Context: Many rural hospitals in the United States continue to have difficulties recruiting physicians. While several studies have examined some of the factors affecting the nature of this problem, we know far less about the role of economic incentives between rural providers and physicians. Purpose: This conceptual article describes an economic theory of organization called Transaction Cost Theory (TCT) and applies it to rural hospital-physician relationships to highlight how transaction costs affect the type of contractual arrangement used by rural hospitals when recruiting physicians. Methods: The literature is reviewed to introduce TCT, describe current trends in hospital contracting with physicians, and develop a TCT contracting model for analysis of rural hospital-physician recruitment. Findings: The TCT model predicts that hospitals tend to favor contractual arrangements in which physicians are full-time employees if investments in physical or other assets made by hospitals cannot be easily redeployed for other services in the health care system. Transaction costs related to motivation and coordination of physician services are the key factors in understanding the unique contractual difficulties faced by rural providers. Conclusions: The TCT model can be used by rural hospital administrators to assess economic incentives for physician recruitment.