Tax-Exempt Debt and the Capital Structure of Nonprofit Organizations: An Application to Hospitals

Gerard J Wedig, Mahmud Hassan and Michael Morrisey

Journal of Finance, 1996, vol. 51, issue 4, 1247-83

Abstract: The availability of tax-exempt financing provides nonprofit (NP) organizations with their own tax-based incentives to issue debt. In this article, we develop a theoretical model in which NPs gain an indirect arbitrage from tax-exempt debt issuance, constrained by: (1) the requirement that fixed investment exceed tax-exempt debt flows (the project financing constraint), and (2) the constraint against share issuance. These constraints cause them to impute tax benefits to projects that afford access to the tax-exempt bond market. Empirical tests indicate that NP hospitals behave as if they have target levels of tax-exempt debt. Debt targeting is constrained by the availability of capital projects, while excess debt capacity stimulates investment. Copyright 1996 by American Finance Association.

Date: 1996
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