Effects of debt financing on operational and capital-investment efficiency in nonprofit hospitals

The 130th Annual Meeting of APHA

5033.0: Wednesday, November 13, 2002 - 9:15 AM

Abstract #35854

Stephen A. Magnus, PhD¹, John R. C. Wheeler, PhD², and Dean G. Smith, PhD². (1) Health Policy and Management, University of Kansas School of Medicine, 3901 Rainbow Blvd., 4040A Varnes Center, Kansas City, KS 66160, 913-588-2699, smagnus@kumc.edu, (2) Health Management and Policy, University of Michigan, 109 Observatory, Ann Arbor, MI 48109-2029

This paper explores whether debt financing improves operational and capital-investment efficiency in nonprofit hospitals. Corporate finance theory holds that debt creates incentives for efficiency in companies. However, this theory has not been applied to, or tested in, nonprofit organizations. We evaluate whether efficiency is higher in nonprofit hospitals that have issued more debt than their peers by performing regression analysis on a national data set of 343 hospitals in 1997, and, as a sensitivity analysis, on 189 hospitals in 1996.

The results suggest that debt either has no effect, or a negative effect, on various measures of hospital efficiency. As for operational efficiency, debt has no statistically significant effect on staff efficiency (FTEs per occupied bed); a statistically significant, negative effect on net operating income to revenues in both years; and a statistically significant, positive effect on expenses per admission in 1996. As for capital-investment efficiency, debt has a statistically significant, negative effect on return on equity in 1996; a statistically significant, negative effect on return on assets in both years; and a statistically significant, negative effect on return on net fixed assets in both years.

In addition to the statistical analysis, we conducted interviews with hospital managers, investment bankers, financial advisors, and others involved in hospital debt markets in order to elucidate hospitals’ decision-making processes regarding debt. Many suggested that the incentives for efficiency following debt issuance may be less powerful in the nonprofit sector than in the for-profit one because there is less oversight of nonprofit debt.

Learning Objectives:

At the conclusion of the presentation, attendees will be able to

3. Understand some ways in which corporate finance theory is being applied to nonprofit hospitals and other nonprofit health care provider organizations.
7. Recognize that not only product markets, but also financial markets, may influence the performance of nonprofit hospitals and other nonprofit provider organizations.
11. Identify several measures of hospital efficiency.
15. Understand the distinction between operational efficiency and capital-investment efficiency.
19. Articulate basic corporate finance theory about the effects of debt financing on organizational behavior.

Keywords: Hospitals, Financing

Presenting author's disclosure statement:
I do not have any significant financial interest/arrangement or affiliation with any organization/institution whose products or services are being discussed in this session.

Financial Issues and Analysis

The 130th Annual Meeting of APHA