Profit, Patients and Public Good: Rethinking the Hospital Debate

During the COVID-19 pandemic, troubling reports emerged about a shortage of pulmonary ICU beds at for-profit hospitals. Allegedly, some of these institutions had repurposed critical care beds for more profitable surgical procedures. The stories appeared to confirm the worst fears about the greediness of profit-making institutions in the healthcare sector at the expense of overall public health.

“The accusation was that they did something that was good for the profit line, but not good for the community,” says Christoph Herpfer, assistant professor of finance at University of Virginia’s Darden School of Business.

As a finance researcher, Herpfer was intrigued by the reports. But when he started reading the healthcare literature, he was surprised to find the picture was far from clear. “Though many loud voices criticized for-profit healthcare providers, an equally stark set of accusations has been levelled against not-for-profit hospitals,” he says.

Just as critics accused for-profit hospitals of pursuing more lucrative service lines and shunning activities with high community benefits, those on the other side accused not-for-profit hospitals of pursuing the same strategies, while also reaping massive tax benefits.

“Some argue that not-for-profit hospitals build the same shiny, new hospital towers with fancy executive wings, while they pay their executives multi-million-dollar salaries,” Herpfer says. In other words, they are just for-profit hospitals with tax breaks.

Both sides have been able to cherry-pick data to support their position, while limited hard evidence exists to definitively pin down the truth.

“Within the academic literature, whatever belief you had going in — whether you thought for-profits hospitals were evil, or not-for-profits were mooching on taxpayers — you could find data to confirm it,” says Herpfer.

Intrigued by this debate, he used a statistical technique to determine which side was right. Herpfer details his findings in a new working paper, Corporate Behavior When Running the Firm for Stakeholders: Evidence from Hospitals, cowritten with Jianzhang Lin and Gonzalo Maturana of Goizueta Business School at Emory University.

The researchers found that, in fact, both sides have merit.

Not-for-profit hospitals do provide more community benefits than for-profits, in keeping with their mission; however, those benefits are offset by the tax benefits they receive.

“Once you take that into account, the whole thing looks like a wash,” Herpfer says. “At the end of the day, for-profits aren’t more profitable than the not-for-profits.” The most intriguing finding of their paper may be that the system works as intended, with the tax code serving as a novel form of corporate governance to ensure hospitals provide care as intended.

A Statistical Wash

Commentators have long been concerned about profitmaking in the healthcare sector, which accounts for more than 20 percent of the nation’s GDP. “It’s the largest industry we have,” Herpfer says. “And within that, hospitals themselves account for a quarter of output, or 5 percent of GDP. That is massive — almost as big as the entire banking sector.”

Faced with the large amounts of money involved, most people have an instinctual fear about mixing profits and people’s health. “We don’t mind that our local restaurant or hairdresser makes a profit, but many people feel hesitation when it’s health,” says Herpfer.

To examine this problem, Herpfer and his colleagues took advantage of state legislation regulating the conversion of hospitals from not-for-profit to for-profit status. Those laws, which vary from state to state, put up hurdles that make it more difficult and expensive for those conversions to occur, presenting the researchers with an outside variable they can use to compare outcomes.

“The more legal obstacles there are to conversion, the fewer of these conversions we expect to see,” Herpfer says. “Statistically, then you can isolate the changes in hospital actions driven purely by these laws, giving you a direct link between for-profit orientation and the behavior of the hospital.”

When the researchers threw the data into their statistical machine, the results they found were clear: not-for-profit hospitals are consistently providing benefits to their communities.

Those benefits include treating a higher percentage of people on Medicaid, which reimburses at lower rates than private insurance, and having more non-surgical ICU beds, which are less lucrative than surgical beds.

They also have larger emergency departments, which treat more patients who lack insurance, including poor and unhoused people.

In fact, Herpfer and his coauthors were even able to show that when a hospital converts from not-for-profit to for-profit, the neighboring not-for-profit hospitals see an increase in emergency department intakes — a seeming spillover effect due to the lack of emergency beds at the new for-profit entity.

“All hospitals are technically required to treat all patients that come to the emergency room, but there’s no requirement that you treat them quickly,” Herpfer explains. “If you shrink the size of the emergency room and staff it with fewer physicians and nurses, you save money — and eventually the people who get sick of waiting end up going to a not-for-profit hospital, which can see them more quickly.”

While that data seem to support the idea that not-for-profit hospitals support their communities, it only takes into account one side of the coin. A complete calculation needs to consider the massive benefits not-for-profits get for those services, Herpfer says. Those include not only tax subsidies and grants but also access to cheap capital through low-interest, tax-exempt municipal bonds.

When the researchers crunched those numbers, they found those elements essentially canceled each other out. “The market seems in equilibrium, meaning that a for-profit conversion can shave off enough community benefits and increase efficiency to make some profits, but it is largely offsets government grants and support.”

Governance by Tax Code

Interestingly, the mechanism that seems to make not-for-profit hospitals perform their tasks is not necessarily classic corporate governance such as boards of directors. Instead, an important driver seems to be the specificity of the tax code around not-for-profit hospitals, which are held to a high standard precisely because of the concerns over mixing profits and health.

“Getting tax-exempt status as a hospital requires a specific list of actions — run a big emergency room, treat Medicaid patients, provide medical services that are good for the community — the exact things we observe in our results,” says Herpfer.

In other words, the tax code serves as an alternative form of corporate governance, performing the same kinds of checks that a board of directors or outside committee should be doing.

At a time when not-for-profit organizations more generally are sometimes being called into question for the way they spend money, understanding the mechanisms that align their behavior with their mission is key to strengthening oversight and improving performance in the sector, says Herpfer.

“The tax code is one way to ensure they benefit communities as intended,” he adds.