University of Virginia Legal Working Paper Series
University of Virginia John M. Olin Program in Law and Economics Working Paper Series
Are Non-Profit Firms Simply For-Profits in Disguise? Evidence from Executive Compensation in the Nursing Home Industry
Abstract
It is relatively well-established that there are differences between executive compensation at for-profit and non-profit firms. In particular, the latter employ performance bonuses with much lower frequency than the former. The question this paper addresses is: do these differences imply that for-profit and non-profit firms have different objectives? Do non-profit care about, e.g., quality or quantity of production, rather than profits? This paper answers in the negative. Observed differences in wage contracts can be explained by the fact that non-profit firms operate in a different regulatory environment than for-profits. In particular, IRS regulations discourage non-profit firms from using performance incentives on pain of paying tax penalties and perhaps losing their tax-exempt status. A non-profit firm which seeks to maximize profits would respond to this constraint by substituting away from performance bonuses (carrots) towards incentives based on the risk of firing (sticks). The result will be higher base salary, to compensate risk-averse executives for the use of as blunt an instrument as firing, and a higher overall salary, because non-profits have a smaller set of feasible contracts from which to choose. We test these predictions on a unique, facility-level data set of executive compensation at 2700 nursing homes in 2001 and 2002. Not only do we find support for our predictions, but we also find that compensation rises with profits, but not with quality or quantity. This last result is notable because it demonstrates that the tax-regulation explanation for non-profit executive compensation is not only more parsimonious, but likely more accurate than the different-objectives explanation.
Subject Area
Corporations, Economics, Taxation
Recommended Citation
Anup Malani and Albert Choi,
"Are Non-Profit Firms Simply For-Profits in Disguise? Evidence from Executive Compensation in the Nursing Home Industry"
(August 2004).
University of Virginia Legal Working Paper Series.
University of Virginia John M. Olin Program in Law and Economics Working Paper Series.
Working Paper 12.
http://law.bepress.com/uvalwps/olin/art12
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