Non-Profit Status and Relational Sanctions: Commitment to Quality through Repeat Interactions and Organizational Choice
32 Pages Posted: 10 Mar 2014 Last revised: 26 May 2017
Date Written: July 30, 2015
An entrepreneur can organize either a for-profit or a non-profit firm to sell product or service to consumers in the long run. Because quality is non-verifiable and unobservable investment can still produce low quality, in equilibrium, consumers impose relational sanctions when low quality is delivered. With sufficient relational sanctions, both types of firms produce the same expected quality. However, because the non-distribution constraint reduces the temptation to shirk from investment, non-profit firm is subject to shorter relational sanctions, which can make the non-profit status attractive even for the entrepreneur who cares only about the return she gets from the firm. Non-profit status is preferred, for instance, as the investment-quality relationship gets weaker or as stronger market competition reduces the profit margin. The paper also shows how both types of firms can co-exist in a market when the legal enforcement against non-profit weakens as the number of non-profit firms increases.
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