Valuing the Hospital Industry from a Financing Efficiency Standpoint

Abstract

We investigate the valuation of the non-government hospital industry focusing on two of its ownershiup structures: nonprofit hospitals (NPHs) and for-profit hospitals (FPHs). We find both structures are inefficient from a financing standpoint by being overlevered with lower grade bond ratings. By not issuing optimal amounts of debt, we estimate that NPHs lost 18% and 61% of their potential value for nongrowth and growth situations, respectively. The corresponding percentages for FPHs are somewhat similar at 19% and 53%. We atttribute these losses to agency and financial distress costs. In terms of absolute dollars, the loss from straying from optimal debt ratios is 173% and 254% greater for NPHs than FPHs for nongrowth and growth, respectively. We find the tax advantages gifted to NPHs require FPHs to be more efficient to achieve equality in NPH firm value. We estimate NPHs must be 47% and 55% less efficient than FPHs for nongrowth and growth situations, respectively, to reach a point where they would convert to a for-profit ownership structure. We offer a waste-warlord agency theory to explain why NPHs convert to FPHs despite their huge tax subsidies. Our results minimally indicate that waste-warlord agent behavior extends to at least a noticeable minority of NPHs. This is consistent with research that finds 5% of NPHs converted to FPHs over an eight-year period.