Financial relationships between physicians and industry are vital to biomedical innovation yet create the potential for conflicts of interest in medical practice. I consider an inducement model of the role of financial relationships in health care markets, where consulting payments induce physicians to use more devices of the firms that sponsor them.

To test the model, I exploit a policy shock, whereby government monitoring of payments to joint replacement surgeons resulted in declines of over 60% in both total payments and in the number of physicians receiving payments from 2007 to 2008. Using hospital discharge data from three states,

I find that the loss of payments leads physicians to switch 7 percentage points of their device utilization from their sponsoring firms' devices to other firms' devices, an effect which is concentrated among surgeons with low switching costs.

These results offer support for the inducement model. I also find evidence of an increase in medical productivity following the policy intervention, which suggests conditions under which regulation of financial relationships would be socially beneficial. 

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