Cost Shifting in Nonprofit Hospitals

Abstract:     
While managers of for-profit organizations are charged with maximizing profits, this is typically not the case for managers of nonprofit organizations. Specifically, managers of nonprofit hospitals are charged with fulfilling the hospital’s mission to the community (i.e., providing quality health-related services at affordable prices), while the hospital earns profits that are near (or perhaps just above) zero. Prior research shows that managers of nonprofit hospitals manage accruals and real activities to avoid earning profits below or well above this zero-profit benchmark. We extend this research by showing that nonprofit hospitals also engage in cost shifting by reclassifying expenses from non-patient-centered (hereafter, 'non-core') to patient-centered (hereafter, 'core') activities when reporting earnings that either fall short of or are well above the zero-profit benchmark. This result tends to be more pronounced for hospitals with greater normative pressures, lower regulatory oversight, and greater reliance on external financing through donations. We expect our findings to yield clarity on the quality of nonprofit hospitals’ earnings by looking beyond bottom-line net income.

Number of Pages in PDF File: 48

Keywords: nonprofit hospitals, classification shifting, earnings management, earnings thresholds

JEL Classification: L31, M41

working papers series