Why Not For-Profit? Conversions and Public Policy

In many industries, such as higher education, hospitals, and museums, nonprofit organizations control great wealth. Public and private donations, tax subsidies, and volunteered services have typically made that wealth accumulation possible. In return for the various forms of assistance, nonprofits are subject to the "nondistribution constraint" - the restriction that profits or accumulated surplus - which are not limited - may not be paid to any officer or trustee of the organization, but may be used only to purchase inputs for the organization's tax-exempt purpose. If a nonprofit converts to a for-profit form, however, that constraint disappears. The challenge for public policy is to determine the conditions under which a conversion would be socially desirable and then structure a conversion so that it does not lead to enrichment of the officers or trustees. This paper shows the nature of the issues involved in establishing efficient public policy toward conversions and enforcing it. Determining the true value of the nonprofit's assets is shown to be a key issue. Other issues involve structuring the conversion contract so as to account for the public services that the nonprofit is providing-socially desirable but privately unprofitable-and the use of the funds paid, ordinarily to another nonprofit organization, by the purchaser. The reasons for conversions being essentially limited to the hospital and HMO industries are examined, as are the conditions under which pressures for conversions in other industries, such as universities, would develop.