Objectives of Non-Profit Organisations: a Literature Review*

May 2003

Cindy Du Bois, Marc Jegers, Catherine Schepers and Roland Pepermans Vrije Universiteit Brussel (VUB)*

The authors thank R. Scott Gassler for his helpful comments.

1

1. Introduction

Economists generally agree on the assumption that the objectives of for-profit firms can be described in terms of profit maximisation. Because the non-profit organisation typically faces a non-distribution constraint, which prohibits the organisation from distributing its net earnings to those who own or are in control of the organisation (Hansmann,H., 1986, p. 58), the traditional framework of profit maximisation does not apply here. If non-profit organisations (NPOs) do not exist to maximise profits, then why do they exist? What objectives do they pursue? What are the motivations of non-profit entrepreneurs? The bulk of the literature on NPOs addresses the demand-side of NPOs. The public goods theory of Weisbrod and the contract failure theory of Hansmann for example1, suggest reasons why there is a demand for products or services produced by NPOs. Questions of objectives and goals on the other hand are addressed by supply-side theories. Despite their importance in understanding the behaviour of the organisations, theoretical as well as empirical supply-oriented work is not so numerous. This paper will summarise the main results and gaps of these supply-oriented theories of the non-profit sector in identifying the objectives of NPOs. If literature on supply of NPOs is scarce, work on the internal organisation and working of a NPO is, with a few exceptions, almost non-existing. As we will argue here, leaving the black-box view of the NPO and studying the internal Principal-Agent relations will also shed more light on the objectives of the NPO. Because there is no consensus among economists regarding the objective function of nonprofit organisations2, different hypotheses regarding the objective function or, in general, regarding their behaviour, are found in the literature. Besides, when ownership is separated from control, defining the objective function of the firm becomes even more difficult since the objectives of the manager(s) need not necessarily coincide with the objectives of the owner(s). In the prevailing literature, it is not always obvious which of both objective functions is discussed. The pre-eminent framework for studying the relation between owner and manager is the PrincipalAgent theory that therefore constitutes our basis for understanding the different objective functions found in the non-profit literature.

1 2

For an extensive overview, see Hansmann,H., 1987 Schiff, J. and B. Weisbrod, 1991, p. 621

2

The outline of this paper is as follows: In the first part, the rather formal supply-oriented theories of NPOs are reviewed. These theories tend to conceptualise the behaviour of NPOs as a neo-classical model where an objective function has to be optimised under certain constraints. The second part discusses the so-called entrepreneurial theories of NPOs. In this approach focus lies more on the preferences of the individuals engaged in the organisations. Although these two theoretical approaches both have their own way of rationalising the supply of nonprofit services, they are consistent with each other and with most of the demand-oriented theories of the non-profit sector. In a third part, the NPO is approached from the Principal-Agent framework. Although the non- profit literature on (internal) Principal-Agent relations is very scarce, we will argue that this approach can contribute a lot in the understanding of the behaviour and internal organisation of NPOs. The final conclusion follows from the three previous parts and addresses the importance of a more general and comprehensive approach with focus on Principal-Agent relations.

3

2. Neo-classical Optimisation Models

Following the neo-classical tradition, most models of the behaviour of non-profit organisations have been optimising models.3 These models conceptualise the NPOs behaviour as the optimisation of an objective function under several restrictions. Their approach to explain the NPOs behaviour is the same, but model variation occurs as authors use different arguments in the objective function. In this section these optimisation models are reviewed and discussed in the light of empirical applications and practical relevance.

1) The Models In the more philanthropic view of a non-profit organisation the objective function obtains some arguments that represent utility derived from the provision of services itself. Arguments often found in early literature are quantity and quality of provided services. A seminal work here is the model of Newhouse for a private non-profit hospital. To show that the non-profit form is usually less economic efficient for a hospital than the for-profit form, he developed what he called a constrained quality-quantity maximising model. The objective of the hospital is to maximise the quantity of services provided and at the same time also the quality of care, while possibilities are limited by a budget constraint (Newhouse,J.P., 1970). Although with another purpose, namely to analyse the major rise of hospital costs during the early seventies in the United States, Feldstein also used the quality of care as maximisation function (Feldstein,M., 1971). In a more recent article, Frank and Salkever (2000) also develop a model of a non-profit hospital to characterise the influence of diversification. Their utility function also includes the delivery of the services itself. Similar models are developed for other industries like the performing arts (Hansmann,H., 1981) and universities (James,E. and E.Neuberger, 1981). If we define altruism as a property of people that derive utility from doing things which benefit other people, we can say that these models assume, although maybe implicitly, some altruistic motivations. Quality of care, quantity of offered education, are objectives because people benefit from it. Also Gassler postulates that a substantial number of NPOs can be explained by altruistic motives more easily than selfish ones4.

3 4

Hansmann,H., 1987, p. 37 Gassler,R.S., 1998, p.174

4

Of course, not all NPOs are born out of altruistic minds. Newhouse himself points out that maximisation of quantity and/of quality can also be consistent with selfish behaviour in that they both positively affect the prestige of the organisation (Newhouse, J.P., 1970, p. 65). What these models do rule out, is the possibility that the organisation pursues goals that are disadvantageous for others like for example maximising managerial perks by using donors money. The models do not account for the possibility that the managers of the organisation do not share the philanthropy of the owner.

In contrast, Pauly and Redisch developed a model of a non-profit hospital where the objective is to maximise the net incomes of the hospitals physicians. Although their model is based on the very strong assumption of total control by the physician staff of the hospital, they address an important point, namely that the objectives of the hospital owner (principal) need not to coincide with the objectives of the physicians (agents) (Pauly,M. and M.Redisch, 1973). Niskanen jr. (1996) also points out that agents of a NPO (as a special form of bureaucrats) have a lot of arguments in their utility function, like e.g. status, salary, control and power, that are positively related to the budget of the NPO. Because the higher the NPOs budget, the higher the utility of the NPOs manager, the latter will try to maximise the NPOs budget. Other authors who also consider the possibility of budget maximising non-profit organisations are Hansmann (1981) and Steinberg (1986). Gassler (1986, 1997) suggests an objective function that incorporates the output of the organisation as well as a variable for amenities or managerial perks.

2) Empirical analyses

The previous review makes it obvious that there exists little consensus among the non-profit theorists about the appropriate model/objective function. Maybe, one of the reasons for this indecisiveness is as Pauly postulates The heart of the theoretical problem is that the objective function is usually unobservable.5 Because this objective function is so hard to observe, empirical comparisons of the different models of non-profit organisations behaviour are difficult. Empirical applications therefore usually start from predictions about the NPOs behaviour that are further contrasted with predictions about the behaviour of other institutional types, like e.g. profit maximisation of the for-profit firm (Steinberg,R., 1987, p. 126).5

Pauly,M.V., 1987, p. 258

5

One example of such an intra-institutional comparative test is that of Badelt and Weiss (1990). These two authors analyse the behaviour of 4380 Austrian nursery schools, which they divide into four groups according to their institutional type: Public Sector Organisations (GOs), Non-profit Organisations (NPOs), Church-affiliated Non-profit Organisations (CNPOs) and For-profit Organisations (POs). They empirically test the assumption that the supply of the four groups would differ and would be consistent with an objective function that typifies their institutional type. Their assumptions are borne out by the empirical tests: CNPOs e.g. were underrepresented in the baby day care (because of their conviction that babies should be raised by their family) and NPOs were largely present in the handicapped care (principle of charity) (Badelt,C. and P. Weiss, 1990, p. 81). There exists a rich empirical literature that focuses on differences in quality of services provided by hospitals of different institutional types. Some empirical examinations conclude that the non-profit form actually has a positive influence on quality of the provided services (e.g. Mark,T.L., 1995), while others find no significant quality difference between the different forms of ownership (Sloan,F.A. et al, 1998). Keeler and co-authors (1992) even find one indicator of quality that indicated higher quality for services provided by hospitals of the for-profit form (Sloan,F.A., 2000). Still other authors show that difference in quality also depends on other factors like the presence of asymmetric information (Chou,S-Y., 2002) or location of the organisation (Mobley,L.R. and W.D. Bradford, 1997 ; Norton,E.C. and D.O.Staiger, 1994 ; Banks,D.A., 1993). To hold other possible influencing factors like location constant, Picone, Chou and Sloan (2002) study the level of quality in hospitals when these converted from non-profit or public status to the forprofit type. Their results indicate that conversion to the for-profit status reduces quality of services, at least for the first two years after conversion6. Most of these studies use impact of the hospitals care on the patients health as performance measure, but assessing such impact is very difficult. McClellan and Staiger (2000) identify three problems in comparing hospital quality; a problem of measurement due to a lack of data, noise due to patient and environmental factors that also have an impact on the patients health and a bias in the results caused by possible patient selection by the hospital. The authors try to address these problems by using a different measure, i.e. a risk-adjusted mortality rate. This rate, based on data of serious health problems, addresses the noise problem by adjusting it for patient-related issues that could influence the results, e.g. age, gender, . To avoid a possible bias in the results, their data only relate to mortality and cardiac complications requiring rehospitalisation, so the possibility of patient selection is strongly reduced. Their

6

results indicate a slightly better performance of non-profit hospitals but they also indicate that this small difference between non-profit and for-profit hospitals masks a big variation within the various groups. Three in-depth case studies effected by the same authors suggest that forprofit hospitals may choose to locate in areas where quality is on average poor. It is probably wise to point out that all these observations are conducted in areas where nonprofit as well as for-profit organisations are present. Competition from one type of organisation could influence the behaviour of the other types of organisation present in the market so that not accounting for this possible influence could result in biased hypotheses about the NPOs objectives and behaviour. To use the words of DiMaggio and Powell (1983), once different organisations enter the same line of business, rational actors will make these organisations increasingly similar. They describe these processes of homogenisation with the term Institutional Isomorphism (DiMaggio,P.J. and W.W.Powell, 1983, p. 149). Some authors (e.g. Hirth,R.A., 1999 ; Hansmann,H., 1980) believe that non-profit organisations do not only directly attribute to the quality of services but also indirectly improve overall quality via spill-over effects on the quality of the for-profit organisations. Grabowski and Hirth (2003) use an instrumental variables approach to test two models of the nursing home market. In the first, asymmetric information, model the existence of non-profit organisations is assumed to have a positive effect on both the quality of the for-profit competitors and on the overall quality of the sector. The second, full information, model assumes that the high quality of non-profit nursing homes will crowed out high quality forprofit nursing homes, so the overall quality of the for-profits will decrease and the general quality in the market will not change. Their results are consistent with the asymmetric information model and thus suggest that the presence of non-profit nursing homes will increase the quality of the entire sector. Others argue that the influence works the other way in that it is the for-profit organisation that forces the non-profit organisation to adopt a profit-maximising behaviour. In a recent article, Duggan presents findings suggesting that not-profit hospitals do indeed behave differently in the presence of for-profit hospitals. The Californian non-profit hospitals in his sample responded more aggressive on financial incentives when they had to share the marketplace with for-profit competitors (Duggan,M., 2002). Cutler and Horwitz (2000) also argue, based on two in-depth case studies of conversions of non-profit hospitals to for-profit hospitals, that having for-profit hospitals in the market appears to cause non-profit hospitals to adopt the same moneymaking measures employed by for-profit hospitals. They define this6

Conversions from for-profit hospitals to the public or non-profit form had no negative effect on the

7

phenomenon as the inverse Hansmann problem, referring to Hansmanns seminal article of 1980 where he argues that non-profit hospitals will force for-profits to deliver high-quality service (Cutler,D.M. and J.R.Horwitz, 2000, p. 71). Without entering the discussion of which type of organisation influences and which is influenced, it is clear that when studying the objectives and behaviour of NPOs, one must account for the competitive environment of the organisation. While summarising this vast amount of empirical applications, one can hardly overlook some contradictory findings. Maybe, non-profit organisations and for-profit firms are not that different after all or maybe the objective function of the NPO is still not quite accurately formulated. A better test of the objective function of a NPO would be to directly compare the different models formulated in theory. Here the applications are not so numerous. Steinberg (1986) constructed such a test to identify the maximands of the non-profit objective function. He specified a parameter, the marginal donative product of fundraising, to characterise the NPOs objective with budget maximising and service maximising as the two extremes. His empirical results suggest that education and art organisations tend to maximise their services, welfare organisations too, but to a lesser extent. Health firms appeared to be more budget maximising, while a too small sample size prevented conclusion for the research organisations (Steinberg,R., 1986).

3) Comments

Although neo-classical economic work has its contributions to the development of a theory of non-profit organisations, some remarks can be (and have already been) made. A first remark concerns the limits inherent in the neo-classical models themselves. Typically these models are based on the assumption of rational economic behaviour. An important characteristic of a rational economic agent is his selfishness; people do things if it enhances their consumption (possibilities). Every activity that does not maximise utility is labelled as irrational. It is clear that to understand why NPOs are founded, one has to use a broader framework of utility. As Rose-Ackerman (1996) postulates Theoretical progress requires a richer conception of individual utility functions and a base in cognitive psychology that incorporates the power of ideas and emotions in motivating behaviour7. In the entrepreneurial theories, which will be discussed in more detail below, the focus is more on the preferences of non-profitquality of services. 7 Rose-Ackerman,S., 1996, p. 701

8

entrepreneurs. Maybe, the insights of these theories can help to overcome problems due to the rather narrow preference framework of the neo-classical models. Of course, individual preferences are not really the field of economists, hence an interdisciplinary approach will surely be beneficial to the development of a non-profit theory. A second remark is not on the neo-classical models per se but more on the applications. Most of the models and also the greater part of empirical work are developed in the United States with a strong focus on hospitals or nursing homes. Like for the health-care sector, the situation in the United States is quite different from the European context so theoretical models or empirical results developed in the US are not automatically applicable to European countries. The role that government appropriates often accounts for these differences between the United States and Europe. Finally, only a few contributions mention possible differences between the objectives of the owner(s) and those of the manager(s). The contract failure theory of non-profit organisations views the non-distribution constraint as a solution to agency problems between the consumer and the organisation (Hansmann,H., 1987, p. 31) but the literature mentions very little about agency problems (and solutions) between owner/board and managers. In contrast, in the forprofit literature, within the Principal-Agent framework, a lot of attention is given to the relation owner-manager. In NPOs, managers can also pursue goals other than that from the owners, so maybe the Principal-Agent theory, which will be discussed in more detail in the third point, can provide a better insight in the objectives of the organisation.

9

3.

Entrepreneurial Theories

The idea of entrepreneurship theories is that NPOs are the result of a specific form of entrepreneurial behaviour. On this basis, various hypotheses on the objective function of NPOs and on their actual behaviour are formulated.8

1) The Model In this section entrepreneurial theories of NPOs are summarised. We will suggest that their results can help the development of more comprehensive theory of NPO behaviour. The unquestionable founder of the entrepreneurial theories of non-profit organisations is Young who searched an alternative for the earlier discussed single-objective optimisation models that were, according to Young, too simple to explain the complex behaviour of NPOs (Young,D.R., 1986). This entrepreneurial approach of the behaviour of NPOs, as we shall argue9, does not have to be viewed as an actual alternative for the neo-classical models, but rather as a consistent approach or even better as a vital part of a comprehensive theory. Within the non-profit literature, an entrepreneur is usually defined as, following Schumpeters definition, an individual who introduces new goods or production techniques or who changes the organisation in an innovative way or in short, as an individual that is the driving force behind organisational change (Young,D.R., 1986, p. 162). Young categorises entrepreneurs according to their personalities. He suggests that the non-profit sector, and within the nonprofit sector different industries, will attract certain personalities. Factors like income potential, bureaucratic structure and service ethics that vary across sectors, will attract different kinds of entrepreneurs. Because non-profit-entrepreneurs have different motivations than their colleagues from other sectors, a non-profit organisation will behave differently than organisations from other institutional types (Young,D.R., 1986).

8 9

Badelt,C., 1997, p. 163 Christoph Badelt also shares this view. See Badelt,C., 1997

10

2) Empirical analyses It is obvious that this line of reasoning is far more qualitative than the neo-classical optimisation models. Therefore, quantitative and extensive econometric evaluations are not always applicable and appropriate (Badelt,C., 1997, p. 168). Still there exists a wide range of empirical applications. In this empirical literature different hypotheses are tested like e.g. are NPOs really innovative enough to speak of entrepreneurship?10. A discussion of these tests lies beyond the scope of this paper. We will therefore limit our discussion to empirical work that concerns the objectives of non-profit-entrepreneurs. Several studies of entrepreneurial motivations in the non-profit sector exist. In a comparative analysis of the non-profit sector in various countries, James (1987) emphasises the religious values that underpin a lot of non-profit organisations. She finds evidence in support of religious motivations that make people found NPOs. Research on wages of lawyers in different sectors points out that lawyers in the non-profit sector earn substantially less than their for-profit colleagues. The lawyers are aware of this difference so it is assumed that the difference can be related to different preferences (Weisbrod,B.A., 1983). With the same objective, Preston (1989) analyses the earnings of American white-collar workers of different sectors. These results also support the hypothesis that non-profit employees are prepared to earn less because they have other preferences than income. Although other-than-profit preferences can explain the lower wages in the non-profit sector, other explanations are also possible. A selection bias of low quality workers in the non-profit sector could possibly also explain the lower wages, so one has to interpret these results with care. Goddeeris (1988) for example uses the same data set as Weisbrod (1983) but controls it for self-selection into the different sectors11. When the model accounts for self-selection of the lawyers into the sector that provided for them the highest utility, no significant lower wages for the non-profit lawyers can be found. The author emphasises the important danger of selection bias. Besides, other studies find opposite results, i.e. higher wages in the nonprofit sector (Mocan,H.C. and E.Tekin, 2003). Young relates various entrepreneurial motivations to different sectors. He finds that preferences like pride of accomplishment, search for personal identity, need for autonomy and independence and desire to preserve a cherished organisation are more heavily found with non-profit entrepreneurs (Young,D.R., 1997, p. 1508).

For an overview, see Young,D.R., 1997, p. 1507 The sample group of public interest lawyers is also extended to lawyers working in the public nonprofit sector.11

10

11

3) Comments After summarising the basic ideas of the entrepreneurial theories of the non-profit sector, it becomes obvious that these theories are rather a complementary approach than an alternative to the optimisation models. The theories complement the neo-classical models in that they provide a necessary element that the neo-classical theory ignores, namely the human aspect. The entrepreneurial theories acknowledge that an organisation exists of individuals who have their own (not always equally rational) preferences and emphasise these preferences to understand and explain the existence of non-profit organisations. In this view, combining neoclassical and entrepreneurial insights will result in a more complete and more realistic theory of NPO behaviour. This focus on individuals preferences also constitutes a major challenge in empirical research, as it is very difficult to find objective measures for subjective concepts. Besides, empirical tests that support the entrepreneurial theory are hardly exclusively supportive for the entrepreneurial theory but also for the formal models (Badelt,C., 1997, p. 162). An advantage of course is that the theory can explain behaviour of NPOs that is hard to formalise in an optimisation model. In various religious organisations and political parties for example, ideological motivations form the base for the organisation and these motivations are more easily approached and explained by the entrepreneurial theories than by neo-classical theories. Another drawback of the theories is that, just like the optimisation models, they do not make an explicit distinction between owners/founders of the organisation and managers. Being an entrepreneur has something to do with the personality of an individual and not with his function as owner or manager or employee, so again it is not always clear on which preferences the theories or the empirical applications are based.

12

4.

An Agency-based theory

Although there exists an immense literature on Principal-Agent relations in for-profit firms, there is very little equivalent work for the non-profit context. Nevertheless, agency theory postulates that, regardless of the organisational type, interests and objectives of the people who work for the organisation are not necessarily aligned with the objectives of the owners.

1) The theory In essence, the contract failure theory views the non-profit firm as a response to agency problems.12 The agency relation where Hansmann refers to in this sentence, is the relationship between the organisation and the donor, where the NPO acts as the agent of the donor or principal. This relation is sometimes described as the external Principal-Agent relation, in contrast with the internal Principal-Agent relation where the organisation is the principal and the manager(s) is/are the agent(s). Although the former relation is without any doubt very important and probably one of the principal arguments in demand-oriented theories of non-profit organisations, it is the latter that is of importance in this paper. For if we want to study the objective function of a nonprofit organisation, it is important that we know the subject of this objective function. If, like agency theory predicts, objective functions of owners and managers (or employees in general) do not always coincide, what is then the objective function of the organisation? Despite the obvious importance of an agency theory for non-profits, little theoretical work has been conducted. In the work that does exist, there seem to be two opposite views. Adherents of the first view argue that Principal-Agent relations in non-profit organisations are even more problematic than in for-profit firms. Because of the lack of ownership incentives and complex, hard-to-define objective functions, the performance of managers is hard to measure and the board of directors lack effective control mechanisms (Herzlinger,R.E., 1996, p. 99 ; Steinberg,R., 1990, p.141). Adherents of the Property-Rights theory postulate that the lack of property rights in non-profit organisations will have a negative influence on the effectiveness of these organisations. Glaeser (2002) believes that one of the implications of this weak governance of nonprofits is that their workers, who will try to influence the behaviour and goals of the organisation, will12

Hansmann,H., 1987, p. 31

13

subvert the social objectives of NPOs. In his model, the worker preferences take a central place and are viewed more important in non-profit than in profit organisations. If the nonprofit is more dependent on donations, this limits the influence of workers preferences and donors preferences become more important. Other factors like legal restrictions also restrict the influence of workers. Glaeser illustrates his model with examples from four non-profit sectors that seem to support his model (Glaeser,E.L., 2002). In the other view, large donors or independent, outside members of the board of directors can perform the role of residual claimant and are motivated enough to monitor and control the activities of the management so Principal-Agent problems are not so significant (Fama,E.F. and M.C.Jensen, 1983 ; Williamson, O.E., 1983). Some authors even argue that the non-profit form can help to resolve agency problems due to information asymmetry between managers and boards of directors (Preyra,C. and G.Pink, 2001). Without entering the discussion whether agency problems are more or less severe in non-profit organisations, it is our view that NPOs are not spared from agency-related problems and that a better insight in these relations13 will enhance the understanding of NPOs behaviour. In Jegers (2002), where the author develops the foundations for a theory of accounting and auditing in NPOs, the agency relation between the board and management is also of a central importance. He distinguishes three situations with their own agency problems (and costs), i.e. a situation where the manager is also founder, where the manager is the agent of an effective or an ineffective board. By means of a concave transformation function between the objectives of the NPO and managerial discretion, He shows that the three different situations will lead to different organisational performance. He also considers other elements (e.g. organisation size, accounting knowledge of board and managers, numbers of volunteers, regulation) that can influence the transformation between NPOs objectives and managerial discretion and therefore influence also the accounting and auditing practice of the NPO.

2) Empirical analyses

While no real agency theory has yet been developed for non-profit organisations, empirical examinations of a relationship between performance of the NPO and compensation of the NPOs manager often use the agency theory for for-profit firms as a framework. Under the assumption that the for-profit agency theory is correct and ready applicable to the non-profit context, a lot of scholars have tried to test empirically whether there is a relation between13

Ortmann argues that these insights can be obtained by game theory. (Ortmann,A., 1996a,b)

14

measures of NPOs performance and the compensation package of the managers. In this way, by estimating factors that influence the managers compensation, they expect to learn something about the objectives of the organisation. A recent example of such an empirical analysis is the work of Brickley and Van Horn (2002). These two authors examined the relationship between performance and turnover and compensation of chief executive officers in a sample of both non-profit and for-profit hospitals. Their results suggest that there is little difference between managerial incentives in the two types of hospitals. In both the non-profit and the for-profit hospitals the CEOs compensation was significantly related to performance of financial measures and not to measures of more altruistic activities. They also tested the possibility that the emphasis on financial performance could be due to competition that forces the NPO to focus on survival, but their results did not support this argument. The authors therefore conclude that their results provide evidence that both the CEO of a non-profit hospital and of a for-profit hospital are stimulated to focus on financial performance and that therefore NPOs are not that different from for-profit firms (Brickley,J.A. and R.L.Van Horn, 2002). Baber, Daniel and Roberts (2002) find that changes in the compensation of managers of charitable organisations are positively associated with changes in spending on programmes that enhances the charitable mission. Because of the hard-to-observe objectives of NPOs, Roomkin and Weisbrod hypothesise that non-profit organisations, as compared to for-profit firms, will use less performance-based compensation for their employees. Their empirical results however show no significant, consistent difference in compensation (Roomkin,M.J. and B.A.Weisbrod, 1999, p. 764). In an attempt to determine the objectives of a non-profit organisation, Erus and Weisbrod (2002) study the structure of the employees compensation plans in different organisational types. Overall, there results support the hypothesis that NPOs use weaker incentives that are less tied to observable performance. They also find limited evidence of different behaviour between religious and secular non-profits (Erus,B. and B.A.Weisbrod, 2002). Other empirical work concentrates more on the role and the composition of the board of directors. Because NPOs can not distribute their earnings, some authors argue that there exist no ownership incentives to monitor the work of the managers and even stronger, they suggest that NPOs do not have principals at all (Brody,E., 1996, p. 466). Indeed, non-profit organisations do not have owners in the ordinary sense of ownership as the right of utilisation, the right to the products and the right to alienate (Putterman,L., 1993, p. 245). Still there is one aspect of ownership that can be exercised by the board of directors, i.e. the right to monitor and control, so the board of directors can act as fiduciary of the sponsors, donors and the community as a whole and can play the role of principal. In this line of reasoning, some scholars argue that an effective board of directors can reduce agency problems and they try to

15

find a relation between board characteristics and performance of the organisation (See for example; Jackson,D.K. and T.P.Holland, 1998 ; Bradshaw,P., V.Murray and J.Wolpin, 1992 ; Handy,F., 1995 ; Callen,J.L. and H.Falk, 1993)

3) Comments

The contract-failure theory of Hansmann views the non-distribution constraint as an effective tool for preventing opportunism of non-profit organisations and argues therefore that NPOs will exist in markets that are characterised by information asymmetry between the consumer and the producer. But can this non-distribution constraint prevent opportunistic behaviour of people inside the organisation? Notwithstanding that profits cannot be distributed directly, they can be used or even misappropriated by managers in other ways. Besides, internal and external Principal-Agent relations are probably not fully independent.

Some authors (e.g. Handy,F. and E.Katz, 1998) argue that there exists a kind of self-selection process for managers of non-profit organisations. NPOs attract committed managers, so the internal Principal-Agent problem is partially resolved. Implicitly, it is assumed that these managers have some kind of intrinsic altruistic motivation and to pursue the objectives of the organisation. The field of motivations and preferences is not really the field of an economist, so we will not try to pretend having the answer here and leave this question hanging. If this assumption however does hold, then one has to be careful in using incentives that are advocated by the for-profit agency theory. For, as Kreps (1997) formulates it, explicit extrinsic incentives that are imposed may fight rather than complement pre-existing incentives. Moreover, evidence exists to support the hypothesis that motivation between non-profit and for-profit managers differs (Buelens,A. et al., 1999).

16

5.

Conclusion and research issues

In this work we reviewed the existing theoretical and empirical work on the objectives of nonprofit organisations. It does not need to be emphasised any more that consensus is not always reached. The neo-classical models tend to conceptualise the objectives of the NPO as a maximisation function with quantifiable arguments. Even within this neo-classical approach, different models are found depending on the arguments that are included in the objective function. Some models support the more philanthropic view of non-profit organisations and take up arguments like quality and quantity of services, while others see the NPO more as a profit in disguise that tries to maximise the budget. Maybe, also here, agency theory could bring more clearness and could make a distinction between objectives of the owner and those of the manager(s). In the so-called entrepreneurial theories of non-profit organisations, emphasis is more on the preferences of the non-profit entrepreneurs. Here the line of reasoning is far more qualitative but therefore not less important. But also these theories do not succeed in identifying the (possible) differences in objectives between owners and managers. The third section reviewed the theoretical and empirical work on internal agency problems from which non-profit organisations can suffer. We argue that this lack of understanding of the NPOs internal organisation constitutes a major drawback in the understanding of the NPOs behaviour. As it is clear from this review, differences in objectives between managers and founders of a NPO can exist and one has to take this into account when studying the objectives of the organisation as a whole. For if the objectives of the principal are not shared and pursued by the agent, the intended objectives do not have to be realised. Of course, it is not so easy to identify one principal for the non-profit organisation for as there are more than one, notably the donors, the consumers, the taxpayer, if not the entire community. Because this group of principals is so heterogeneous, we think it might be appropriate to consider the board of directors as representing all these principals. In order to have a clearer view on the objectives and behaviour of non-profit organisations, we thus argue that more research on Principal-Agent relations is needed. We will try to develop a number of agency-based hypotheses of non-profit objectives that can be tested

17

empirically and that hopefully will shed some more light on the internal organisation of nonprofit organisations. As mentioned earlier in this text, micro-economic theory or the economic theory as a whole, fails in understanding motives and preferences of individuals and often ignores what lies behind the behaviour of economic agents, usually presented as a utility function. Because these are crucial elements in the understanding of agency relations and it is a central topic in the discipline of organisational psychology, we think it might be fruitful to combine our economic approach with insights of organisational psychology. In general, we suggest a more general, comprehensive, multidisciplinary, agency-based approach to overcome the shortcomings of the existing literature on non-profit objectives.

a

6. References BABER,W.R., P.L.DANIEL and A.A.ROBERTS (2002) Compensation to Managers of Charitable Organisations: An Empirical Study of the Role of Accounting Measures of Program Activities in The Accounting Review, vol. 77(3), p. 679-693 BADELT,P. and P.WEISS (1990) Specialization, Product differentiation and Ownership structures in Personal Social Services: the case of Nursery Schools in KYKLOS, vol. 43(1), p. 69-89 BADELT,C. (1997) Entrepreneurship theories of the non-profit sector in Voluntas, vol. 8(2), p. 162-178 BANKS,D.A. (1993) Voluntary and proprietary hospital behavioural response to socioeconomic stimuli in Applied Economics, vol. 25, p. 853-868 BRADSHAW,P., V.MURRAY and J.WOLPIN (1992) Do Nonprofit Boards Make a Difference? An Exploration of the Relationships Among Board Structure, Process, and Effectiveness? in Nonprofit and Voluntary Sector Quarterly, vol. 21(3), p. 227-249 BRICKLEY,J.A. and R.L.VAN HORN (2002) Managerial incentives in nonprofit organisations: evidence from hospitals in Journal of Law and Economics, vol. 45, p. 227-249 BRODY,E. (1996) Agents without principals: The economic convergence of the nonprofit and for-profit organisational forms in New York Law School Review, vol. 40, p. 457-535 BUELENS,A. et al. (1999) Differences in motivation to manage between the profit and the non-profit sector in PEPERMANS,R. et al. (eds.) Managerial behaviour: empirical studies on management development and socialisation, Leuven, Acco, p. 43-57 CALLEN,J.L. and H.FALK (1993) Agency and efficiency in nonprofit organisations: the case of specific health focus charities in The Accounting Review, vol. 68(1), p. 4865 CHOU,S-Y (2002) Asymmetric information, ownership and quality of care: an empirical analysis of nursing homes in Journal of Health Economics, vol. 21, p. 293-311 CUTLER,D.M. and J.R.HORWITZ (2000) Converting Hospitals from Not-for-Profit to For-Profit Status: Why and What Effects? in CUTLER,D.M. (ed.), The Changing Hospital Industry, Comparing Not-For-Profits and For-Profit Institutions, Chicago, The University of Chicago Press, p. 45-79 DIMAGGIO,P.J. and W.W.POWELL (1983) The iron cage revisited: Institutional Isomorphism and collective rationality in organisational fields in American Sociological Review, vol. 48, April, p. 147-160 DUGGAN,M. (2002) "Hospital market structure and the behaviour of not-for-profit hospitals" in Rand Journal of Economics, vol. 33(3), p. 433-446

b

ERUS,B. and B.A.WEISBROD (2002), Objective Functions and Compensation Structures in Nonprofit and For-Profit Organizations : Evidence from the Mixed Hospital Industry, NBER Working Paper, September 2002, 31 p. FAMA,E.F. and M.C.JENSEN (1983) Agency problems and residual claims in Journal of Law and Economics, vol. 26, June 1983, p. 327-349 FELDSTEIN,M.S. (1971) Hospital price inflation: a study of nonprofit price dynamics in American Economic Review, vol. 61, p. 853-872 FRANK,R.G. and D.S.SALKEVER (2000) Market forces, diversification of activity and the mission of not-for-profit hospitals in CUTLER,D.M. (ed.), The Changing Hospital Industry, Comparing Not-for-Profit and For-Profit Institutions, Chicago, The University of Chicago Press, p. 195-215 GASSLER,R.S. (1986), The economics of nonprofit enterprise, a study in applied economic theory, New York, University Press of America, 120p. GASSLER,R.S. (1997) The Economics of the Nonprofit Motive: A Suggested Formulation of Objectives and Constraints for Firms and Nonprofit Enterprises in Journal of Interdisciplinary Economics, vol. 8(4), p. 265-280 GASSLER,R.S. (1998) Altruism and the economics of non-profit organizations in Financial Accountability an Management, vol. 14(3), p. 173-182 GLAESER,E.L. (2002), The Governance of Not-For-Profit Firms, NBER Working Paper No. 8921, May 2002, 61 p. GODDEERIS,J.H. (1988) Compensating Differentials and Self-Selection: An Application to Lawyers in Journal of Political Economy, vol. 96(2), p. 411-428 GRABOWSKI,D.C. and R.A.HIRTH (2003) Competitive spillovers across non-profit and for-profit nursing homes in Journal of Health Economics, vol. 22, p. 1-22 HANDY,F. (1995) Reputation as Collateral: An Economic Analysis of the Role of Trustees of Nonprofits in Nonprofit and Voluntary Sector Quarterly, vol. 24(4), p. 293305 HANDY,F. and E.KATZ (1998) The wage differential between Nonprofit institutions an Corporations: getting more by paying less? in Journal of Comparative Economics, vol. 26, p. 246-261 HANSMANN,H. (1981) Nonprofit enterprise in the performing arts in Bell Journal of Economics, vol. 12, p. 341-361 HANSMANN,H. (1986) The role of the nonprofit enterprise in ROSE-ACKERMAN,S. (ed.), The Economics of Nonprofit Institutions, New York Oxford, Oxford University Press, p. 57-84 HANSMANN,H. (1987) Economic theories of nonprofit organisations in POWELL,W.W. (ed.), The Nonprofit Sector: a research handbook, New Haven, York University Press, p. 27-41

c

HERZLINGER,R.E. (1994) Effective Oversight: A guide for Nonprofit Directors in Harvard Business Review, July August 1994, p. 52-60 HERZLINGER,R.E. (1996) Can public trust in nonprofits and governments be restored, in Harvard Business Review, March April 1996, p. 97-107 HIRTH,R.A. (1999) "Consumer information and competition between nonprofit and forprofit nursing homes" in Journal of Health Economics, vol. 18, p. 219-240 JACKSON,D.K. and T.P.HOLLAND (1998) Measuring the Effectiveness of Nonprofit Boards in Nonprofit and Voluntary Sector Quarterly, vol. 27(2), p. 159-182 JAMES,E. and E.NEUBERGER (1981) The University Department as a Non-Profit Labor Cooperative in Public Choice, vol. 36, p. 585-612 JAMES,E. (1987) The Nonprofit Sector in a Comparative Perspective in POWELL,W.W. (ed.), The Nonprofit Sector: a research handbook, New Haven, Oxford University Press, p. 397-415 JEGERS,M. (2002) The Economics of Non Profit Accounting and Auditing: Suggestions for a Research Agenda in Annals of Public and Cooperative Economics, vol. 73(3), p. 429-451 KREPS,D.M. (1997) Intrinsic Motivation and Extrinsic Incentives in American Economic Review, May 1997, p. 359-364 MARK,T.L. (1995) Psychiatric Hospital Ownership and Performance in The Journal of Human Resources, vol. 31(3), p. 631-649 MCCLELLAN,M. and D.STAIGER (2000) Comparing Hospital Quality at For-Profit and Not-For-Profit Hospitals in CUTLER,D.M.(ed.), The Changing Hospital Industry, Comparing Not-For-Profit and For-Profit Institutions, Chicago, The University of Chicago Press, p. 93-112 MOBLEY,L.R. and W.D.BRADFORD (1997) Behavioral differences among hospitals: is it ownership, or location? in Applied Economics, vol. 29, p. 1125-1138 MOCAN,H.N. and E.TEKIN (2003) Nonprofit sector and part-time work: an analysis of employer-employee matched data on child care workers in The Review of Economics and Statistics, February 2003, vol. 85(1), p. 38-50 NEWHOUSE,J. (1970) Towards a theory of non profit institutions: an economic model of a hospital in American Economic Review, vol. 60(1), p. 64-74 NISKANEN,W.A. Jr. (1996), Bureaucracy and Public Economics, Virginia, The Locke Institute, 298p. NORTON,E.C. and D.O.STAIGER (1994) How hospital ownership affects access to care for the uninsured in Rand Journal of Economics, vol. 25(1), p. 171-185 ORTMANN,A. (1996a) Modern economic theory and the study of nonprofit organisations: why the twain shall meet in Nonprofit and Voluntary Sector Quarterly, vol. 25(4), p. 470-484

d

ORTMANN,A. (1996b) Economics for Nonprofit Managers: review in Nonprofit and Voluntary Sector Quarterly, vol. 25(2), p. 248-258 PAULY,M.P. and M.R.REDISCH (1973) The Not-For-Profit Hospital as a Physicians Cooperative in American Economic Review, vol. 63, p. 87-99 PAULY,M.V. (1987) Nonprofit firms in Medical Markets in American Economic Review, vol. 77(2), p. 257-262 PICONE,G., S-Y.CHOU and F.SLOAN (2002) Are for-profit conversions harmful to patients and to Medicare? in RAND Journal of Economics, vol. 33(3), p. 507-523 PRESTON,A.E. (1989) The Nonprofit Woker in a For-Profit World in Journal of Labor Economics, vol. 7(4), p. 438-463 PREYRA,C. and G.PINK (2001) Balancing incentives in the compensation contracts of nonprofit hospital CEOs in Journal of Health Economics, vol. 20, p. 509-525 PUTTERMAN,L. (1993) Ownership and the nature of the firm in Journal of Comparative Economics, vol. 17, p. 243-263 ROOMKIN,M.J. and B.A.WEISBROD (1999) Managerial Compensation and Incentives in For-Profit and Nonprofit Hospitals in The Journal of Law, Economics and Organisation, vol. 15(3), p. 750-781 ROSE-ACKERMAN,S. (1996) Altruism, nonprofits and economic theory in Journal of Economic Literature, vol. 34, p. 701-728 SCHIFF,J. and B.WEISBROD (1991) Competition between for-profit and nonprofit organisations in commercial markets in Annals of Public and Cooperative Economics, vol. 62(4), p. 619-639 SLOAN,F.A. et al. (1998) Hospital Ownership and Cost and Quality of Care: Is there a Dimes worth of Difference?, National Bureau of Economic Research, Working Paper N 6706, 26p. SLOAN,F. (2000) Not-for-profit ownership and hospital behaviour in CUYLER,A.J. and J.P.,NEWHOUSE (eds.), Handbook of Health Economics, vol. 1B, North Holland, Elsevier, p. 1141-1174 STEINBERG,R. (1986) The revealed objective functions of nonprofit firms in Rand Journal of Economics, vol. 17(4), p. 508-526 STEINBERG,R. (1987) Nonprofit Organisations and the Market in POWELL,W.W. (ed.), The Nonprofit Sector: a research handbook, New Haven, Oxford University Press, p. 118-138 STEINBERG,R. (1990) Profits and incentive compensation in nonprofit firms in Nonprofit Management and Leadership, vol. 1(2), p. 137-151 WEISBROD,B.A. (1983) Nonprofit and Proprietary Sector Behaviour: Wage Differentials among Lawyers in Journal of Labor Economics, vol. 1(3), p. 246-263

e

YOUNG,D.R. (1986) Entrepreneurship and the behaviour of nonprofit organization: Elements of a theory in ROSE-ACKERMAN,S. (ed.), The economics of nonprofit managers: Studies in structure and policy, New York, Oxford University Press, p. 161184 YOUNG,D.R. (1998) Nonprofit Entrepreneurship in International Encyclopaedia of Public Policy and Administration, Pennsylvania, University of Pittsburgh, p. 1506-1509