A New Cost Efficiency Measure for Not-for-Profit Firms: Evidence of a Link Between Inefficiency and Large Endowments

Joseph Hughes

Atlantic Economic Journal, 2013, vol. 41, issue 3, 279-300

Abstract: Cost functions and cost efficiency are commonly estimated for industries with detailed data on production and cost, both for firms that are for profit as well as not for profit. The data on not-for-profits obtained from the IRS Form 990 lack these details and, consequently, encourage substitution of the ratio of program expenses to total expenses to gauge performance. While a larger program expense ratio captures better administrative cost efficiency, it does not gauge best-practice cost and the extent to which an organization’s administrative costs exceed best practice. Using the Form 990 data, this study constructs an administrative cost function for not-for-profits and uses the distribution-free technique of estimating a best-practice cost frontier to gauge the relative efficiency of not-for-profit organizations. Focusing on not-for-profit hospitals and their holdings of liquid assets, the empirical evidence is consistent with Jensen’s free cash flow hypothesis: hospitals holding liquid assets in excess of a benchmark have lower program expense ratios and lower cost efficiency. In addition, the CEOs of more cost efficient hospitals earn higher compensation. The agreement of the evidence on agency problems related to excess holdings of liquid assets from the program expense ratio and administrative cost efficiency reinforce the credibility of the latter as a measure of the performance of not-for-profit organizations. Copyright International Atlantic Economic Society 2013

Keywords: Not-for-profit; Cost efficiency; Free cash flow hypothesis; D24; D22 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://hdl.handle.net/10.1007/s11293-013-9374-2 (text/html)
Access to full text is restricted to subscribers.

Related works:
Working Paper: A NEW COST EFFICIENCY MEASURE FOR NOT-FOR-PROFIT FIRMS: EVIDENCE OF A LINK BETWEEN INEFFICIENCY AND LARGE ENDOWMENTS (2011)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:kap:atlecj:v:41:y:2013:i:3:p:279-300

Ordering information: This journal article can be ordered from
http://www.springer. ... cs/journal/11293/PS2

DOI: 10.1007/s11293-013-9374-2

Access Statistics for this article

Atlantic Economic Journal is currently edited by Kathleen S. Virgo

More articles in Atlantic Economic Journal from Springer, International Atlantic Economic Society Contact information at EDIRC.
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().