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What Are the Determinants of Nonprofit Net Assets?

Thad CalabreseDoctoral Candidate, New York UniversityBaruch College - CUNY,

School of Public Affairsthad.calabrese@baruch.cuny.edu

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Presentation Outline

Explanation of Net Assets

Policy Relevance

Existing Literature/Theories

Net Assets and Uncertainty

Empirical Section - Data, Models, Variables

Results and Conclusions

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What Are Net Assets? Annual surpluses that an organization

accumulates:

Revenue - Expenses = Surplus/(Deficit)

Accumulates on balance sheet:

Assets - Liabilities = Net Assets

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More on Net Assets

In for-profit sector, net assets called “Owner’s Equity” - measure of wealth.

Restrictions by donors may make nonprofits unable to access these surpluses.

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Motivation

Almost no literature empirically addresses this question.

Nonprofit literature seemed in opposition to experiences with charities.

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Policy Relevance Understanding Nonprofit Net Assets

1. Current benefits for donors/nonprofits (tax expenditures); unclear future benefits;

2. Wealth concentration within sector; but is it entirely by organizational choice?

3. Effect on implementation of government policies.

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Current Literature: Theories of Nonprofit Organizations

Public Goods Theory

- Private suppliers of public goods

- Fill demand for additional public goods for those with preferences above the median voter.

Theory silent on financial operations of organizations.

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Current Literature, con’t Contracts Failure Theory

- nonprofits more likely to match quality/types of complex services sought.

- nondistribution constraint increases trustworthiness of nonprofits.

Theory assumes net assets spent on additional output.

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Behavioral Theories of Nonprofits

1) Maximizing Behavior

- usually output (compared to profit in

corporate finance)

- most assume breakeven operations are goal

(if mentioned at all)

- Tuckman and Chang (1992) are sole

exception

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Behavioral Theories of Nonprofits (con’t)

2) Supply Response

- Nonprofits respond to increases in demand for services

- Incomplete capital financial markets limit nonprofits (net assets as a source of funds)

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Behavioral Theories of Nonprofits (con’t)

3) Subsidizing Behavior

- Nonprofits provide services that cannot be supported on their own

- Breakeven operations assumed

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Behavioral Theories of Nonprofits (con’t)

4) Net Assets as Goal

- Especially as hedge against revenue uncertainty (slack resource)

- Potential agency problems

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Net Assets and the Current Literature

1) Ignores possibility of donor restrictions;

2) Assumes breakeven operations (no net

assets);

3) Ignores financial operations completely;

4) Exceptions to 2 and 3 are:- Chang and Tuckman (1990): descriptive- Tuckman and Chang (1992): cross-sectional- Fisman and Hubbard (2002, 2003): cross-sectional

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A Simple Theory of Net Assets & Uncertainty

Two-period model:

U (Q1 , Q2), where U1 > 0 and U2 >0

The first period budget constraint (no prior NA balance) is:

Y1 = v1Q1 + NA1 = v1Q1 + NA1

The second period budget constraint is:

Y2 + r1NA1 = v2Q2 + NA2

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A Simple Theory (con’t)

Under certainty, each variable in each budget constraint is known/knowable: no reason for precautionary savings

But this assumption is unrealistic, and each variable in the model is affected by uncertainty; net assets become desirable

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A Simple Theory (con’t)

Under certainty, each variable in each budget constraint is known/knowable: no reason for precautionary savings

But this assumption is unrealistic, and each variable in the model is affected by uncertainty; net assets become desirable

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A Simple Theory (con’t)

Net Assets are valued for:

1) Maximizing preferences in light of uncertainty;

2) Hedging against uncertainty of expansion of

services;

3) Hedging against uncertainty of subsidization

of clients;

4) Hedging against revenue uncertainty.

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Data

Comes from Guidestar-Digitized Database from

NCCS based on Form 990 data

Years: 1998 - 2003

Only data with restriction information

More representative of sector than SOI data

Final sample: 699,717 observations (50%)

covering 134,421 organizations (40%)

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Empirical Model

Net Assets = f (Q, E, C, R, O, t, S)

Vectors:Q = Output related O = Other controlsE = Expansion t = Year FEC = Subsidization of clients S = Subsector FER = Revenue

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Dependent Variables

Net Assets defined in three ways (all natural logs):

1) Total Net Assets (includes restrictions)2) Unrestricted Net Assets (without

restrictions)3) Unrestricted + Temporarily Restricted

Net Assets (earned through operations)

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Independent Variables: QLiterature suggests output affected by demographic and

population characteristics:

1) Change in average per capita income (BEA)

2) Change in proportion of youth population (Census)

3) Change in proportion of elderly population (Census)

4) Change in community homogeneity (Census)

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Independent Variables: E

1) Fixed assets (ln PPE)

2) Capital replacement (ln Depreciation)

3) Access to debt (Dummy 1 = LT Borrowing)

4) Organizational borrowing cost (ln Interest

Expense/Total Liabilities)

5) Interact Access to debt*Fixed assets

6) Interact Access to debt*Capital replacement

All derived from Form 990 data

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Independent Variables: C

Based on population need:

1) Change in state welfare recipients per capita (DHHS)

2) Change in state unemployment rates (BLS)

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Independent Variables: R

1) Government funding

2) Donations from individuals

3) Self-generated

4) Investment revenue

All derived from Form 990 data

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Independent Variables: O

1) Size (total revenues) - 990 data

2) Number of employees - 990 data

3) Attorney General oversight - OH AG

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A Few Descriptive Statistics

Average Total Net Assets: ~$430,000

Average Unrestricted: ~$310,000

Orgs with Access to Debt: ~26 percent

Average Size: Under $500,000 in revenue

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Regression Results, TNA – All Subsectors

Q Vector

pcichangelag -0.001**

lagdeltayouth -0.003***

lagdeltaelderly -0.002***

lagdelta_diversity 0.237***

Except for community heterogeneity variable, proxies for output have little effect (although significant).

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Regression Results, con’t

E Vector

accessdebt -0.156***

L.logint_rate -0.021***

L.logFixed_Assets 0.260***

L.logDepreciation -0.002

L.FAXDebt 0.002

L.DepXDebt -0.012***

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Regression Results, con’t

welfaredeltalag 0.040***

joblessdeltalag -0.012**

Small effects again, although significant.

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Regression Results, con’t

R Vector

L.logGF -0.033***

L.logDon_Fund 0.104***

L.logSelf_Fund -0.033***

L.logInvest_Fund 0.328***

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Regression Results, con’t

O Vector

L.logTR 0.381***

L.AGOversight -0.005***

L.logemp -0.022***

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Change in Variables When Excluding Restrictions

Variable (Vector) LogTNA LogUNA

Pcichangelag (Q) -0.001** -0.000

lagdelta_diversity (Q) 0.237*** -0.015

L.logDepreciation (E) -0.002 0.017***

L.FAXDebt (E) 0.002 0.010***

L.logDon_Fund (R) 0.104*** 0.053***

L.logSelf_Fund (R) -0.033*** -0.002

L.logInvest_Fund (R) 0.328*** 0.294***

L.AGOversight (O) -0.005*** -0.002

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Conclusions

1. Sector needs to communicate need for net assets;

2. Sector not over-retaining on average;

3. Increased state oversight likely to have minimal effect on net assets;

4. Progressive spenddown requirements may be warranted.

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Current Economic Climate

1. “Safe” government funds drying up;

2. Bank credit also drying up.

Results suggest that nonprofits might retain rather than spend in current climate (similar to households).