Network Formation and Bargaining in Vertical Markets: The Case of Narrow Networks in Health Insurance

This paper develops a model of vertical markets with multiple upstream and downstream firms. Networks of vertical relationships, negotiated contract terms for those relationships, and downstream prices charged to end customers all arise endogenously. In addition, I provide an estimation procedure to fully rationalize the observed network and contracts in a computationally scaleable manner. I empirically apply the framework to the market between hospitals and health insurers. I use the model to quantify the effects of “network adequacy regulations,” which are designed to broaden patients’ hospital choice sets but can backfire by increasing prices. I show that “tight” regulations have adverse effects. I also show market response is substantially impacted by complex mechanisms involving the interplay among multiple insurers and between upstream negotiation and downstream pricing.