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ABSTRACTA dramatic change in the hospital industry is the increasing emphasis on linking provider payment to quality performance metrics. This is one of several considerations leading hospitals to employ physicians. Yet, there is little evidence regarding whether physician employment as a form of hospital‐physician integration leads to better operational performance. Using data from 201 California hospitals that experienced a total of 405,766 eligible opportunities to conform to external performance metrics (conformance quality) for treating patients in the cardiovascular service area, we empirically evaluated the relationship between physician employment and conformance quality. We also evaluated whether the presence of core capabilities in the hospital's cardiovascular service area complements or substitutes for physician employment. Findings suggest that physician employment is not only positively associated with conformance quality, but also associated with more consistent conformance quality. Moreover, the presence of core capabilities in the service area substitutes for physician employment. Theoretical, managerial, and policy implications are discussed.