Can the Use of Debt by Nonprofit Organizations Raise Government Funding?

Abstract

Nonprofit organizations (NPOs) may be reluctant to debt financing because it is associated with an increase in their financial vulnerability. However, based on arguments from signaling and agency theory, debt in NPOs can be viewed favorably from the perspective of government funders. First, the existence of a creditor can be interpreted as a prior guarantee of the NPO's financial health, which would lead to an increase in the government funds received. Moreover, by becoming supervisors of the NPO they finance, creditors encourage an increase in organizational efficiency. This increased efficiency also ultimately influences the increase in government funding. This study seeks to examine the influence of NPO indebtedness on the raising of government funds, proposing that efficiency has a mediating effect on this relationship. For a sample of 6,850 NPOs in England and Wales over the years 2015-2020, our results evidence a partial mediating effect of efficiency on the relationship between NPO debt and government funding. In addition, we find a curvilinear effect of debt on government funding, such that as indebtedness grows, government contributions also increase until the point at which indebtedness is excessive and the effect reverses.