Question

Compare and contrast the following two not-for-profit hospital models: the quality-quantity maximizing model and the managerial expense preference model. In your answer, discuss the residual claimant of the hospital and the hospital’s goal. Explain with graphs and a few sentences.

Answer 1

This paper provides evidence of the growing similarity in capacity of for-profit and nonprofit hospitals.
In 1960, nonprofit hospitals maintained on average more than three times as many beds per hospital as
their for-profit counterparts; following a monotonic decline in relative size, by 2000, the average
nonprofit hospital was only 32% larger than the typical for-profit hospital. Hospital level data for the
United States indicate that the convergence was driven primarily by industry-wide effects such as entry,
exit and ownership switches, rather than expansions or downsizing of existing hospitals. These findings
suggest that hospitals may in fact strategically choose their ownership type (nonprofit vs. for-profit status)
and hence, their regulatory environment. Accordingly, I develop a model in which firms have identical
objectives but differ in their ability to benefit from a given ownership form. In contrast to the existing
literature, this approach relies neither on different ownership type-specific objectives nor on market
failure to generate an equilibrium in which both ownership types are chosen by a strictly positive fraction
of hospitals. Changes in the economic environment alter firms’ incentives to maintain a given ownership
type. This in turn induces firms to modify their capacity and encourages some firms to switch their
ownership type. Crowding-out of government hospitals, population growth and increasing involvement of
the government in the healthcare market may account for the convergence in size. Policymakers and
legislators often exert pressure on nonprofit hospitals by tying tax-exemptions to hospital-level measures
of community benefits such as free care for the indigent. I argue that by omitting industry-wide effects of
a hospital’s tax-exempt status on price and industry output, such pressure may both lead to convergence
in size and be welfare decreasing. Analysis at the state and Metropolitan Statistical Area (MSA) level as
well as at the hospital level corroborate the principal theoretical predictions.

There are several comprehensive surveys of the theoretical and empirical literature on
nonprofit organizations. For example, James and Rose-Ackerman (1986) focused on
theoretical justifications and models, which attempt to explain the existence of nonprofit
organizations. Sloan (2000a) concentrates primarily on empirical research and provides
an excellent survey of the empirical state of affairs. Malani et al. (2003) survey three
alternative economic models of nonprofit organizations and point out where existing
empirical evidence allow us to distinguish between these models.23 However, to my
knowledge, none of the existing surveys attempt to cluster these different theories by
considering their key attributes simultaneously. Such an attempt is made in this section as
I classify various economic theories of nonprofit organizations around a taxonomicsystem. This taxonomy identifies the conceptual building blocks of these models,
highlights their importance for the study of nonprofit organizations and offers a practical
way to organize the various models. In addition, such classification will enable me to
show how my theoretical approach relates to the literature.
In order to obtain the suggested taxonomy I have combined two conceptually
independent dimensions: an objective-choice dimension and a complete information-
incomplete information dimension. My choice of organizing dimensions is not unique, in
fact, proposing different organizing dimensions can lead to a different taxonomy.24
Nevertheless, I find the dimensions identified in this present taxonomy are very useful for
organizing a wide range of theories of nonprofit organizations.
The objective –choice dimension
Ownership status, whether for-profit or nonprofit, represents a choice. For some, this
choice can be traced back to intrinsic differences in objectives across individuals. For
example, the altruist will choose to organize as a nonprofit while the opportunist will
choose to organize as a for-profit. For others, the choice of ownership status need not rely
on a-priori differences in objectives; it results from simply balancing the benefits and
drawbacks of each status under a set of market conditions. In the present taxonomy, the
objective – choice dimension corresponds to these two polar viewpoints: a theory is
classified as “objective” if it contains the assumption that nonprofit and for-profit firms
differ in their objectives. Conversely, theories that rely on uniform objectives for both
nonprofit and for-profit firms are classified as “choice”.25
The complete information – incomplete information dimension
In a landmark paper, Arrow (1963) emphasizes the role of uncertainty and incomplete
markets for risk as candidate explanation for nonprofits’ dominance of the healthcare
sector. The idea is that the hospital care purchaser is often not well informed about thequality of the service being purchased and is frequently less informed than the supplier.
Consequently, some scholars claim that the solution for this asymmetric information
problem surface due to the availability of the nonprofit legal status. In this taxonomy, any
theory that relies on incomplete information will be classified as such.

The theoretical model in this section is intended to explore potential reasons for the large
difference in size between nonprofit and for-profit hospitals, by emphasizing the role that
a choice of regulatory status has on the choice of capacity. In addition, the model aims to
elucidate candidate explanations for the subsequent convergence in hospitals’ size, by
focusing on the role of demographic trends, subsidies, local pressure and government
behavior.In this model, all hospitals are assumed to produce a homogeneous service. Patients and
physicians do not favor one ownership type over the other; hence, service prices and
wages are equal across ownership types.32 Formally, I use a reduced form analysis, in
which all decisions; in both for-profit and nonprofit firms are made in accord with the
wishes of the person or group in control of the organization, which I shall refer to as the
owner.33 The owner has access to a common production technology and maximizes utility
from monetary and non-monetary gains by choosing an ownership type (nonprofit status
or for-profit status). Switching from one ownership type to another is assumed to be
costless. In addition, if the owner chooses a nonprofit status, she will benefit from cost
advantages and will be subject to a non-distribution constraint.
Cost advantages: nonprofit hospitals benefit from tax-exemptions, government grants and
access to tax-exempt capital financing.34 Hansmann (1987) finds that “tax exemption
offers nonprofit firms a significant advantage in establishing market share vis-à-vis for-
profit firms offering similar services.” Debt has always been the most important source of
capital for private hospitals (Institute of Medicine, 1986). Federal and state laws permit
private nonprofit hospitals to issue tax-exempt bonds through local and state
governments. This allows these hospitals to borrow money at substantially lower rates
than offered by lending institutions, because bondholders need not pay taxes on the bond
interest income.35 Formally, I model all the economic advantages of nonprofit firms
trough access to lower capital prices.