of patients who didn't seek care. Additionally, if patients are tied to groups of providers in the long term, capitation encourages the provi- sion of preventive and other appropriate care because the group remains liable for the increased costs of too-long untreated illness. Denying appropriate spe- cialist care in the short run, this argument runs, costs the group more in the long run. "The Ching case is a classic example of why denying appropriate care does not save you money in the long run. Anyone who's capitated should know they must provide all the appropriate care right away. This was a very expensive case for those doctors" (Maureen O'Haren, chief lobbyist for the California Association of Health Maintenance Organizations, cited in Palermo, 1996: 27). Group practices are not, on the other hand, guaranteed that their patients today will be their patients tomorrow, so that returns to their provision of preventive care may in fact flow to a competitor. And while the Ching case was an expensive case for Drs. Gaines and Engeberg, given its eventual devolution to negligence rather than motivation, the threat of malpractice remains an imperfect mecha- nism on which to depend for encouraging short-term behavior consistent with medical ethics.

Hiepler's breach of fiduciary duty claim charged that "by failing to properly diagnose the decedent and/or refer her to a specialist, for personal financial gain, the defendants recklessly and/or intentionally failed to comply with their fiduciary responsibilities" (cited in Azevedo, 1995: 47). On the final day of the trial, however, Judge Ken W. Riley reversed his earlier decision to allow the breach of fiduciary duty charge, disallowing Hiepler to argue that financial in- centives had played a key role in Joyce Ching's death. Without the ability to address the physicians' motivation, the case devolved to a malpractice suit and thus simply the provision of substandard care. In the customary interest of giv- ing the plaintiff the benefit of the doubt, however, the judge refused to instruct jurors to disregard the previous testimony they had heard on how capitation works and the financial pressures it creates for physicians. In his summation, defense attorney Michael Gonzalez reinforced the impression that the breach of fiduciary duty was no longer at issue. "This is first, last, and only a medical malpractice case. That is the only issue involved for your consideration," he told the jury (cited in Palermo, 1995: 25). The defense argued that the doctors were simply confused by the symptoms presented. "They simply didn't believe that a woman so young could have colon cancer, so they looked to other causes for her 'vague abdominal complaints,'" including her past history of fibroids (cited in Palermo, 1995: 27). "Do you save money for not referring? Yes. But there was no reason to refer, in our opinion" (Gonzalez, cited in Palermo, 1995: 27).

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At issue, then, was simply whether the defendant physicians had provided Joyce Ching with the standard of care. Without the breach of fiduciary duty charge, the physicians' motivation for doing so—potential financial gain—was no longer important to the judgment. After two days of deliberations, the jury awarded the Ching family $2.9 million—$450,00 in compensatory (economic) damages and $2.5 million for pain and suffering (non-economic)—the largest medical malpractice verdict ever awarded in Ventura County. The judge ulti- mately awarded the Joyce Ching's 37-year-old husband and 5-year-old son only $715,288 (including both economic and non-economic damages, the latter lim- ited to $250,000 under California's 1975 Medical Injury Compensation Reform Act [MICRA]). Whether fiduciary duty charges fall under MICRA—and thus whether the Ching family could have received a larger award had the fiduciary charge been allowed—remains at question (Gonzalez. 1997).

Discussion

The case study captures many of managed care's basic tensions and highlights the inadequacy of stakeholder theory, in its cun-ent form, to explain the events as they occuiTed or to direct physicians in ambiguous situations. As stakeholder theory does not currently appreciate the influence of incentives, but rather fo- cuses only on ethical imperatives, a stakeholder analysis of the Ching case could not explain the physicians' apparent disregard for their patient's welfare—and thus for their profession's guiding ethic. The Ching case instead points out the conflicting imperatives and incentives currently shaping physician behavior, in- cluding the potential power of financial incentives and the incompatibility of these incentives with physicians' duties to particulai- stakeholder groups. In addition to failing to explain the physicians" behavior, by relying purely on norms and ethical expectations to guide behavior, stakeholder theory offers little advice to physi- cians facing the economic incentives presented by capitation. These incentives encourage physicians to behave in a way inconsistent with the ethic of their profession. In its current form, stakeholder theory suggests little more than an admonishment to physicians to behave ethically through "simultaneous atten- tion to the legitimate interests of all appropriate stakeholders," as Donaldson and Preston (1995: 67) recommend. The lack of consistency between normative expectations and incentives for ordering stakeholder claims, however, leaves physicians and their patients in a highly ambiguous position. Stakeholder theo- rists must begin to offer some heuristics to decision makers regarding the ordering of stakeholder claims. Though many issues may need to be resolved on a "case-by-case" basis, we can surely go be\'ond the modest suggestions of Donaldson and Preston (1995) and Evan and Freeman (1993).

Developed as a truly managerial theor}'. stakeholder theory would instruct and explain positive action within organizations meant to advance the interests of various stakeholders while keeping the mterests of one group from dominat- ing or intruding upon the legitimate interests of another. The health care example

426 BUSINESS ETHICS QUARTERLY

challenges stakeholder theorists not only to articulate the obligations and re- sponsibilities of health care organizations and their decision makers, but to develop the managerial substance of stakeholder theory. In particular, in order to make the theory more directive and explanatory, stakeholder theorists should incorporate both ethics and incentives into a more general model. Health care currently provides a context in which both mechanisms are highly visible and controversial. Researchers should heed the insights of Hardin (1988) and rec- ognize that creating organizations in which desired behaviors occur requires institutional structures that encompass both ethics and incentives to encourage and reinforce those behaviors. Desired behaviors might include acting on par- ticular stakeholder prioritizations. Unless institutional arrangements foster a setting in which ethics and incentives are mutually reinforcing, managerial be- havior may not be completely consistent with either. Some actions will be guided by ethics and others by incentive structures, and it may be difficult to predict which will be dominant in any given situation. Stakeholder theory currently instructs organizations on the use of ethics, but not about the use of incentives. We suggest ways in which incentives might be incorporated into stakeholder theory in the concluding section.

Conclusions and Implications

We began by suggesting that the dynamics of health care provision high- light stakeholder theory's lack of managerial direction or predictive capacity. Stakeholder theory's vague normative doctrine that decision makers recognize the interests of all legitimate stakeholders does little to help allocate resources. The theory also suggests, however, that were prioritization clear, decision mak- ers would act according to such a prioritization. The case study highlights these limitations of the theory by examining a particular type of decision maker: phy- sicians. The health care example demonstrates that without accounting properly for influences other than normative prioritizations—namely, incentives—on decision makers' behavior, stakeholder theory cannot presume the effects of such prioritizations on behavior.

Specifically, stakeholder theory does not adequately account for the influ- ence of incentive structures on behavior. Unless ethical standards and incentive structures are aligned, however, the likelihood that individuals will act accord- ing to either is diminished. In health care, an alignment between ethical standards and incentive structures appears key to patient advocacy. In organizations more generally, incentive structures may enable ethical behavior. For its normative expectations of organizations to be fulfilled, then, stakeholder theory must ad- dress both ethics and incentives.

Through emphasizing the importance of both ethics and incentives, we en- courage stakeholder theory's ability to provide managerial direction and the theory's empirical tractability. Greater direction and greater empirical tracta- bility will allow more meaningful analyses of stakeholder theory's implications.

ETHICS AND INCENTIVES 427

We see such development as necessary if stakeholder theory is to accomplish the objectives set forth by its advocates and be embraced by practitioners and researchers alike.

We see three related areas of research. First, stakeholder theorists should develop heuristics for stakeholder prioritization. Second, the theory should ad- dress the potentially differential impact of ethics and incentives on behavior, and the individual differences that moderate these relationships. Third, theo- rists need to work to overcome the false dichotomy presented by Donaldson and Preston between the normative and instrumental strands of the theory. We detail each of these research programs below.

Organizations must develop clear stakeholder prioritizations before they can design concordant incentive systems. There are a variety of ways that stake- holder theory might help managers to prioritize stakeholder claims, although no extant work offers a clear recipe for doing so. Freeman (1984) suggests au- diting the expectations of stakeholders, and comparing them to core firm values, as well as to broader societal standards (e.g., public expectations regarding pro- vision of care from health care firms). Explicitly, the firm's core values should be established through a dialogue with key stakeholders, although Freeman does not provide instructions for completing this dialogue.

Donaldson and Dunfee's (1994) Integrated Social Contracts Theory (ISCT) also begins to offer a method through which firms might work with their stake- holders to identify a morally robust value system. Because relationships between fii-ms and their stakeholders cannot violate so-called hypemorms—those prin- ciples fundamental to human existence—ISCT proposes that the identification of these hypemorms is fundamental to developing the firm's value system. The con- vergence of religious, philosophical, and cultural beliefs suggests the existence of a hypernorm. Terms of the social contract between the firm and stakeholders must be explicitly compatible with these hypemorms. ISCT remains limited as a source for instructing managers on the prioritization, however, because hypemorms are necessarily broad (e.g., the right to physical security and well- being, ownership of property, and a subsistence wage). Comparing existing explicit and implicit contracis between firms and their stakeholders with extant hypemorms, may, howevei, lead to insight into or action towards morally appro- priate stakeholder prioritizations by makmg conflicts apparent and by making existing prioritizations explicit. Making prioritizations explicit or developing more ethically sound prioritizations should additionally help managers create incentive arrangements which reinforce the firm's value system (Paine, 1994).

In addition to providing a clear basis for stakeholder prioritization, stake- holder theory needs to address the potentially differential impact of ethics and incentives on behavior, and the individual differences that moderate these rela- tionships. When ethics and incentives encourage the same behavior, the respective impact of each influence is difficult to identify. Situations in which ctliics and incentives conflict, however, offer an opportunity to discern the ef- fects of each. Our case describes a situation in which physicians' traditional

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normative ethic conflicts with the incentives they face. We have suggested that when presented with this choice, many physicians will still choose to follow their clinical ethic and put the interest of their patient above that of their own financial interest, while other physicians will instead choose their own finan- cial interest over the interest of their patient. We suggest that individual differences among physicians are the source of these differences in behavior. Physicians with certain personality characteristics—the value they place on behaving ethically, for example—might be more or less likely to follow the ethic over the incentive. More generally, individual personality differences might determine the likelihood that individuals behave according to ethics or incen- tives. Experimental methodologies might be useful for establishing the effects of these individual differences on behavior. The results of this research would provide a basis for designing incentive systems meant to support established prioritizations. Ideally, ±ese incentive systems would recognize that not every- one responds to the same ethics and incentives in the same way.

Finally, our evaluation and development of stakeholder theory suggests the need for theorists to overcome the false dichotomy drawn between the norma- tive and instrumental strands of the theory. Instrumental stakeholder theory describes the stakeholder outcomes associated with particular managerial ac- tions (i.e., instruments). The case describes two such instruments: incentives and the legal system. The case suggests that organizations might consciously or unconsciously use incentives to encourage behavior inconsistent with an estab- lished ethic. The case additionally highlights the use of the legal systems as another instrument that might be used to encourage behavior consistent with the established ethic: the legal costs associated with unethical behavior. These examples emphasize the importance of stakeholder theory's instrumental dimen- sion to its normative dimension. Instruments, like incentives and legal costs, can be used to buttress normative expectations. Rather than seeing instrumen- tal and normative claims as separate and independent (ala Donaldson and Preston, 1995), we follow Weaver and Trevino (1994) in suggesting a symbiotic relationship between them.

Notes

The authors would like to thank Thomas Donaldson, Thomas W. Dunfee, R. Edward Freeman, Paul Glezen, Thomas M. Jones. Albert R. Jonsen, Virginia Maurer, Robert Phillips. Patricia Werhane, and James Q. Wilson. Earlier versions of this paper were presented at the 1997 International Association of Business and Society Conference in Destm, Florida, at the 1998 Westem Academy of Management Annual Meeting in Portland, Oregon, the 1998 University of Virginia, Darden School of Business Administration's Olsson Center for Applied Ethics' Conference on Organization Ethics and Health Care in Charlottesville. VA. and the Hurst Legal Studies Seminar at the Warrington College of Business Adminis- tration. University of Florida, Gainesville, FL

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' Note that the Hippocratic oath does not include a similar ordering, but even m 1989. only 47% of U.S. accredited allopathic medical schools administered graduation oaths worded to resemble the Hippocratic oath

2 By ethics, we refer to rules or standards governing conduct, rather than the branch of philosophy that deals with the general nature of good and bad.

3 Fee-for-service simply means that the physician was paid for each service provided to the patient.

•• This consistency also holds for group practice under fee-for-seivice compensation 5 In many states, including California, direct contracting between employers and

providers remains illegal, forcing the additional stakeholder relationship between pro- viders and insurers. In other states, including Texas, legal direct contracting alleviates this requirement.

*> The ownership structures of many medical groups do not include all of the physi- cians in the group, making some physicians residual claimants while others are not. Those who are not owners do not share the same risks, and thus the same incentives, to behave in ways consistent with the interests of residual claimants, associated with partner status

'' Although perhaps the less their behavior impacts any one residual claimant (depend- ing on the structure of ownership)

* James D, McGinley was plaintiff attorney Mark O Hiepler's counsel for the Ching v Gaines case and prepared the plaintiff's theory.

^ Michael Gonzalez was the defense attorney in the Chins v. Gaines case

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