Abstract
In this paper, we examine bad debt and charity care reporting by nonprofit hospitals around bond issuance. Given the tax advantages afforded to nonprofit hospitals, including the ability to issue tax-exempt debt, hospital managers encounter stakeholder pressure to provide community benefits. When nonprofits issue debt, they also face economic pressure to meet creditors’ financial performance expectations. We document a reporting strategy that allows nonprofit hospitals to reduce the cost of bond debt while simultaneously alleviating regulators’ and community members’ concerns about inadequate provision of charity care. Using data from public bond issues for California nonprofit hospitals, we find that hospital managers shift costs from bad debt expense to charity care in periods prior to a public bond issuance and that the strategy is associated with a lower cost of debt. Our results inform those relying on accounting measurements to infer nonprofit hospitals’ social good provisions and financial health.
Highlights
Nonprofit entities enjoy significant economic benefits via federal, state, and local tax exemptions, including access to the tax-exempt municipal bond market
Hospital Controls includes variables that are plausibly associated with both bond issuance and shifting incentives: lagged Return on Assets (ROA) controls for prior period performance; charity care (CCRevs) and bad debt expense (BDERevs), both scaled by revenues,20 control for the relative significance of uncompensated care to total revenues; and Beds controls for size
When combined with the DBDE coefficient, the results suggest that discretionary charity care increases by approximately $2.02 for every dollar that discretionary bad debt expense decreases in the aggregated three years prior to bond issuance
Summary
Nonprofit entities enjoy significant economic benefits via federal, state, and local tax exemptions, including access to the tax-exempt municipal bond market. Prior studies provide evidence that nonprofit hospitals manage bad debt expense and charity care to report near-zero profits (Leone and Van Horn 2005; Eldenburg et al 2015), and that hospitals shifted costs between these two accounts during a reporting transition when a change in accounting and reporting guidelines presented the opportunity to do so (Eldenburg and Vines 2004). We provide the first empirical evidence that nonprofits strategically use accounting discretion to obtain capital, and show that, in the case of nonprofit hospitals, this is achieved by shifting costs into charity care We contribute to this literature by documenting an instance where a nonprofit can “kill two birds with one stone,” given our findings that decreasing bad debt expense by shifting costs to charity care simultaneously lowers a nonprofit’s cost of debt and increases the amount the nonprofit is able to report in charity care (as justification for its tax-exempt benefits). Our setting provides a powerful setting in which to examine the potential effects, on firm reporting behaviors, of such tax incentives
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