OBJECTIVE: The authors evaluated the impact of Medicare's Prospective Payment System on aspects of quality of care and outcomes for depressed elderly inpatients in acute-care general medical hospitals. METHOD: The depressed elderly inpatients (N = 2,746) were hospitalized in 297 acute- care general medical hospitals. The authors used a retrospective before- and-after design, controlling for differences over time in sickness at admission. Quality of care and outcomes were assessed through clinical review of explicit and implicit information in the medical records; secondary data sources provided information on postdischarge outcomes. RESULTS: After implementation of the prospective payment system 1) a higher percentage of patients had clinically appropriate acute-care admissions; 2) the initial assessment of psychological status by the treating provider was more complete; 3) the quality of psychotropic medication management, as rated by the study psychiatrists, improved; 4) the rates of any inpatient medical or psychiatric complication, of discharge to another hospital or a nursing home, and of inpatient readmission declined; and 5) there was no marked change in the percentage of patients rated by study clinicians as having acceptable overall clinical status at discharge or the rate of mortality 1 year after admission. CONCLUSIONS: After the implementation of the Medicare Prospective Payment System, the quality of care for depressed elderly inpatients improved and there was no marked increase in adverse clinical outcomes. Despite these gains, after implementation the quality of care was moderate at best and over one-third of the patients had unacceptable clinical status at discharge.