The rise and fall of the physician practice management industry.

Abstract

PROLOGUE: “Ivory-tower teachers of finance,” says Uwe Reinhardt, have been trying for years to drum a simple lesson into their students' heads: To enhance value for shareholders, the return on an acquisition must exceed the company's weighted average cost. Simple lessons like these seem to have eluded participants in the frenzy surrounding the creation—and subsequent collapse—of the physician practice management (PPM) industry. Observers have described PPM firms as “Ponzi schemes” involving investment bankers, initial investors, venture capitalists, physicians, and others. Regardless of how the industry is characterized, the facts are clear: Between December 1997 and September 1998 Wall Street's valuation of the fifteen largest PPM firms fell by 64 percent, and the entire industry lost as much as half of its commercial value. In this paper Reinhardt uses the tale of that industry's rise and fall to illustrate how Wall Street values stocks and Wall Street's ability to allocate resources efficiently. He is critical of Wall Street securities analysts, whose job it is to sift through the reams of information and assist their clients in making appropriate decisions. Reinhardt is the James Madison Professor of Political Economy at Princeton University and has taught at Princeton since 1968. A native of Germany, Reinhardt received his doctorate in economics from Yale. He has served as an adviser to numerous public- and private-sector health policy endeavors and sits on the editorial boards of several health publications, including Health Affairs. The dominant view among academic economists is that the financial markets value financial securities “efficiently,” in the sense that the prevailing prices of widely traded securities fully and properly reflect, at any time, all publicly available information that bears on these securities. Although that theory has great intuitive appeal, it requires intellectual effort to reconcile it with the rise and fall of the physician practice management industry. This paper explores how acquisition-driven firms are valued in the financial markets and what structural factors may stand in the way of truly efficient security valuation.