Investment Decisions of Not-for-Profits : Evidence from Hospitals

This paper examines the investment decisions of not-for-profit hospitals. More than 20% of U.S. firms are not-for-profit, yet this organizational form has received little attention in corporate finance. This paper takes a step towards closing this gap. Our goal is to examine the role of frictions such as governance problems and financing constraints in investment decisions of not-for-profit firms. We start by developing a simple frictionless framework to analyze investment of not-for-profits, similar to the Q-theory for shareholder owned firms. We then test how exogenous shocks to cash flows affect hospital spending on different types of investments, salaries, and perks. The not-for-profit hospital sector provides a unique setting to examine these questions because most hospitals hold large financial assets (e.g., endowments), and hospital-specific shocks to the performance of these assets are likely unrelated to hospital investment opportunities. We find that hospital capital expenditures increase by 10 cents for every dollar received from financial assets, and the sensitivity comes almost exclusively from spending on equipment. The sensitivity increases to 23-27 cents when we consider investments over a two-year period. Hospitals in states with no regulatory oversight of capital expenditures have significantly higher cash-flow-investment sensitivities, suggesting that external governance mechanisms constrain overinvestment. The cash-flow-investment sensitivities are also higher for hospitals with lower financial slack