Tax-Exempt Debt and the Capital Structure of Nonprofit Organizations: An Application to Hospitals





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    • Wedig is from Indiana University. Hassan and Morrisey are from the University of Alabama at Birmingham. Previous versions of this article were presented at the health economics workshop at the Lister Hill Center, University of Alabama at Birmingham, the 6th annual Conference on Health Economics, and the 12th annual Health Services Research meetings. The authors thank René Stulz, Tom McGuire, and the referee for useful comments on a previous draft. Funding was received from a grant from the Agency for Health Care Policy and Research (AHCPR). Van Kampen Merritt provided some of the data used in the analysis. Leslie Howard provided able research assistance. Opinions and errors reside with the authors.


The availability of tax-exempt financing provides nonprofit (NP) organizations with their own tax-based incentives to issue debt. In this article, we develop a theoretical model in which NPs gain an indirect arbitrage from tax-exempt debt issuance, constrained by: 1) the requirement that fixed investment exceed tax-exempt debt flows (the project financing constraint), and 2) the constraint against share issuance. These constraints cause them to impute tax benefits to projects that afford access to the tax-exempt bond market. Empirical tests indicate that NP hospitals behave as if they have target levels of tax-exempt debt. Debt targeting is constrained by the availability of capital projects, while excess debt capacity stimulates investment.