The Impact of Changes in Regulation on Cost Behavior

This paper examines the effect of fixed price regulation on cost behavior. First, we posit that a change in regulation from quantity regulation to fixed price regulation with a quantity constraint results in an increase in the operating risk faced by firms. In response, firms attempt to influence their cost structures by increasing their cost elasticity and reducing cost stickiness. However, such responses to regulation are constrained by institutional pressures. Analysis of data from the German hospital industry for the years 1993-2008 indicates the
following. First, fixed price regulation increases cost elasticity to a greater extent in for-profit relative to non-profit hospitals. Second, the change to fixed price regulation is associated with a decrease in cost stickiness. This effect is stronger in the case of for-profit relative to nonprofit or government hospitals. Our study reveals that economic as well as sociological factors influence firms’ cost structure responses to regulatory changes.

Keywords: Cost elasticity, cost stickiness, price regulation, institutional theory, hospitals