OBJECTIVE: To determine the effects of Medicare's prospective payment system (PPS) on hospital care, changes in length of stay and intensity of clinical services received by 2,746 depressed elderly patients in 297 acute care general medical hospitals were studied. METHODS: A pre- post design was used, and differences in sickness at admission were controlled for. Data on length of stay and use of specific clinical services were obtained from the medical record using a medical record abstraction form. Care provided on units exempt from PPS was compared with care provided in nonexempt units. RESULTS: After implementation of PPS, the average length of stay fell by up to three days within the different types of acute care settings studied, but this decline was partially offset by proportionately more admissions to psychiatric units, which had longer lengths of stay. Intensity of clinical services increased after PPS implementation, especially in nonexempt psychiatric units. CONCLUSION: Despite financial incentives for hospitals to reduce clinical services under PPS, its implementation was not associated with a marked decline in length of stay, when averaged across all treatment settings, and was associated with an increase in the intensity of many clinical services used by depressed elderly patients in general hospitals.