Nonprofits and Pass-Throughs: Performance Comparison

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Van Dalsem, Shane
Hull, Robert M.
Washburn University. School of Business
Kaw Valley Bank
Issue Date
November 2020
Alternative Title
Nonprofits (NPs) resemble pass-throughs (PTs) in size. While not profit-seeking like PTs, NPs should still seek to achieve maximum firm value (max VL). Using a historical growth rate of 3.12% and the same risk class, we find the following. NPs obtain a max VL that is 51.63% greater than PTs. NPs achieve a 13.83% increase when going from a nongrowth max VL to a growth max VL compared to only 3.42% for PTs and NPs do this with a before-tax plowback ratio that is 26.63% lower than PTs. Such growth-related achievements occur because NPs, unlike PTs, are not taxed on retained earnings used for growth. In terms of the maximum gain to leverage (max GL), we find that NPs gain 2.25% less in dollars added from debt. However, if greater growth occurs under TCJA, NPs gain more and not less. Despite having 12.27% greater optimal debt-to-firm value ratios than PTs, the maximum percentage change in unlevered firm value (max %l\.Eu) from debt is 37.32% less for NPs. Even with greater growth, the max %l\.Eu is substantially less for NPs. NP's ability to profit more from growth and achieve less relative gain from debt can be attributed to their tax-exempt status.