Abstract
The goal of nonprofit organizations is to marshal resources to create an amount of output that is consistent with givers’ subjective preferences. This is different from the goals of both for-profit firms and the government. Nonprofits thus emerge in areas where people will give, rather than in response to market or government failures. This dissertation presents a new theory through which to understand the nature, function, and role of nonprofits – the giving theory – and explains how the nonprofit organizational form helps to fulfill these. The giving theory views the nonprofit, for-profit, and public sectors as partly overlapping. Nonprofit purpose promotion requires giving as an extra resource allocation mechanism in addition to exchange. The nonprofit sector is therefore a “nonprofit economy,” differing from the market economy and command economy.
The nonprofit form – which combines the nondistribution constraint, the purpose fixity requirement, and voluntariness – helps to fulfill nonprofit purposes for three reasons. First, it helps to channel resources to desired people and uses. This is critical because the intended beneficiaries do not have a claim on the organization’s resources, while givers have concerns over who and what with regard to the use of their donations. Second, the nonprofit form, by forgoing equity owners, gives an organization the flexibility to develop a suitable control structure and management for its organizational purpose. Third, the nonprofit form lowers the transaction costs of collecting free resources because the organizational form itself meets most givers’ needs without the requirement of a specific contract.
The contract-failure theory posits that the nonprofit form can be an indicator of high product quality, because the nondistribution constraint reduces the nonprofit manager’s financial benefits from cheating. This would give nonprofits an advantage over for-profit firms when consumers cannot determine product quality, and thus explains nonprofits’ existence.
This dissertation finds that nonprofits are not generally more trustworthy. It is methodologically wrong to compare the nonprofit and for-profit managers’ personal benefits from cheating to one another. Instead, both nonprofit and for-profit managers will act to maximize their respective utility, seeking either higher income and/or more leisure. Since providing low-quality products leads to both less effort and a lower cost, both nonprofits and for-profit firms will cheat. Further, providers cannot overcharge because there are no informational asymmetries about product price. The market price in “contract failure” situations will drop, forcing both nonprofits and for-profit firms to offer only the lowest quality product. Shifting to nonprofit purposes requires nonprofits to allocate part of their resources through giving, which makes some of their transactions trustworthy. However, consumers usually cannot identify trustworthy transactions.
Not only will adopting the nonprofit form not make an untrustworthy provider trustworthy, but trustworthy providers are also not necessarily more likely than untrustworthy ones to take that form because it costs untrustworthy-inefficient providers even less to do so. The nonprofit form thus cannot be an effective signal of high quality.
Even if nonprofits were more trustworthy, this cannot explain why nonprofits exist. It is the supply side, which only partly overlaps the “contract failure” situations, that drives the nonprofit sector. The existence of other informational-asymmetries-relieving mechanisms also reduces consumers’ demand for the nonprofit form.
The productive efficiency of nonprofits is input-output efficiency, which describes their ability to achieve the greatest nonprofit purpose at the lowest cost. However, the nature of nonprofit purposes makes it difficult to measure their efficiency. Their different organizational goals also mean that we cannot directly compare the efficiency of nonprofit and for-profit organizations.
This dissertation argues that the absence of ownership is an efficient arrangement for nonprofits because equity owners’ interests would directly conflict with the nonprofit organization’s goals, while the residual claim cannot internalize an integral part of the increased efficiency, essentially an externality, in nonprofit production. The absence of ownership is typically associated with weak markets for capital and corporate control, as well as with less effective nonprofit boards. The measurability difficulty and the fear of triggering outrage make performance-based executive compensation less effective and therefore less appealing to nonprofits. Nevertheless, perceived future revisions in both human capital and broader personal interests continue to constrain nonprofit managers.
In contrast, internal incentive systems and external competition operate similarly in both nonprofit and for-profit organizations. When seeking to induce individual contributions, an organization must use the available incentives wisely, considering the effectiveness, cost, and compatibility of each. Nonprofits are neither necessarily in a worse position to use performance pay, nor are they in a better position to use intrinsic incentives than are for-profits. Competition from other organizations in the input, product, and donation markets forces nonprofits to achieve more with less input. The efficiency of a nonprofit organization depends on a combination of various mechanisms, rather than on any single one. This dissertation rejects the commonplace claim that nonprofits are inefficient.
