Evaluation of Resulting Financial Risk for Disclosure in Annual Reports

Abstract

Study Purpose: The Centers for Medicare and Medicaid Services (CMS) reduces its normal revenue payments to acute care hospitals for sub-standard quality of care.  CMS uses a variety of measures for making these assessments.  The measures used for the payment adjustments are being phased into the payment process beginning with cardiac patient readmissions in 2013.  CMS announced in October, 2014, that 721 hospitals will have their Medicare payments reduced by one percent for high rates of hospital acquired infections and other injuries. This study analyzes whether such penalties will influence lenders’ assessment of the financial risk of the penalized hospitals and increase interest rates.  Net income and cash flow of hospitals with sub-standard quality could also be negatively affected if this information is used by consumers to change their healthcare purchasing decisions.  This risk should be of interest to hospital CFOs and hospital auditors.

Methods: Acute care hospitals’ average interest rates (cost of debt) for 2008, 2009 & 2010 were regressed on weighted average mortality scores (from Hospital Compare) using Stata 11 with robust clustering to account for repeated observations of hospitals across years.  Separate regressions were used to test for differences between not-for-profit and for-profit hospitals, and whether the strength of the relationship between mortality rate and interest rate increased over time.

 Results: The results indicated a negative correlation between mortality rates and interest rates (-.165, significant at .01 level).  Accordingly, hospitals’ mortality scores that were higher than the mean for the study population were correlated with a lower average cost of capital that was statistically significant. The results did not differ significantly between For Profit and Not-for-Profit hospitals, nor did they differ significantly from year-to-year within the study period.    

Discussion:  It is unlikely that lenders would view an increase in a hospital’s mortality rate as reducing risk and lower their interest rate requirement on a loan.  A more likely explanation is that hospitals were still receiving higher revenues from readmissions and the longer stays that result from problems with the quality of care.    

 Conclusion:  The study results suggest that hospital quality scores may have a small correlation to cost of debt.  While this study is an initial examination of the relevance of hospital quality reporting to financial statement users, the results suggest that users of hospital financial statements have not yet developed a high sensitivity to hospital quality scores.   However, hospital CFO’s and financial statement auditors should continue to monitor quality as a potential risk area that should be considered in assessing financial risk.