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Patients with health insurance do not make the most cost conscious healthcare decisions since they bear only a fraction of the total cost of medical care. Managed care advocates point to financial incentives as a way to reduce wasteful resource use. However, physicians with managed care contracts feel financial pressures designed to reduce waste may also limit medically necessary services and adversely impact the quality of patient care. In light of a growing public and professional distrust of the motives behind offering financial incentives, the economic theory of agency is used to illustrate how financial contracts designed to reduce wasteful resource use influence physician behavior.

A review of the literature was conducted to determine the effects of financial incentives on resource use, cost and the quality of medical care. The method used to undertake this literature review followed the approach …