Impact of Financial Reserves and Liquidity Constraints on Hospital Capital Investment

My paper investigates how hospitals are using financial reserve in response to liquidity constraints when financing capital investment. Capital investments include investments on plant, property, and equipment needed for hospital operations. Hospitals can fund capital investments with internal funds or externally borrow debt from capital markets. However, capital market with hospitals as borrowers do not functioning efficiently because of asymmetric information and uncertainty. To reduce uncertainty, lenders may consider the liquidity of a hospital when deciding to supply capital. Given such constraints from the external capital market, hospitals may hold a financial reserve in response to liquidity constraints. Hospitals may compensate for poor liquidity by holding a larger financial reserve, where financial reserve can be used to internally fund capital investment (financial reserve is substitute for debt) or to improve access to debt from capital market (financial reserve is complement for debt).

Theoretical investigation on how financial reserve and liquidity constraints affect hospital capital investment is a novel contribution to the literature. Hospital capital investment decision with financial reserve and liquidity constraints is modeled as an investment Euler equation. Subsequent empirical model derived from the theory is estimated using generalized method of moments and hospital financial data from the California Office of Statewide Health Planning and Development (2002-2010). Preliminary results suggest that from 2007 to 2010 there was a decrease in hospital capital investment among not for profit and investor owned hospitals.

Investigating hospital capital investment is timely given the recent recession. National estimates based on hospital financial data from 2005 to 2008 have documented the poor operating margins of general acute care community hospitals during the recession years. Poor operating margins contribute to poor liquidity; consequently hospitals may not be able to access the capital market to fund capital investment. Hospital cutbacks in capital investment for plant, property, and equipment needed for its operations may have negative implications for patient outcomes down the road as the hospital will fall behind in acquiring and maintaining technology and equipment needed to address patient needs. Furthermore, holding financial reserve has negative welfare implications as those funds could have been used for hospital operations had there been an efficient capital market.