The adoption of pay-for-performance mechanisms for quality improvement is growing rapidly. Although there is intense interest in and optimism about pay-for-performance programs, there is little published research on pay-for-performance in health care. To evaluate the impact of a prototypical physician pay-for-performance program on quality of care. We evaluated a natural experiment with pay-for-performance using administrative reports of physician group quality from a large health plan for an intervention group (California physician groups) and a contemporaneous comparison group (Pacific Northwest physician groups). Quality improvement reports were included from October 2001 through April 2004 issued to approximately 300 large physician organizations. Three process measures of clinical quality: cervical cancer screening, mammography, and hemoglobin A1c testing. Improvements in clinical quality scores were as follows: for cervical cancer screening, 5.3% for California vs 1.7% for Pacific Northwest; for mammography, 1.9% vs 0.2%; and for hemoglobin A1c, 2.1% vs 2.1%. Compared with physician groups in the Pacific Northwest, the California network demonstrated greater quality improvement after the pay-for-performance intervention only in cervical cancer screening (a 3.6% difference in improvement [P = .02]). In total, the plan awarded 3.4 million dollars (27% of the amount set aside) in bonus payments between July 2003 and April 2004, the first year of the program. For all 3 measures, physician groups with baseline performance at or above the performance threshold for receipt of a bonus improved the least but garnered the largest share of the bonus payments. Paying clinicians to reach a common, fixed performance target may produce little gain in quality for the money spent and will largely reward those with higher performance at baseline.