Managerial Economics of Non-Profit Organizations

Marc Jegers

• Publisher: Routledge
• Year: 2008
• Print ISBN:
  9780415433822
• eBook ISBN:
  9781134080182
• Topic: Business
• Subtopic: Business General
• Index: Business

This is the first book of its kind to bring together the microeconomic insights on the functioning of non-profit organizations, complementing the wide range of books on the management of non-profit organizations by instead focusing on both theoretical and empirical work. Jegers begins by considering definitions of non-profit organizations before ex

1 Introduction

The focus of this book is on the economics of non-profit organizations’ management. The social and economic roles of non-profit organizations all over the world are obvious, as becomes visible from the historical overview of the non-profit sector in the West by Robbins (2006) and in the US by Hall (2006), and from the description of the current position of non-profit organizations in a sample of 35 economically and socially very diverse countries by Anheier and Salamon (2006) (see also Boris and Steuerle (2006) for the situation in the US). As the way non-profit organizations are managed impacts on their functioning, non-profit management is important when it comes to making the organization’s social and economic roles maximally operational.

In non-profit research, managerial topics are prominently present, but their economic foundations (the economics of management or ‘managerial economics’) are often ignored or neglected, as witnessed by their absence from the authoritative Research Handbooks edited by Powell (1987) and Powell and Steinberg (2006), who even ‘consciously exclude … chapters on the management of non-profit organizations’ (Powell and Steinberg 2006: 9). Furthermore, neither management nor managerial economics show up in the list of topics they plan to include in their Research Handbook’s next editions (ibid.: ix).

Given the availability of numerous practitioner oriented texts on the management of non-profit organizations, there seems no need to increase their number with another one. The situation for managerial economic textbooks dealing with non-profit organizations is totally opposite: apparently, and somewhat surprisingly, their number was exactly zero. It is hoped that this number has increased to one by the production of the present work. Though its title, Managerial Economics of Non-profit Organizations, is selfexplaining, an alternative title might have been Theory of the Non-profit Organization, mirroring the traditional ‘Theory of the Firm’ denomination of the managerial economic approach to profit organizations, but being less clear for a potential readership not familiar with this body of theories.

An attempt has been made to integrate as far as possible the bits and pieces of high level economic work scattered in a wide diversity of academic publications, as reflected by the list of references, to arrive at a coherent treatment of all the topics relevant for understanding non-profit organizations’ management. The focus is on economic theory, but wherever possible theoretical insights are compared with the available empirical evidence. This procedure has led to a book that could be labelled unbalanced, both with respect to the space devoted to the different topics and as to the empirical evidence, most of which is US based and/or relates to health care industries. This lack of balance exactly reflects the status of the literature, and in that way shows in which domains further managerial economic research might be useful, though it will also become clear that on almost no managerial economic topic for non-profit organizations has a generally accepted theoretical framework emerged yet.

The next chapters, excluding the concluding one, can be grouped under three headings: definitions; the economic rationale of non-profit organizations and its implications for their functioning; and the economics of non-profit management.

The first group in fact consists of only one chapter (Chapter 2). After having described the generic institutional forms under which goods or services can be produced (governments (at different levels), profit organizations, and non-profit organizations), and having elaborated on real life organizational forms, the definition of a non-profit organization used throughout this book is presented: an organization whose founders are not entitled to (a part of ) the organization’s profits, a condition traditionally called the non-distribution constraint (Hansmann 1987: 28). This definition is a purely economics based definition, which is justified by the fact that this book concentrates on what economic theory can teach on the functioning of non-profit organizations. It goes without saying that other approaches (such as from sociology, law, psychology or organization sciences) are equally valuable, and that these complement an economic approach to non-profit organizations.

Two aspects of the Hansmann definition are crucial in an economic analysis: organizational objectives, and incentive mechanisms with the ensuing efficiency consequences. Both are discussed, before closing the chapter with a section on a number of taxonomies of non-profit organizations.

In the second group of chapters, economic justifications of the existence of non-profit organizations are presented. Chapter 3 is on the ‘demand’ for non-profit organizations, and Chapters 4 and 5 on the ‘supply’ of them. First, in Chapter 3, a fundamental economic reasoning on institutional choice is presented: the transaction cost theory, rooted in work by Coase (1937). Its prediction, if not its prescription, is that only institutions that minimize transaction costs can survive. Non-profit organizations are then compared with profit organizations from this perspective, which in fact amounts to translating the different forms of market failure known from the literature in a transaction cost language. Government failure theories are instrumental in comparing non-profit organizations with public bodies. Finally, industries in which at least two of the institutional forms coexist (‘mixed’ industries), need some explanation, as such a situation seems contrary to the idea that there is always one optimal institutional form for each transaction.

After having described why non-profit organizations might be viable, even in market oriented economies, the question why such organizations are established is discussed in Chapters 4 and 5. The first of these concentrates on ‘simple’ organizations, whose activities are under the control of the founder (usually also the manager), and Chapter 5 considers more complex organizations. The simple organizations can be characterized by a founder modelled as a non-profit entrepreneur. Under some circumstances, even an entrepreneur who is not altruistic can be shown to ‘supply’ a non-profit organization. A specific model including both an entrepreneur-manager and subordinate staff is also discussed in Chapter 4.

An economic analysis of complex organizations is traditionally and fruitfully framed within the confines of a principal–agent approach. Therefore, its usefulness for specifically analysing complex non-profit organizations is the first topic dealt with in Chapter 5. Then, principals are discussed. In most analyses, the board is assumed to perform the principal’s role: The effect of the composition of the board on organizational behaviour and more generally the functioning of the board are therefore discussed, before other possible principals (theoretically, every stakeholder can be a principal) are presented. The most frequently researched agent in non-profit organizations is the manager, to whom Chapter 5 devotes appropriate attention, including theory and (non) practice of performance based remuneration systems for managers. Other agents comprise non-managerial staff members, who are also discussed. Finally, some agency based theoretical insights on agent selection close the section on agents. The chapter’s last section turns the attention to volunteers and their place in principal–agent theorizing on non-profit organizations.

In the last group of chapters the economics of managing a number of functional domains are discussed through the lens of non-profit organizations, acknowledging the fact that management of non-profit organizations is ‘a variant of the basic management model’ (Newman and Wallender 1978: 31), and not something completely different. Therefore, the focus will be on the idiosyncracies of non-profit organizations.

Strategic management is elaborated on in Chapter 6. First, strategic planning and strategic choices in non-profit organizations are discussed, and then some models designed to predict differences in strategic responses to exogenous shocks between non-profit organizations and profit organizations are presented, as well as a model on profit–non-profit competition in a mixed industry. The chapter ends with a short discussion of strategic differences between public providers and non-profit organizations.

The next chapter deals with marketing for non-profit organizations. After discussing the role of marketing management in non-profit organizations, the economics of four marketing decisions are analysed: pricing, the role of volunteers, subisidies and gifts (both by individuals and by corporations), and the development of profit activities by non-profit organizations.

Chapter 8 is devoted to non-profit accounting, including auditing. Though it is argued that the accounting and audit principles are not different from the principles to be applied in profit firms, understanding the presence and implementation of accounting and auditing in a non-profit context is different. A principal–agent based (‘accounting and economics’) theory is presented, in which non-profit specificities are taken into consideration, including the problem of (the lack of) accounting knowledge of board members and non-profit staff, and the question of non-profit organizations’ compliance with accounting regulations. Specific cost accounting issues are also discussed, and economic analyses of accounting choices in financial accounting and cost accounting are presented.

The last chapter in this group deals with non-profit financial management, the economics of which are partly related to the standard financial theory, but also depart from it in a number of crucial respects. The topics analysed are the different sources of funds available for non-profit organizations, the determination of the cost of capital (and its impact on investment analysis), the ensuing insights on capital structure, and, finally, the measurement of a non-profit organization’s financial vulnerability.

2 Defining non-profit organizations

Introduction

In this chapter an economics based definition of non-profit organizations is presented, building on traditional institutional ideas about the way goods and services can be provided. The non-profit organization is described as one of the generic organizational forms, together with profit organizations and governmental bodies. Its specificity is the fact that financial surpluses, if present, cannot be distributed to owners and/or staff, making the group of non-profit organizations very diverse as to possible objectives, and possibly vulnerable because of the absence of financial incentives to run the organization in an efficient way.

The chapter concludes with an aside on how to categorize non-profit organizations.

The provision of goods and services

Generic organizational forms

Except in very primitive societies, the production of a substantial part of goods and services (defined to include the promotion of ideas, ideologies or religions) is taken care of by formalized entities. These can be public or private.

The public sector is governed by its own set of decision rules and mechanisms, which are studied from a microeconomic point of view in the research field called Public Choice (Mueller (2003) is a leading textbook). Clearly, the role of the public sector goes beyond producing goods and services, and includes domains such as macroeconomic policy, income redistribution, and fiscal policy.

The group of privately established organizations is very diverse. A fundamental divide is that between organizations founded by individuals who are allowed to increase their financial wealth out of the organization’s profits, and other organizations. The first group is called the group of profit organizations, and the microeconomic theory of their functioning can be found in, for example, Milgrom and Roberts (1992). Logically, the second group (also called the third sector, but other more or less accurate designations exist (Salamon and Anheier 1992a: 128)) consists of non-profit organizations.

This brings us to three generic organizational forms: governments (at different levels), profit organizations, and non-profit organizations (Figure 2.1).

Most of the economic analyses of organizational behaviour pertain to these generic or pure institutional forms, a position also taken in this book, with some exceptions. It goes without saying that in reality, organizational forms are frequently more complex (Weisbrod 1988: 1).

Real organizational forms

Figure 2.2 gives an (admittedly stylized) idea of how we might characterize real life organizations at a given moment in time. There is no reason to assume these characterizations should be static.

Organization A in Figure 2.2 could be a privately founded non-profit organization subsidized by a government (Salamon 1987). The fact that it receives a subsidy makes it (in a more or less limited way) subordinate to the subsidizing authority, as the latter might force the organization to behave in a way different from the way it would behave if not receiving subsidies. Organization B is an example of a legally private non-profit organization founded and subsidized by a public authority, and C is an example of a profit firm owned by a government. A foundation owned and possibly funded by a profit firm, or an organization grouping firms of the same industry, can be represented by the point D, and by E if it is subsidized. Note that organizations A, B, D and E would be called bureaus by Niskanen (1971: 15), who defines them as organizations subject to the non-distribution constraint, earning part of their revenues from sources other than sales.

Figure 2.1 Generic organizational forms

Figure 2.2 Real organizational forms

The fact that most real life organizations are mixtures of generic institutional forms implies that if one wants to assess the practical implications for organizational behaviour of theoretical predictions, one has to take into consideration two or three bodies of research, not always mutually consistent, weighing the profit, non-profit, and public characteristics of the organizations under study.

Definition

The previous section implies the following definition of a non-profit organization: an organization whose founders are not entitled to (a part of ) the organization’s profits, a condition traditionally called the non-

Although for economic analysis this definition is sufficient, and conveniently parsimonious, more elaborate alternatives also appear in the literature, leading Anheier to say that ‘definitions are perhaps the most lamented and frequently misunderstood “deficit” in our field’ (Anheier 1995: 16). A definition frequently encountered is the structural–operational one by Salamon and Anheier (1992a: 135): A non-profit organization should be formal, private, self-governing, voluntary (in membership and participation), and should satisfy the non-distribution constraint. Apart from the involvement of volunteers, there is no conceptual difference from the definition above, as using the term ‘organization’ implies it is formal, private and self-governing. Needless to say, a large number of non-profit organizations lean on volunteers, but surely not all of them. This might explain why the United Nations makes no reference to volunteers in its definition of a non-profit organization: an organization that is self-governing, institutionally separate from government, non-compulsory, and that meets the non-distribution constraint (United Nations 2003: 17).

Morris (2000: 39–41) seems to define the non-profit sector more in terms of activities and social outcomes, including in the sector, for example, mutual-aid societies and cooperatives, which do not meet the structural-operational definition of non-profit organizations, let alone the non-distribution constraint. But this does not seem to be an appropriate critique of the definition of a non-profit organization as such, but only points to the difference between the group of non-profit organizations and the larger group of civil society institutions, as in fact Morris herself rightly points out (Morris 2000: 41).

Therefore, there seems no reason to depart from the non-distribution constraint characterization of non-profit organizations. Notice that this does not imply that non-profit organizations are barred from making profits, or that they are forbidden to employ paid staff. The point is that potential profits cannot be distributed to owners and consequently also not to board members or staff (making profit based wage schemes incompatible with the non-profit status of the organization; see also Chapter 5).

Finally, note that legal or administrative conditions, such as registration under the US Internal Revenue Service articles 501(c)(3) or (4), are just that: legal and administrati...

Table of contents

• Cover Page
• Title Page
• Copright Page
• List of illustrations
• Preface
• Acknowledgements
• List of frequently used symbols
• 1 Introduction
• 2 Defining non-profit organizations
• 3 The demand for non-profit organizations
• 4 Founding a non-profit organization
• 5 Governing and staffing a non-profit organization
• 6 Organizational strategy and behaviour of non-profit organizations
• 7 Marketing in non-profit organizations
• 8 Accounting in non-profit organizations
• 9 Financial management in non-profit organizations
• 10 Gaudium et spes
• Appendices
• Bibliography