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Brian Cadman

University of Utah, David Eccles School of Business

The Consequences of Restricting the Distribution of Earnings for Tax-Exempt Organizations

Friday, May 26, 2023
11:15 AM – 12:45 PM
Bronfman 340

Abstract:

Organizing as a tax-exempt business amplifies agency problems through limited own- ership and restricted earnings distribution. We study the consequences of this orga- nizational structure in the setting of private tax-exempt hospitals, which own 75% of total industry assets, holds 75% of total cash on their balance sheets, care for 70% of total patient-stays, and employ 70% of total industry employees. These tax-exempt hospitals earn net income of $9 million, on average, and hold an average cash balance of $28 million. Using a re-weighted, multivariate regression, we find that tax-exempt hos- pitals distribute economic profits to employee-stakeholders through 42% larger salary expenses and also invest more in fixed assets through capital expenditures that are 88% larger than taxable hospitals. In addition, we show that tax-exempt hospitals hold four times more cash and 40% more net assets than taxable hospitals. As further evidence of the tax-exempt status trapping cash in the firm, we show that tax-exempt hospitals sharply reduce their cash balances immediately upon converting to taxable status. Taken together, the evidence highlights that restrictions on earnings distribu- tions traps cash and equity within the firm, inducing potentially perverse behavior for those tax-exempt organizations that are profitable.

For more information, contact linda.foster [at] mcgill.ca (subject: Ernst%20%26%20Young%20Speaker%20Series%20with%20Brian%20Cadman) (Linda Foster)