The Tax Code as Regulator of Nonprofit Corporate Governance

Researchers from the University of Virginia and Emory University have posted an interesting paper. The interesting assertion is that the tax code “is a [the?] major source of governance for nonprofits.”  Either way, the assertion’s plain obviousness belies a whole host of policy decisions about how civil society governs itself.  I haven’t read the article yet.  Here is the abstract and an excerpt from Corporate Behavior When Running the Firm for Stakeholders: Evidence from Hospitals:

We study how stakeholder orientation impacts firm management and performance. We exploit state-level law changes governing the conversion of hospitals from nonprofit to for-profit and find that for-profit orientation reduces hospital spending on emergency rooms and Medicaid patients, while increasing focus on revenue and affecting investment decisions. Consistent with spillovers, nonprofit hospitals located near converting hospitals experience increased emergency room visits and expenditures. We investigate governance channels that align corporate behavior with stake- holders and find that converted for-profit hospitals adjust their boards by replacing MDs with MBAs, and that the tax code is a major source of governance for nonprofits.  

. . . 

Finally, we explore the mechanisms that connect stakeholder orientation and hospital behavior. Lewellen et al. (2023) document that corporate governance in nonprofit hospitals is relatively weak. How do nonprofit hospitals successfully align their actions with their mission? First, our findings point to a novel channel of corporate governance in nonprofits: the tax code. The services that hospitals reduce after conversion to for-profit are required prior to conversion to retain federal tax-exempt status under the Internal Revenue Service (IRS) code. To the best of our knowledge, this is the first evidence of the tax code acting as a corporate governance mechanism. Finally, we show that hospitals also leverage traditional corporate governance channels to align their actions. Specifically, we show that for-profit hospitals adjust their board composition by replacing MDs with MBAs.

darryll k. jones