The key question addressed in this study is whether performance-based reimbursement (PBR) is a useful way to create the right incentive for efficiency improvements in health care. In this 4-year prospective cohort study, physicians in one council with PBR and in ten councils without such a system were studied. The results of this study indicate that PBR, compared to an annual budget system, creates a different incentive, an 'inner incentive' which may be stronger than the external incentive of financial pressures. PBR may result in a greater cost awareness and shorter average length of stay, but it may also lead to negative effects on the quality of care. A strong cost awareness was found to be a negative predictor of quality of care indicating that it is a difficult balancing act to maintain cost considerations at a 'good' level in order to retain the benefits of cost awareness without adversely impacting quality of care. There is a need for further studies of the impact of PBR on financial performance and quality of care issues.