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By Liz Warren-Pederson

Competition for effective leaders has motivated both for-profit and nonprofit hospitals to adopt profit-based incentives in setting executive compensation. A new paper co-authored by Deloitte & Touche Professor of Accounting Leslie Eldenburg and forthcoming in The Journal of Contemporary Accounting Research is the first to examine the effect of profit-based incentives on charity care.

McClelland Professor of Accounting Leslie Eldenburg.

Deloitte & Touche Professor of Accounting Leslie Eldenburg.

“Because charity care reduces profits, such incentives should lead for-profit hospital managers to reduce charity care levels,” Eldenburg said. “Nonprofit hospital managers, however, may respond differently to the same incentives because they face a different set of institutional pressures and constraints.”

In 2011, nearly 5,000 community hospitals provided $41.1 billion in uncompensated care as part of the $759 billion total hospital economic output.

“Hospitals have many ways to manage charity care,” Eldenburg explained. Government and teaching hospitals provide the most charity care. For-profit hospitals minimize charity care by constraining the services they provide. “Typically for-profit hospitals don’t offer trauma care,” she pointed out. “They also try to keep the care that they provide simple and straightforward – more complex cases are less profitable.” But because nonprofit hospitals are mission-driven and tax exempt, managers cannot minimize charity care without facing scrutiny from donors, regulators, and other stakeholders.

Performance-based incentives normally consider three areas: financial performance, patient satisfaction, and clinical quality. In for-profit hospitals, when managers miss financial targets, they still get some bonus based on performance in the other areas. “In nonprofit hospitals, managers won’t receive any bonus when they don’t hit their financial benchmarks,” Eldenburg said.

“What we found is that as the weight on financial performance in compensation increased in for-profit hospitals, charity care decreased,” she continued. “However, there was no relationship at all in nonprofits.  The weight on financial performance just did not influence charity care decisions.”

Eldenburg and her co-authors (Theodore Goodman of Purdue University and Fabio Gaertner of the University of Wisconsin) point out that this evidence should partially alleviate concerns over the pay-per-performance model that nonprofit hospitals have adopted to compete for effective managers with their for-profit peers. More broadly, she said, “We also provide insights for accounting researchers about organizational influences that affect managerial responses to financial incentives in compensation contracts.”

Top photo by David Harvey.