Managers' Compensation in a Mixed-Ownership Industry

The total number of nonprofit organizations has increased by 24% during the past decade. In 2010, about 2.3 million nonprofits were operating in the U.S., and their economic activities make up 5.5% of the U.S. GDP.  Despite their significant influence, nonprofit organizations are a challenging subject for traditional economic analysis. The non-distribution constraint contradicts the fundamental profit-maximizing assumption and the motives of nonprofit organizations remain a puzzle. This paper investigates nursing home managers' compensation and its relationship with performance measures in order to provide new empirical evidence of the difference between for-profits and nonprofits. In addition, we also study how the compensation may interact with the widely implemented quality rating system.

        In the paper, we directly test whether for-profits and nonprofits place different weights on financial and altruistic motives in deciding managers' compensation. Managers are contracted by the board of directors/trustees to act as the representative agents for the security owners (in for-profits) or the donors and communities (in nonprofits). Therefore, managers should receive incentives that reflect the motives of their organizations.  If nonprofits truly pursue objectives beyond financial performance, other altruistic objectives should also be important in determining managers' compensation.

        The empirical analysis relies on a unique eight years (2003-2010) dataset. We obtain audited nursing home cost reports from the Ohio Department of Job and Family Service. These reports provide detailed data related to managers' compensation and their ownership. This Ohio data also provides information describing managers' experience and educational background that can be used as proxies for ability.  We also utilize the implementation of 5-star quality rating in December 2008 as the difference-in-difference strategy to study the elasticity of compensation with respect to quality.  The different weights of quality on compensation between nonprofits and for-profits may be narrowed, because effective quality rating increases the financial rewards/penalty of quality and reduces the altruistic motive of quality.

        Overall, we find no consistent relationship between compensation and either financial or altruistic performance. Rather, managers' compensation is positively correlated with directly observable characteristics, including work experience, number of beds, occupancy rate, and payer mix. The finding is consistent with the literature that for-profit and nonprofit do not respond to quality rating differently. However, the results should be interpreted with caution. The absence of significant relationship between compensation and performance does not necessarily indicate that nonprofits are not different from for-profits.  Because managers' turnover is not included in the analysis, it is possible that the board replaces managers who have poor performance rather than reduces their compensation. Also, the evaluation and monitoring of financial and altruistic performance can be too costly to the governing board, preventing managers' compensation from reflecting short-term performance.