What do Nonprofit hospitals maximize

Why do nonprofit hospitals exist? If they act exactly as for-profit hospitals, then they should be under private ownership. If they act according to some other maximization strategy, what is it?

These are the questions that Jill Horwitz and Austin Nichol look to answer in their 2007 NBER working paper. First, let us examine the composition of hospital ownership between 1988 and 2005.

We see that there is a slow change towards more for-profit (FP) ownership, and less government ownership. We can also look at the hospital figures weighted by admissions.

Here, we see a similar increase in FP ownership and a decrease in government ownership. Nevertheless, non-profit (NP) hospitals, still serve the bulk of patients in the United States.

Theories of Non-Profit ownership

1. Output Maximization. This theory was developed by Newhouse (AER 1970) and claims that non-profit hospitals offer more health care until profits are driven to zero. But the non-profit’s choice of how to maximize output is affected by neighboring hospitals. “If their neighbors are driven more by profit motives, then the nonprofit will tend to treat less profitable patients who seek less profitable types of care. In this case, the nonprofit’s behavior will be affected through the binding constraint on profits—in the absence of the profit-seeking competitors ‘cream-skimming’ patients, they would have offered a mix of services (and served a mix of patients), call it X, that generated zero profit, but in the presence of the profit-seekers, the mix X will lose money, so they must alter their behavior to generate additional profits. Thus a nonprofit will be induced to look more like a profit-seeker in an environment where there are more profit-seekers, by both being less likely to offer unprofitable services and more likely to offer profitable ones.”
2. Market Output Maximization. This theory was developed by Weisbrod (1988) and claims that non-profits seek to maximize the total medical service output for the entire community.
3. For-profits in disguise. “Pauly and Redisch ([AER] 1973) develop a formal model in which physician employees capture nonprofit hospitals, operating them to benefit physician cartels by maximizing doctors’ incomes.”
4. Mixed Objective.

Results

Horwitz and Nichol use AHA Annual Survey of Hospitals data between 1988 and 2005. The authors conclude that the output maximization theory–the Newhouse model–is supported by the data. The evidence includes the following:

• Non-profit hospitals in markets with a high concentration of for-profit hospitals are more likely to offer profitable services (e.g.: MRI) than those in low for-profit concentration markets.
• Non-profit hospitals are less likely to provide unprofitable services (e.g.: HIV/AIDS treatment) in high for-profit penetration markets than in other markets.
• “Perhaps the most convincing evidence for the effect of market mix is the results for home health and skilled nursing, post-acute services that were first ambiguously profitable, then profitable, then less profitable again. During the most profitable period, nonprofits were more likely to offer them in high, compared to low for-profit markets. During less profitable periods, depending on the specification, there was either no discernable difference or more dramatic exit among nonprofits in for-profit markets.”

References

• Horwitz, J.R.; Nichols A.; (2007) “What Do Nonprofits Maximize? Nonprofit Hospital Service Provision and Market Ownership Mix” NBER Working Paper 13246.
• Newhouse, J. (1970) “Toward a Theory of Nonprofit Institutions: An Economic Model of a Hospital,” The American Economic Review, Vol. 60, No. 1., pp. 64-74.
• Pauly, M.; Redisch M.; (1973) “The Not-For-Profit Hospital as a Physicians’ Cooperative,” The American Economic Review, Vol. 63, No. 1., pp. 87-99.