Thinking about nonprofits

The discussion of nonprofit firms by Klein (noted previously) at Organizations and Markets should remind us that for-profit firms are not the only firms in the economy. Large sectors of the economy are dominated by nonprofit firms. Areas such as health, education and welfare are obvious examples. Private hospitals trend to be nonprofit, as do private universities - in countries lucky enough to have them - along with private welfare organisations such as IHC, Cancer Society, YWCA, RSPCA etc. A number of interesting questions are raised by nonprofit firms, why are they only in certain areas of the economy, why the nonprofit form, who owns them and how do these firms behave?

In their paper Not-For-Profit Entrepreneurs Edward Glaeser and Andrei Shleifer argue that entrepreneurs who start new firms may choose not-for-profit status as a means of committing to soft incentives. Such incentives protect donors, volunteers, consumers and employees from ex post expropriation of profits by the entrepreneur. Such protection is important in areas like health, education and welfare. When entrepreneurs have a taste for producing high quality products, argue Glaeser and Shleifer, the incentives are even softer, and, moreover, non-profit status can serve as a signal of that taste. Even in the absence of tax advantages, unrestricted donations would flow to non-profits rather than for-profit firms because donations have more significant influence on the decisions of the non-profits.

The paper by Jill Horwitz and Austin Nichols, What Do Nonprofits Maximize? Nonprofit Hospital Service Provision and Market Ownership Mix looks at the conflicting theories of the nonprofit firm have existed for several decades. The paper notes that empirical research has not resolved these debates, partly because the theories are not easily testable but also because empirical research generally considers organizations in isolation rather than in markets. Horwitz and Nichols examine three types of hospitals, namely, nonprofit, for-profit, and government. They look at the effect of for-profit ownership share within markets in two ways, on the provision of medical services and on operating margins at the three types of hospitals. Their findings indicate that nonprofit hospitals' medical service provision systematically varies by market mix. They find no significant effect of for-profit market share on the operating margins of nonprofit hospitals. These results fit best with theories in which hospitals maximise their own output.

Another paper by Glaeser, The Governance of Not-For-Profit Firms, looks at the implications of weak governance institutions on non-profit behaviour. A primary implication of Glaeser's results is that non-profits will often evolve into organisations that resemble workers' cooperatives. The primary check on this tendency is the need of the organisations to compete in outside markets. The paper considers four different sectors (hospitals, museums, universities and the church) and finds that all display significant signs of capture by elite workers, but all still perform their basic missions reasonably, probably because of market competition.

A further question about nonprofits is who owns them? Henry Hansmann (see "The Ownership of Enterprise", Cambridge, Mass.: The Belknap Press of Harvard University Press, 1996) argues that by definition they have no owners. This is because no one receives the residual earnings of a nonprofit firm. Jennifer Kuan, on the other hand, argues, in her paper "The Phantom Profits of the Opera: Nonprofit Ownership in the Arts as a Make-Buy Decision", that the nonprofits do have owners. In her model consumers make a "make or buy" decision with regard to a nonrival product. The result of the consumer decision to become the producer of the good, for their own consumption, is a nonprofit firm. These consumer/producers are the owners of the
organisation.

All in all nonprofits are important players in the economy who deserve more attention than they get from economists.