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Nonprofit Organization Behavior in For-Profit Markets (WP-02-36)

Maxim Sinitsyn and Burton A. Weisbrod

This paper addresses the behavior of nonprofit organizations in their money-generating activities. It presents a two-good model in which commercial activities are undertaken for the sole purpose of raising revenue for use in maximizing the organization’s mission output. We test two implications of this model for six industries, including higher education and hospitals. Among the key findings: (1) Nonprofit organizations in different industries engage in systematically different unrelated business (UB) activities, selecting those for which cost complementarities with mission activities are greatest, and which, therefore, are more likely to be truly profitable; and (2) the joint costs are allocated, subject to Generally Accepted Accounting Practices constraints, between the taxed, UB activities and the untaxed, mission activities so as to minimize tax liabilities and thereby maximize real after-tax profit. In the process of testing, we shed light on the finding that half or more of all the nonprofit organizations engaging in unrelated business activity report no profit or, more often, a loss, even though the pursuit of profit is the only apparent rationale for engaging in it. We conclude that this two-good model of nonprofit sector behavior, in which nonprofits act like profit-maximizers in their revenue-generating activities, is consistent with a number of types of observed behavior.

Maxim Sinitsyn, Doctoral student, Department of Economics, Northwestern University

Burton A. Weisbrod, John Evans Professor of Economics; Faculty Fellow, Institute for Policy Research, Northwestern University

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