Pay for performance (P4P) incentives for physicians are generally designed as additional payments that can be paired with any existing payment mechanism such as a salary, fee-for-services and capitation. However, the link between the physician response to performance incentives and the existing payment mechanisms is still not well understood. In this article, we study this link using the recent primary care physician payment reform in Ontario as a natural experiment and the Diabetes Management Incentive as a case study. Using a comprehensive administrative data strategy and a difference-in-differences matching strategy, we find that physicians in a blended capitation model are more responsive to the Diabetes Management Incentive than physicians in an enhanced fee-for-service model. We show that this result implies that the optimal size of P4P incentives vary negatively with the degree of supply-side cost-sharing. These results have important implications for the design of P4P programs and the cost of their implementation. Copyright © 2012 John Wiley & Sons, Ltd.