Financial Disclosure Management by Nonprofit Organizations 1

Ranjani Krishnan, Michelle H. Yetman, Robert J. Yetman*

Eli Broad College of Business, Michigan State University, East Lansing, MI 48824.
Tippie College of Business, The University of Iowa, Iowa City, IA 52240

______________________________________________________________________________

Abstract

This paper examines how nonprofit organizations respond to incentives to manage their
publicly available financial information. Prior research identifies two operating ratios donors
commonly use to evaluate the efficiency and effectiveness of nonprofits (i.e., the program
service ratio, defined as the fraction of total expenses committed to advancing the charitable
mission of the organization, and the fundraising ratio, defined as the ratio of fundraising
expenses to donations revenue). Nonprofit managers have an incentive to over-report the
expenses classified as program services and under-report the expenses classified as
administrative and fundraising in order to improve these ratios. We examine whether nonprofits
respond to these incentives, and we find evidence consistent with opportunistic cost shifting to
improve the program service and fundraising ratios. Additional analysis finds that smaller
nonprofits that are more reliant on donations revenue manipulate their operating ratios to a
greater extent.

JEL classification: M4; L3

Key words: Nonprofit organizations, earnings management, disclosure, hospitals.

______________________________________________________________________________

*Corresponding author. Tel.: (319) 335-0841; fax (319) ; email: robert_yetman@uiowa.edu

1
We thank Ashiq Ali, Ramji Balakrishnan, Leslie Eldenburg, Lil Mills, Shiva
Sivaramakrishnan, and workshop participants at the University of Arizona and Texas A&M
University for their helpful comments.
1. Introduction

This paper examines how nonprofit organizations respond to incentives to manage their

publicly available financial information through accounting expense allocations. Although

nonprofit organizations do not have an observable stock price, there are nonetheless significant

contractual incentives for financial disclosure management. In particular, implicit contracts with

donors provide nonprofits with an incentive to appear efficient in raising their donations and in

allocating their resources to charitable, rather than administrative, outputs.

Typically, two ratios are used to measure a nonprofit organization’s donative and operational

efficiency. Nonprofit financial statements aggregate all expenses into one of three categories

(i.e., program services, fundraising, and administrative), and the ratios are based on these

expense categories. The first ratio, known as the program service ratio, is program service

expenses divided by total expenses. Because program service expenses are those directly related

to the nonprofit’s primary charitable output (as opposed to either administrative or fundraising

expenses), this ratio measures a nonprofit’s operating effectiveness. The second ratio, known as

the fundraising ratio, is fundraising expenses divided by donations revenues and captures a

nonprofit’s fundraising efficiency. Numerous industry watchdog groups suggest that donors use

these two ratios to determine which charities are “worthy” of receiving donations, and a growing

body of empirical research finds evidence consistent with donors responding to information

contained in these ratios (Weisbrod and Dominguez 1986; Posnett and Sandler 1989; Callen

1994; Tinkelman 1999; Okten and Weisbrod 2000; Yetman and Yetman 2002; Baber, Daniel and

Roberts 2002).

To the extent that nonprofit managers believe that donors respond to these ratios, there is an

incentive to allocate expenses out of the fundraising and administrative categories and into the

1
program services category in order to improve reported operating ratios. Although these kinds of

accounting expense allocations have long been suspected, they have never been empirically

documented (Khalat and Hueslein 1992). For example, an article in Forbes states, “Moreover

from a public relations standpoint, charities have every incentive to maximize the charitable

commitment figure and minimize reported fundraising expenses. Dubious accounting isn’t rare.”

(Barret, 1999). Our paper provides empirical evidence consistent with nonprofits using

accounting expense allocations to overstate their program service expenses and understate their

fundraising expenses, thereby making themselves more attractive to potential donors. Further

analysis estimates the magnitude of these accounting expense allocations, and examines the

effects of political costs and reliance on donations as a revenue source on a nonprofit’s

propensity to make expense allocations.

This research is of potential interest for several reasons. First, nonprofits provide a natural

setting (free of price-related incentives) in which to examine the effects of contractual incentives

on financial reporting choices. Second, the effects of disclosure management on the quality and

decision usefulness of publicly available financial information generally has not been addressed

in the nonprofit setting. Nonprofit organizations, which constitute over 10 percent of national

gross domestic product, are an important part of the United States economy (Independent Sector

2001). Annual donations received by nonprofits total over $200 billion (American Association

of Fundraising Council Trust for Philanthropy, 2002). To the extent that donors make resource

allocation decisions based on reported financial information and are unable to disentangle

disclosure management, economic resources are potentially misallocated. Third, a small but

growing body of research uses these ratios for empirical analysis without considering the

implications of managerial manipulation (Baber, Roberts, Visvanathan 2001; Yetman 2001;

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Baber, Daniel, and Roberts 2002;). By documenting the extent and method of nonprofit

disclosure management, we provide valuable information for future research.

We conduct our analysis using two databases. The first database contains matched sets of

IRS 990s and state regulatory reports for a pooled sample of 719 observations from California

hospitals for the years 1994 to 1998. The IRS 990, which is freely available for all nonprofits, is

considered to be the principal publicly available source of financial information for nonprofit

organizations (Joint Committee on Taxation, 2000). The state regulatory reports are available

from the California Office of Statewide Health Planning and Development and are referred to as

OSHPD reports. For reasons discussed later, we believe that the OSHPD reports are not likely to

be used by donors to evaluate a particular hospital’s operating efficiency or effectiveness and

therefore managers have less incentive to manipulate their OSHPD reports. We compare the

amounts of program service expenses reported by the hospitals on their OSHPD reports with the

amounts reported on their publicly available IRS 990 financial statements.

Results of this analysis find that, although nonprofit hospitals in California report the same

amounts of total expenses (i.e., the sum of program service, administration, and fundraising) on

their OSHPD and IRS 990 forms, they report an average of $13.9 million more program service

expenses (and $13.9 million less administrative and fundraising expenses) on their IRS 990

forms than on their OSHPD reports. These expense allocations increased the average program

service ratio from 68 percent to 83 percent, causing the average organization to appear to be

more operationally effective in that a larger proportion of total expenses are for charitable

purposes. This result is consistent with nonprofit managers understating the amounts of program

expenses reported on their publicly available financial reports (i.e., the IRS 990s) in order to

appear more operationally efficient to potential donors.

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 The advantage of our first empirical test is that it measures disclosure management by

comparing data on two sets of matched financial reports as self-reported by the nonprofits (i.e.,

each organization acts as its own control). The disadvantage of our first test is its limitation to a

relatively small sample (i.e., 719) of California hospital observations. To overcome this

limitation, we conduct a second empirical analysis using a second database of over 100,000

organization-year observations from 1982 to 1998, which includes educational, medical and

charitable nonprofits in all 50 states (plus the District of Columbia). Because the only publicly

available data for this larger sample is the IRS 990, we employ an estimation technique to

determine expected expenses, and then compare this expected amount with the amounts reported

on the IRS 990s, with the difference representing accounting expense allocations. Our

estimation technique uses a regression model based on prior research to derive nonprofit-level

estimates of fundraising expenses. We examine only fundraising expenses with this larger

sample (rather than program services or administrative expenses) because prior research supplies

models that can be used to estimate fundraising expenses.

Results of our second analysis show that educational, medical, and charitable nonprofits

under-report an average of $1,656 thousand, $129 thousand, and $227 thousand, respectively, in

fundraising expenses on their IRS 990s. These expense allocations decreased the average

fundraising ratios for educational, medical, and charitable nonprofits by 16 percent, 3 percent,

and 7 percent, respectively, causing the average organization to appear to be more efficient in

raising donations.

Our third set of empirical tests is based on our observation that almost 40 percent of all

nonprofits that report earning some amount of private donations (i.e., from individuals or

corporations) report zero fundraising expenses. We investigated these nonprofits further because

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it seems unlikely that such a large percentage of nonprofits could earn substantial private

donations (average of $1.8 million each) with zero fundraising effort. To conduct this analysis,

we randomly selected a sample of 10 percent of nonprofits that report zero fundraising expenses

yet earn private donations and searched their Internet web pages for evidence of fundraising

activities. Of the 349 organization web pages searched, we found evidence of fundraising

activities for 130 organizations (37%). The instructions to the IRS 990 require that any and all

expenses related to fundraising activities, such as those we found on the internet, be reported as

fundraising. The results of this analysis imply that a substantial portion of nonprofits that report

zero fundraising expenses actually do incur some amount fundraising expenses. This analysis

corroborates the findings of our two previous tests that nonprofits allocate costs among various

accounting categories so as to appear more operationally effective and efficient to potential

donors.

In the fourth and final portion of our analysis, we test the prediction that accounting expense

allocations are negatively related to political costs (as measured by size) and positively related to

the relative importance of donations as a revenue source. Results generally support our

predictions.

Our results have at least two implications. First, as with earnings management by for-profit

entities, nonprofit financial disclosure management accomplished through accounting

manipulations has potential resource allocation implications. Second, the results suggest that

future nonprofit research using the program service or fundraising ratios must account for

possible managerial manipulation.

Prior research examined earnings (i.e., net income) management by nonprofit hospitals and

finds that they smooth their net income and do not avoid reporting losses (Leone and Van Horne

5
2001). We differentiate our research in several ways. First, we focus on the manipulation of

operating ratios rather than on net income because, in the nonprofit setting, operating ratios are a

more commonly used evaluation metric. Prior research suggests that, since a nonprofit’s value is

not reflected in a price metric, nonprofit objective functions generally do not include net income

maximization, but rather include maximizing charitable output and meeting donor expectations

(Rose-Ackerman 1996). Second, we consider all kinds of nonprofits, not just hospitals. Finally,

we develop and test predictions about the characteristics associated with disclosure management;

while prior research does not.

The next section reviews the nonprofit financial disclosure environment. Section III

discusses our data; Section IV presents our empirical analyses; Section V provides robustness

tests, and the final section our conclusion.

2. Nonprofit Financial Disclosure Environment

2.1. The Agency Problem in Nonprofit Organizations

Public demand for nonprofit financial statement data is at least partially driven by the

inherent agency conflict within the nonprofit setting. The economics literature typically assumes

that not-for-profit firms have different objectives and behave differently from for-profit firms.

Much of the work in this area draws on the seminal research of Arrow (1963), who suggests that

nonprofit hospitals arise in response to the asymmetry of information between patients and

providers of healthcare. Fama and Jensen (1983) argue that nonprofits arise for particular forms

of organizations such as charities because unrestricted donations pose agency problems for any

organization with residual claimants. In order for donors to be assured that residual claimants do

not consume their resources, the nonprofit form arises, which has no alienable residual claims.

6
Fama and Jensen (1983) conclude that “the absence of residual claims avoids the donor-residual

claimant agency problem and explains the dominance of nonprofits in donor-financed activities.”

However, the absence of residual claimants does not automatically ensure that nonprofit

managers will use donations in the most efficient manner. Managers can consume more

resources than efficient production requires for various reasons. For example, managers can

consume excessive perquisites and expend resources in activities peripheral to the stated mission

of the organization. Also, in some cases efficient production requires additional effort by the

manager who would otherwise be unwilling to expend that effort in the absence of high-powered

incentive contracts.

Donors have an implicit contract with nonprofits in that donors supply net cash flow in

exchange for the nonprofit efficiently and effectively providing some charitable output with the

provided funds. Accounting information can assist donors in monitoring their implicit contracts

by providing a means (i.e., the fundraising and the program services ratios) for donors to

evaluate whether the nonprofit is using their donations in the most efficient and effective

manner. The following sections discuss the financial disclosure requirements for nonprofit

organizations that facilitate financial analysis of nonprofits by donors.

2.2. IRS 990 Financial Disclosures

Federal regulations require that nonprofits annually prepare and disclose their IRS 990,

which contains typical financial statements, including a statement of revenues and expenses and

a balance sheet, as well as a substantial amount of other information related to the nonprofit’s

charitable purpose and activities. IRS 990 data on most nonprofits is freely available on the

Internet at www.guidstar.org. Congressional reports suggest that the intent of the IRS 990 is to

7
provide the public with the necessary information to evaluate the performance of a nonprofit and

that the IRS 990 is the primary source of publicly available nonprofit financial information (Joint

Committee on Taxation 2000).

Nonprofit financial statements on the IRS 990 group all expenses into one of three

accounting categories: program service, administrative, and fundraising expenses. Instructions

to the IRS 990 indicate that fundraising expenses are any and all incurred either directly or

indirectly to generate, maintain, or keep track of government grants or donations, both from the

general public and from “feeder” organizations such as the United Way. Program service

expenses are those incurred to further the charitable mission of the nonprofit, such as professors’

salaries at nonprofit universities, direct patient care at nonprofit hospitals, and specimen

acquisitions at nonprofit zoos and aquariums. Expenses that are not properly classified as

program service or fundraising are considered to be administrative. Overhead expenses, which

are shared among the three categories of expenses, have to be allocated using a reasonable

method of cost allocation.

Although nonprofits can elect to undergo financial statement audits, there is no requirement

that these audited financial statements be made public, nor is there any IRS requirement that the

IRS 990 conform to audited financial statements. Although most accounting rules for both the

IRS 990 and for financial statements presented in accordance with Generally Accepted

Accounting Principles coincide, there are some differences. For example, the IRS 990 does not

use materiality thresholds, any amount of fundraising must be separately stated.

Industry watchdogs use information from the IRS 990s to compute the program service and

fundraising ratios and make annual recommendations to the public via printed publications and

the World Wide Web. The largest watchdog groups include the American Institute of

8
Philanthropy (AIP), the Philanthropy Advisory Service (PAS) of the Council of Better Business

Bureaus (CBBB), and the National Charities Information Bureau (NCIB). In addition to these

agencies, the popular press (e.g., Forbes , Money, and The Wall Street Journal) utilize IRS 990

data in news articles and/or in annual lists comparing nonprofits’ relative program service and

fundraising ratios. 2, 3

2.3. OSHPD Financial Disclosures

In addition to IRS disclosure requirements, hospitals providing medical care in the state of

California must provide additional disclosures to state regulatory authorities. The California

Office of Statewide Health Planning and Development (OSHPD), a department of the California

Health and Human Services Agency, collects, analyzes, and disseminates data on hospitals

licensed in California. The information collected by OSHPD includes financial reports, patient

statistics, and usage statistics.

Expenses on the OSHPD report are provided in the following format: The OSHPD data

include totals (and some details) for general service, administrative, and program service

expenses, but does not generate a separate total for fundraising expenses. General services

include expenses such as printing, non-patient food services, grounds, security, parking,

accounting, and data processing. Administrative expenses comprise hospital administration,

2
For example see “Giving Smartly: A Guide to Charities 2001” in http://www.forbes.com/charities.
3
For example, Barrett (1999) in a Forbes article titled “Look Before you Give” reports, “The Cancer Research
Institute funneled 89% of its budget to scientific inquiry, much greater than the 62% of the far larger American
Cancer Society, or the 56% of the smaller Cancer Fund of America. Much of the difference had to do with
fundraising. Only 3 cents of every dollar raised by the Cancer Research Institute are spent on generating the
donations. At the Cancer Fund, 24 cents go out the door that way, and at the American Cancer Society, 30 cents.”

9
personnel, library, staff administration, and public relations. Program service expenses 4 as per

the OSHPD data include daily hospital services such as medical/surgical intensive and acute

care, coronary care, pediatric care, obstetrics, and psychiatric care; ambulatory services such as

emergency room, medical transportation, and home health; ancillary services such as radiology,

occupational therapy, and renal dialysis; research expenses; education costs; insurance and

malpractice; and other operating overhead and miscellaneous costs not classified as

administrative or general expenses.

There are two primary users of the OSHPD reports: First, the Health Planning and Policy

(HPP) Division of OSHPD, which conducts research on issues related to healthcare cost

containment, access to needed services, and improving the quality of care, demands a great

amount of accurate, detailed information. Second, health care researchers and other medical

policy makers also rely on the data. Therefore, OSHPD reporting guidelines are very detailed

(the instruction manual is about 1,000 pages) and specific for each line item.

We believe that hospitals are less likely to manipulate their operating ratios on the OSHPD

reports as compared with their IRS 990s for four reasons. First, the OSHPD data have to be

purchased at a cost of $375 per year; while the IRS 990s are freely and easily available to

potential donors. Second, the OSHPD reports contain large amounts of complex data (hundreds

of accounts) that must be aggregated across various categories and cost centers in order to

compute a nonprofit’s performance ratios. In contrast, the IRS 990 contains only three

categories of expenses which can be easily used to construct the operating ratios (all data

necessary to calculate the two ratios are clearly presented on page one of the IRS 990). Third,

4
The OSHPD database does not specifically refer to these expenses as program service expenses. However,
consistent with the IRS 990 classification, all expenses other than administrative, fundraising, and general are
program service expenses.

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the popular press and all watchdog agencies use IRS 990 data in forming their recommendations.

Finally, the OSHPD data are available only for California hospitals; while the IRS 990 data are

available for all types of nonprofit organizations located throughout the country. Donors are

likely to be interested in comparing a variety of nonprofits in a number of locations before

making decisions.

It is also possible that, rather than overstating the amount of program service expenses on the

IRS 990, California hospitals are actually understating their program service expenses on their

OSHPD reports, although we are not aware of any incentive to manipulate the OHSPD reports in

this manner. To the contrary, it is possible that there are incentives, such as expense

reimbursement policies or state regulatory scrutiny, for hospitals to overstate, rather than

understate, the program expenses on their OSHPD reports. The effect of overstated OSHPD

program expenses is to bias our tests against finding results.

The differing opportunities and incentives for earnings management between the IRS 990

and the OSHPD reports guide our interpretation that the reported expenses on the OSHPD data

are less managed compared with the financial information on the IRS 990. However, to the

extent that hospitals do simultaneously overstate their program services on both their OSHPDs

and IRS 990s, our estimates of expense allocations will be biased downward, conservatively

influencing our results.

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3. Data

3.1. Sample Selection

3.1.1. Sample of California Nonprofit Hospitals

Our pooled cross-sectional sample of California hospitals is based on the intersection of two

databases: the OSHPD Hospital Financial data and the IRS 990 data from the “Statistics of

Income” (SOI) files. The SOI files contain data on all 501(c)(3) organizations with more than

$10 million in assets plus a random sample of approximately 4,000 smaller organizations and

include most financial variables on the IRS 990. The SOI data files were obtained from the

National Center for Charitable Statistics (NCCS). The NCCS, which is a project of the Center

on Nonprofits and Philanthropy (CNP) of the Urban Institute, is the national repository of data

on the nonprofit sector in the United States (http://nccs.urban.org).

We matched each nonprofit hospital in the OSHPD database with each nonprofit hospital in

the IRS 990 database. Since the two databases have different firm identifier numbers (a unique

9-digit hospital number in the OSHPD data and a unique 9-digit Employer Identification Number

(EIN) in the IRS 990s), we matched by hospital name and zip code. Because external changes in

the hospital industry make the analysis of a large panel of data noisy, we restrict our analyses to

the most recent five years for which data are available (1994-1998). The matching process

produced 719 hospital-year observations. The number of hospitals per year ranges from 167 in

1994 to 122 in 1998. Although there are about 262 nonprofit hospitals in California, not all

hospitals are represented in the IRS 990 database. Our sample is less likely to include very small

hospitals (under 25 beds), because the IRS 990 data only contains a random sample for hospitals

with less than $10 million in assets.

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3.1.2. Larger Sample of Educational, Medical, and Charitable Nonprofits

The second sample is based on the pooled cross-section of all educational, medical, and

charitable nonprofits contained in the IRS SOI sample files for the years 1982 to 1998, for a total

of 163,093 organization-year observations. We reduce our sample by 39,383 observations which

report zero donations. We further reduce our sample by 2,590 observations by trimming off the

top and bottom one percent of the most extreme values of all analysis variables, although results

are robust to no trimming and further trimming up to 10% of extreme observations. After these

data screens, our sample contains 25,501, 37,602, and 48,017 educational, medical, and

charitable nonprofit-year observations, respectively.

3.2. Sample Characteristics

3.2.1. California Nonprofit Hospitals

Table 1, Panel A provides descriptive statistics for the hospital sample. The average number

of staffed beds is 209; the percentage of Medicare patients is 45.41 percent; the percentage of

Medi-Cal (i.e., the California state Medicaid program) patients to total patients is 20.82 percent

and the occupancy rate is 59.54 percent. These data suggest that the hospitals represented in the

sample are representative of the overall population of nonprofit hospitals in California (average

staffed beds = 192, percentage of Medicare patients = 41, percentage of Medi-Cal patients = 21,

and percentage occupancy rate=59). Hospitals in the sample provide charity care of about 2.4

percent of revenue. The average net income margin as a percentage of revenue is 3.51 percent.

A large percentage of revenue is from program services (93.9 percent). Donations constitute

only 2.8 percent of revenue. However, because average net income margins are only 3.51

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percent, donations are likely to make a difference between the hospital’s breaking even versus

incurring a loss.

3.2.2. Educational, Medical, and Charitable Nonprofits

Table 1 panel B reports descriptive statistics for our sample of 25,501, 37,602, and 48,017

educational, medical, and charitable observations, respectively. Educational nonprofits receive

the largest average dollar amount of donations, followed by charitable nonprofits. Medical

nonprofits’ average program service revenues (i.e., the sales of products and services) is over 43

times as large as average donations, suggesting that medical nonprofits rely primarily on

program revenues. Charitable nonprofits earn roughly equal amounts of donations (mean of $3

million) and program revenues (mean of $4 million).

4. Empirical Analysis and Results

4.1. California Nonprofit Hospitals Expense Allocations

In this section, we compare the amount of program service expenses as reported on a

nonprofit’s IRS 990 to those reported on its OSHPD report for a matched set of 719 California

hospitals. Note that this analysis can determine whether excess expenses were allocated to

program services, but it cannot determine whether those expenses were allocated from

fundraising or administrative expenses because the OSHPD database aggregates both fundraising

and administrative expenses into a single expense category.

The program services ratio as reported on the IRS 990 is program service expenses divided

by total expenses. We compute the program service ratio using the OSHPD data by aggregating

expenses across the following expense centers: patient care expenses; research expenses;

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education expenses; insurance, malpractice, and other operating overhead; and miscellaneous

costs not classified as administrative or general expenses.

Using the means from the sample, we find that the average California hospital reports $13.9

million more program service expenses on their IRS 990 than on their OSHPD report (and

correspondingly $13.9 million less fundraising and administrative expenses on their IRS 990

than on their OSHPD report). The top portion of table 2 contains a two-sample matched pair t-

test of the difference between reported program service ratios and program service expenses as

per the IRS 990 and the OSHPD data for our sample of California Hospitals. The mean

differences are highly significant across all the years (t=28.3, p<0.001), and also for each

individual year (untabulated), with no discernable pattern observable across the years. These

results suggest that nonprofit hospitals overstate their program service ratios on their IRS 990s

by overstating their program service expenses. These expense allocations increased the average

program service ratio from 67.9 percent to 82.8 percent, making the average organization appear

to donors to be more effective at delivering its charitable output.

4.2. Educational, Medical, and Charitable Nonprofits Expense Allocations

For the larger sample of nonprofit organizations, there is no publicly available data source

(similar to the California OSHPD reports) that we can use as a benchmark of the amount of

expenses nonprofits should report as program services, fundraising, or administrative.

Therefore, we employ an alternative procedure in which we first estimate, using regression

analysis, the fundraising expenses we would expect a nonprofit to report on its IRS 990, and then

compare that estimate to the fundraising expenses actually reported on the IRS 990, with the

difference representing our estimate of allocations out of fundraising. For this analysis, we focus

15
on fundraising expenses only (and not on program services or administration) because prior

research provides us with a means of estimating a particular nonprofit’s fundraising expenses.

The model we use to estimate nonprofits’ expected fundraising expenses follows those used by

Weisbrod and Dominguez 1986, Posnett and Sandler 1989, and Okten and Weisbrod 2000, as

well as by many others. The intent of these models is to estimate the determinants of private

donations to nonprofits, and they generally take the form:

Private donationsit = α + β1 Fundraising expensesit-1 + β2 Priceit-1 + β3 Ageit-1

+ β4 Program revenuesit-1 + ε i. (1)

Unlike either program service expense or administrative expense, fundraising expense has a

direct revenue counterpart (i.e., donations revenues). Because of this relationship, it is possible

to use regression analysis to derive estimates of fundraising expenses. Note that a similar

procedure could not be used to estimate program service expenses or administrative expenses

because they have no direct revenue counterparts. The dependent variable, Private donations, is

the dollar amount of donations from individuals and corporations and excludes government

grants and feeder donations, such as those from the United Way. Fundraising expenses are those

incurred, directly or indirectly, to generate or otherwise manage donations. Fundraising can

affect donations in two ways. First, fundraising will increase donations to the extent it increases

donor awareness and communicates information about the quality of the nonprofit’s output

(Nelson 1974). Second, excessive fundraising will reduce donations if donors are concerned

with the portion of their donation that is spent on additional fundraising. The variable Price is

defined as 1 / (1 - Fundraising expenses / Private donations) and captures donor sensitivity to

16
nonprofits’ fundraising efficiency. The variable Age is the number of years a nonprofit has

existed and is intended to measure a nonprofit’s stock of reputation capital. We include Program

revenues to control for possible crowding-in or crowding-out effects of this alternative revenue

source. All variables (except for Age) are scaled by assets, although our results are qualitatively

robust to alternative specifications that use total expense or total revenue scaled variables as well

as using logarithmically transformed variables. All independent variables are lagged, because a

donor does not have access to nonprofit financial information until the end of the year.

Consistent with prior research, we interpret the coefficient estimate β 1 as the average dollar

amount of donations generated by one dollar of fundraising expenses. We derive an

organization-specific estimate of the fundraising expenses a nonprofit should report on its IRS

990 by dividing a nonprofit’s private donations by our coefficient estimates (i.e., if the

coefficient estimate were four, suggesting that one dollar of fundraising generates four dollars of

donations, we would divide the nonprofit’s reported amount of donations by four to derive an

estimate of the fundraising expenses the nonprofit incurred). We then compare our organization-

level estimate of fundraising expenses based on model (1) with those reported on the nonprofit’s

IRS 990, with the difference representing our estimate of a nonprofit’s allocation of expenses out

of the fundraising category.

By using this estimation methodology we make several assumptions. First, we assume that

nonprofits’ private donations revenue generation process is constant within nonprofit type (i.e.,

educational, medical, or charitable). Second, we assume that all fundraising expenses are

incurred to generate private donations and not feeder or government grants (i.e., the dependent

variable is only private donations; whereas the independent variable Fundraising expenses is all

fundraising expenses). Although it is possible that nonprofits make fundraising expenditures to

17
raise grants, we make this assumption for two reasons. First, prior research has not recognized

any link between grants and fundraising expenses, leaving us with no prior model of the

relationship between fundraising and grants. Second, several institutional factors render the

association between fundraising expenses and grants difficult to determine at best and tenuous at

worst. 5 To the extent that fundraising expenses are incurred to generate either feeder donations

or government grants, our estimates of expense reallocations are conservatively biased.

Table 3 contains the results of estimating equation (1). We estimate the model controlling

for a first-order auto-regressive process as well as general heteroscedasticity. 6 We find that each

dollar of fundraising is associated with $1.94, $4.29, and $5.58 of private donations for

educational, medical, and charitable nonprofits, respectively. The magnitude of these results are

similar to those found in prior studies using similar models (Weisbrod and Dominguez 1986;

Posnett and Sandler 1989; and Okten and Weisbrod 2000).

Because a working supposition of our paper is that the reported amount of fundraising

expenses are systematically understated, equation (1) contains a regressor with systematic

measurement error. Econometrically, this measurement error is reflected in the error term, ε, and

if ε is correlated with the measured variable (i.e., Fundraising expenses), then ß1 is biased. The

direction of the bias depends on the directions of the covariance between the measurement error

and both Fundraising expenses and Private donations; if the direction is equal (unequal), then ß1

5
Our discussions with grant writers at various charities and hospitals around the country suggests that feeder
donation and government grant contracts usually span several years, with the majority of the “fundraising expenses”
being front-loaded, causing the relationship between grants and fundraising expenses to be difficult to estimate. In
addition, grants are usually less costly to acquire than private donations because the fundraising effort is directed at a
particular agency; whereas the generating efforts for private donations are comparatively broad.
6
A Durbin-Watson tests suggests that our model error terms exhibit first order serial correlation. A Lagrange
multiplier test shows that the errors exhibit non-constant variance. We use a generalized autoregressive procedure
(i.e., GARCH) with a long memory process (i.e. all past squared residuals are used to estimate the current error
variance). As compared with using ordinary least squares , the GARCH procedure produces higher expense
allocation estimates for educational nonprofits, and qualitatively similar allocation estimates for medical and
charitable nonprofits.

18
is biased upwards (downwards). Given that fundraising is performed to generate donations, it

seems reasonable that the covariance between Fundraising expenses and Private donations is

positive, biasing ß1 upwards and our results downwards. Additionally, it seems reasonable that

the larger the true fundraising expenses, the more opportunity there will be for unreported

fundraising expenses, making an additional case for a positive covariance between reported

fundraising and the measurement error which would again conservatively bias our results. In

sum, the expected covariance structures predict an upwards bias on ß1 , causing us to derive too

high an estimate of “true” fundraising expenses, which when compared with reported fundraising

expenses on the IRS 990, would result in an understatement of the allocated fundraising

expenses producing a mechanical conservative bias in our results.

Although this analysis suggests that the presence of systematic measurement error in reported

fundraising expenses of the type we suspect exists would cause a conservative bias in our results,

we supplement that analysis with simulation results. To conduct our simulation analysis, we

construct plausible models of the measurement error and directly estimate their effects on our

equation (1) regression estimates. Our error models take the form:

True fundraising expenses = φ Reported fundraising expenses + γ, (2)

True fundraising expenses = Reported fundraising expenses λ + η, (3)

where φ and λ are greater than 1, and γ and η are random errors with mean zero. We conducted

analysis holding φ and λ cross-sectionally constant as well as permitting them to randomly vary

across organizations. These models assume that the systematic error component is increasing

[linearly in equation (2) and non-linearly in equation (3)] in the amount of true fundraising

19
expenses. 7 We consider these relationships to be plausible representations of the actual

systematic error, although it is not possible to determine ex-ante the exact nature of the error.

Our simulation results (untabulated), which varied the parameters φ and λ across a wide range of

positive numbers, find that the errors represented by equations (2) and (3) produce coefficient

estimates of ß1 that are systematically biased upwards, in turn biasing our estimated expense

allocations downward. These simulation results support our analytical error analysis above and

suggest that, if one assumes that our error models are descriptive, our results contain a

conservative bias of unknown magnitude. This inherent conservative bias, in conjunction with

the previously discussed conservative bias caused by assuming that no fundraising expenses are

incurred to generate grants, suggests that our estimations of fundraising expense allocations are a

lower bound and should be interpreted accordingly.

The bottom portion of table 2 reports our aggregate estimates of nonprofits’ fundraising

expenses and compares

those estimates with the fundraising expenses reported on the IRS 990. The average educational

nonprofit in the full sample reports a mean of $493 thousand of fundraising expenses. Using our

estimation methodology, our expectation of the mean fundraising expenses for educational

nonprofits is $2,320 thousand, suggesting that educational nonprofits allocate a mean of $1,827

thousand in expenses out of the fundraising expense category. We estimate that the average

medical nonprofit allocates a mean of $168 thousand of expenses out of the fundraising category;

7
It is well known that random measurement error (i.e., γ and η) biases coefficient estimates towards zero. In an
attempt to control for the random portion of the measurement error in fundraising expenses, we replicated both our
simulation and primary results using two-stage least-squares where the value of fundraising that enters the
estimation model is the fitted value from a regression of fundraising expenses on the exogenous variables in
equation (1) as well as lagged values of fundraising expenses (up to three lags were included). The general
inferences of the results were not altered by the two-stage procedure.

20
while the average charitable nonprofit allocates a mean of $299 thousand of expenses out of the

fundraising category. Median values show similar patterns, although with smaller magnitudes.

We estimate that educational nonprofits reduced their average fundraising ratios using

accounting expense allocations from 21.0 percent down to a reported figure of 2.8 percent.

Medical nonprofits used accounting expense allocations to reduce their average fundraising

ratios from 5.2 percent down to 1.5 percent; while charitable nonprofits reduced their average

fundraising ratios from an estimated 13.3 percent down to a reported 3.3 percent.

To the extent that our estimation methodologies are reasonable, our results are consistent

with a behavior that has long been suspected by the popular press. If donors rely on the reported

ratios to make their donations decisions, and are unable to disentangle managerial expense

allocations, then financial disclosure management by nonprofit organizations likely results in

economic misallocation of resources.

4.3. Analysis of Nonprofits that Report Zero Fundraising Expenses

This analysis examines the portion of our samples that, despite earning some amount of

private donations, report zero fundraising expenses. We focus on private donations because, as

compared to feeder or government grants, they are the kind most likely to be associated with

continuous fundraising efforts. Table 4 shows that 95 of 122 California hospitals in the 1998

sample report earning private donations but record zero fundraising expenses. For the larger

sample, we find that 25 percent, 46 percent, and 33 percent of educational, medical, and

charitable nonprofits, respectively, that earn private donations report zero fundraising expenses.

The average dollar amount of private donations received by a nonprofit that reports zero

fundraising expenses is over $1.8 million.

21
 Although it is possible that a nonprofit could earn private donations without incurring any

fundraising effort, it seems unreasonable that such a large proportion of nonprofits could earn

such significant amounts of private donations with zero effort. In an attempt to determine if any

of these nonprofits actually do incur some amount of fundraising expenses, we conducted a

search of the nonprofits’ Internet web pages for evidence of fundraising activities. We examined

web pages for all of the 95 California hospitals from the year 1998 (most recent year) that

reported earning private donations but reported zero fundraising expenses. Rather than

examining all 5,000 web pages of the larger set of educational, medical, and charitable

nonprofits for the year 1998, we randomly selected a sample of 10 percent of the observations in

the sample year 1998 (most recent year) for each of the three nonprofit types.

To perform our investigation we first accessed the nonprofit’s most recent IRS 990 at

www.guidestar.org to make sure that it continues to earn private donations in its most recent year

(i.e., a positive amount on page 1 line 1a of the IRS 990 for the year 2001) and still reports zero

fundraising expenses (i.e., zero on line 15 of page 1 on the IRS 990 for the year 2001). For those

nonprofits that report earning private donations and yet report zero fundraising expenses in their

most recent year’s IRS 990, we searched the Internet (using the Yahoo search engine) for their

web pages and examined their web pages for evidence of fundraising activities. We consider

evidence of fundraising activities to be either direct solicitations for donations or providing

instructions on how a potential donor could contribute.

Table 4 reports the results of our web page search. For the 95 California hospitals in 1998

that reported earning private donations yet reported zero fundraising expenses we found evidence

of fundraising for 19 hospitals (20 percent of web sites searched). For the larger sample of

nonprofits we found evidence of fundraising activities for 26 of 38 educational nonprofits, 13 of

22
91 medical nonprofits, and 72 of 125 charitable nonprofits. If our samples are representative,

these results suggest that over one-third of nonprofits that report zero fundraising expenses on

their IRS 990s actually do incur some amount of fundraising. A list of the nonprofits that we

found evidence of fundraising for is included in Appendix A. For many of the nonprofits we

found evidence of substantial fundraising activities beyond simply soliciting donations. Some

web sites had links to separate offices for fundraising development while many others contained

the names of individuals whose job titles included “Director of Foundation and Government

Grants” and “Director of Individual Giving”. It is possible that organizations engage in other

types of fundraising efforts that are not revealed by an internet web page search (such as

mailings or radio announcements). If true, our analysis provides a conservative estimate of

fundraising expense under reporting. These results provide additional evidence that nonprofits

under-report the true extent of their fundraising activities on their publicly available financial

reports.

4.4. Characteristics Associated with Expense Allocations

The purpose of this analysis is to use the estimated expense allocations from our prior

analyses as dependent variables to test the hypotheses that accounting expense allocations are

decreasing in political costs and increasing in a nonprofit’s reliance on donations as a revenue

source. Prior research suggests that larger for-profit firms make more conservative accounting

choices so as to avoid drawing unwanted attention to themselves (Watts and Zimmerman 1978),

and we test this hypothesis in the nonprofit setting. The incentive to report more favorable

fundraising and program service ratios is likely to be higher for those nonprofits that rely more

heavily on donations as a funding source. We first conduct this analysis using the expense

23
allocation estimates for the sample of 719 California hospitals, and then using the allocation

estimates we derived for the larger set of educational, medical, and charitable nonprofits.

Although both analyses test the same research hypotheses, they include somewhat different

control variables because the OSHPD dataset permits us to include an institutionally richer set of

controls. Results are not qualitatively sensitive to the choice of control variables.

We empirically test our predictions using the combined OSHPD and IRS 990 data on a

sample of 719 California hospitals by estimating the following regression:

Program allocations it = α + β 1 Sizeit + β2 Marginit + β 3 Donations it + β4 LOSit + β5 Medicareit

+ β6 Medi-Calit + β 7Occupancyit + β 8Charityit + ε it, (4)

where Program allocations is a nonprofit’s reported program service ratio (i.e., program service

expenses / total expenses) calculated using IRS 990 data less its program service ratio calculated

using the OSHPD data; Size is total assets in $millions; Margin is net income divided by net

revenue; Donations is donations revenue divided by total revenue; LOS is the average length of

stay from admission to discharge; Medicare is the proportion of Medicare patients to total

patients; Medi-Cal is the proportion of Medi-Cal patients to total patients; Occupancy is the

actual patient days divided by available patient days and Charity is charity care expense divided

by net revenue. Our primary variables of interest are Size and Donations, and we predict that the

sign of the coefficient estimate will be negative for Size and positive for Donations. Medicare,

Medi-Cal, LOS, and Occupancy are control variables. Prior health care studies suggest that

these variables have an influence on hospital outcomes (e.g., for Size: Alexander and Lee, 1996;

French, 1996; Mick and Wise, 1996; Robinson and Phibbs, 1989; for Medicare and Medi-Cal:

24
Dranove, 1988, Lynk, 1995; for LOS: Dranove, Shanley, and White, 1993; Lynk, 1995). The

model includes, but does not tabulate, yearly fixed-effects. 8

To empirically test our predictions for the larger sample of nonprofits, we estimate the

following regression:

Fundraising allocations it = α + β1 Sizeit + β 2 Marginit + β3 Donationsit + ε it. (5)

Fundraising allocations is our estimate of a nonprofit’s fundraising expense allocations

scaled by total revenues (to be consistent with equation (4) above). Size is total assets in $

millions; Margin is net income divided by revenue and Donations is private donations revenue

divided by total revenue. Once again our primary variables of interest are Size and Donations,

and we predict that the sign of the coefficient estimate will be negative on Size and positive on

Donations. Margin is included as a control variable. Because the IRS 990 data do not include as

much institutional detail as the OSHPD reports, we are not able to include as many control

variables for our sample of medical nonprofits in equation (5) as for equation (4). We estimate

equation (5) separately by nonprofit type and include (untabulated) yearly fixed-effects.

Table 5 contains the results from estimating equation (4); while table 6 contains the results of

estimating equation (5). Results in table 5 support our prediction that hospitals with a greater

reliance on donations as a revenue source have larger expense allocations into program services,

but they do not support our hypothesis that expense allocations are sensitive to political costs as

measured by total assets. Although not a part of our hypothesis, the results for the charity care

8
Because we use time series data, we cannot eliminate the possibility of auto-correlation. To control for this, we
use a linear auto-regression model whose error term is assumed to be an autoregressive process. Our models also
control for conditional heteroscedasticity (ARCH) and generalized heteroscedasticity (GARCH).

25
variable are of interest. Hospitals that perform a greater proportion of charity care have larger

differences in reported program expenses. Charity care is a measure of community service used

by regulators to examine whether a nonprofit is deserving of its tax exemption (Bryce 2001,

Potter and Longest 1994) 9 . Nonprofit hospitals can also manage their expenses in various ways,

such as pricing the charity services at gross prices and including other community services under

this category. These results show that hospitals having greater reported charity expenses also

have greater reported program service expenses as per the SOI. With respect to the remaining

control variables, the results demonstrate that hospitals with higher occupancy rates had greater

differences in reported program service expense. Hospitals with a greater proportion of

Medicare and Medi-Cal patients over-report program service expenses to a lesser extent.

Table 6 contains the results of estimating equation (5) and, consistent with the above

analysis, shows that fundraising expense allocations are increasing in the relative importance of

donations as a revenue source across all nonprofit types. The results in table 6 also support our

hypothesis that expense allocations are decreasing in political costs as measured by assets.

In comparing the results of our analyses across samples, we find the magnitudes and signs of

the donations coefficient using the larger sample of medical nonprofits (0.24) is qualitatively

similar to that obtained from the model using only California hospitals (0.21).

9
The criteria set by the IRS for tax-exempt status by a hospital under Section 501(c)(3) as stipulated in its 1969
Ruling 69-545 and subsequent 1983 revision (83-157) require that: (1) the hospital should provide care to all insured
patients, including those sponsored by government programs such as Medicare and Medicaid, (2) the hospital should
provide fulltime availability of emergency room services to anyone needing them, including the indigent, (3) the
hospital should select its board of trustees from the community, (4) the hospital should provide medical staff
privileges to all eligible physicians, and (5) the operating surplus of the hospital should be applied to capital
replacement, expansion, debt amortization, improvements in patient care, medical training, education, and research
(United States Internal Revenue Service Ruling 69-454 (1969) and Ruling 83-157 (1983). Also see Bryce (2001)
for a discussion.

26
5. Robustness Tests

We conducted a series of analyses intended to test the robustness of our results to various

assumptions as well as to provide cross-checks of our results across the various modeling

procedures. In our first robustness test, we replicate equations (4) and (5) using alternative

deflators including assets, total revenues, and total expenses for each independent and dependent

variable in various combinations. Results were not qualitatively altered, and inferences were

unchanged by using these alternative deflators.

In our second robustness test, we replicated the fundraising expense allocation procedure

contained in part 4.2, which was originally conducted on the larger sample of nonprofits, on the

smaller sample of 719 California hospitals. Results of this analysis find that the smaller

California hospital sample allocated an average of $331 thousand out of fundraising expenses.

This compares with the results for the larger sample of medical nonprofits (primarily hospitals),

which table 2 reports allocated an average of $168 thousand out of fundraising expenses. We

then estimated equation (5) on this sample of 719 California hospitals and find that, similar to the

results in table 5, the ratio of fundraising expense allocations to total expenses is increasing in a

nonprofit’s reliance on donations as a revenue source but is not related to size.

In our third robustness test, we replicate equations (4) and (5) using only those variables that

were common to both samples (i.e., the IRS 990 and the OSHPD databases). These variables

included total assets, total donations, and net income margin. Again, the general inferences of

our results were not altered.

As our fourth robustness analysis, we correlated the expense allocation measures derived

using the California hospitals and those derived using the larger sample of medical nonprofits for

the 719 hospitals that are common to both datasets. Recall that the allocation estimates

27
generated using the California hospital database (i.e., OSHPD) are estimates of expenses

allocated into program services; whereas the expense allocation estimates generated from the

larger sample analysis were estimates of expenses allocated out of fundraising. Although the

two measures are based on different expense categories, they should nonetheless capture the

same economic construct of financial ratio management using accounting expense allocations

and, to the extent that expenses allocated out of fundraising were allocated into program services,

the two measures should be statistically correlated. We find that the Pearson (Spearman)

correlation between our two measures of expense allocations is 22 (15) percent and is significant

at the 0.0001 (0.0016) level. This result provides some comfort that our estimation procedures

capture common elements of nonprofit financial reporting behavior.

In our next robustness test, we use the sample of 719 California hospitals to replicate the

results of equations (4) and (5), but we switch the dependent variables. Equation (4) originally

used the dependent variable constructed by comparing the OSHPD database with the IRS 990

database. We replicate equation (4) using as the dependent variable our fundraising expense

allocations generated by the regression equation (1). In a similar manner, we re-estimate

equation (5), which originally used the fundraising expense allocations generated by the

regression equation (1) as a dependent variable, with the amount of expense allocations

constructed by comparing the OSHPD database with the IRS 990 database. This procedure

provides an integrity test of our two alternative measures of expense allocations. If the two

measures are each independently capturing financial statement management, then they should

produce similar results when swapped out for each other in subsequent empirical analysis.

Results (untabulated) produce similar statistical inferences (although somewhat different

coefficient magnitudes) as does the primary analysis in the paper.

28
 As our final robustness test, we reclassify the hospital expenses on the OSHPD report based

on what is required, under all circumstances, to be only administrative expenses rather than

taking the reported amounts at face value. The purpose of this test is to address concerns that

some of the expenses reported on the OSHPD dataset as administrative were due to the

differences in reporting format between the OSHPD and the IRS 990s, and should have more

appropriately been reported as program services. To conduct the reclassification of possible

differences due to the differences in reporting format between the OSHPD and the IRS 990

databases, we reclassified all those expense items that could be possibly included as program

services. While performing this reclassification, we used a donor perspective, i.e., we examined

each expense item line-by-line and determined whether donors would prefer their money to be

used in that expense rather than in direct program service expenses. We reclassified the

following items out of administrative and general expenses and into program services from the

OSHPD data: dietary, laundry and linen, social work services, central patient transportation,

central services and supplies, pharmacy, auxiliary groups (hospital volunteer groups), chaplaincy

services, medical records, nursing float administration, utilization management, and community

health education. 10 Even after this strict reclassification, the reported administrative and general

expenses as per the OSHPD data was greater (21.7%) than the reported administrative expenses

as per the IRS 990s (17.2%). We then re-estimated all subsequent empirical analysis using these

re-classified expense allocation estimates with inferences generally unchanged, although the

magnitudes of the estimated expense allocations were smaller.

10
After the reclassification, the following expense items remained as a part of administrative and general expenses
as per the OSHPD data: education administration office, student housing, printing and duplicating (non-patient),
kitchen (non-patient), non-patient food services, purchasing and stores (excluding medical purchases), grounds,
security, parking, housekeeping, plant operations (non-medical), plant maintenance, communications, data
processing, accounting, credit and collection, admitting, registration, hospital administration, governing board
expense, public relations, management engineering, personnel (non-medical), employee health, library, staff
administration, insurance (excluding medical and malpractice), and employee benefits (non-payroll related).

29
6. Conclusions

This paper examines how nonprofit organizations respond to incentives to manage their

publicly available financial information as disclosed on their IRS 990s. The IRS 990 is

considered to be the primary source of nonprofit financial information, and prior literature

suggests that donors evaluate whether a nonprofit is “worthy” of their donations by examining

two operating ratios based on IRS 990 data. We examine the extent to which nonprofits allocate

expenses between various accounting expense categories so as to improve these ratios, thereby

appearing more efficient and effective to potential donors. Because nonprofits do not have a

stock price, they provide a natural setting (free of price related incentives) in which to examine

the effects of contractual incentives on financial reporting choices.

Our empirical analyses uses two different data sets: a matched set of IRS 990s and hospital

regulatory financial data (OSHPD reports) for 719 observations from nonprofit hospitals located

in California, and a larger set of over 100,000 IRS 990 for educational, medical, and charitable

nonprofits. Our analyses suggest that nonprofit organizations over-report expenses in the

program services category and under report their fundraising expenses, which have the effect of

improving the ratios used by donors when making their resource allocation decisions. The

results are robust to the data source (i.e., the IRS 990 and OSHPD financial statements) and a

variety of specification tests. Additional results suggest that nonprofits that are more reliant on

donations as a revenue source and face lower political costs manipulate their operating ratios to a

greater extent.

Some of the limitations of our study should be noted when drawing inferences from our

results. First, our empirical analysis on California nonprofit hospitals, which combines the IRS

990 and the OSHPD financial database, assumes that donors are more likely to use the IRS 990.

30
Although this assumption is plausible given the intended purposes of the databases, it is possible

that nonprofit hospitals manage their operating ratios on both the IRS 990s and the OSHPD

reports. If true, our results based on the sample of California hospitals are conservatively biased.

Additionally, in our empirical analysis of educational, medical, and charitable nonprofits we rely

on a model to estimate fundraising expenses. The accuracy of the estimates is a function of the

model, its related assumptions, and independent variable measurement issues. Although

plausible, our estimates undoubtedly capture the true underlying expense allocations with error

and likely contain several conservative biases.

This study makes several important contributions to accounting research. First it

demonstrates that expense allocation choices affect the quality and usefulness of financial

disclosures in a nonprofit setting. To the extent that donors base their contribution decisions on

the ratios reported in the nonprofits’ financial statements, opportunistic management of these

ratios can reduce social welfare because of misallocated resources. Second, prior accounting

research that empirically examines the financial performance of nonprofit organizations has not

considered the extent to which the incentives to manage reported operating efficiency affect the

quality of accounting disclosures in nonprofits’ financial statements.

Future research could examine the extent to which the ability to manage expense ratios

affects the nonprofit’s growth and survival. It would also be interesting to examine disclosure

management in nonprofits that have converted from non-profit to for-profit status and vice-versa.

Of late, such conversions have been frequently appearing in the hospital industry. For example,

between 1991 and 1997, 185 hospitals comprising approximately 6.5% of total hospitals in the

country converted status. Of these, 127 hospitals converted from non-profit to for-profit and 58

hospitals converted from for-profit to nonprofit status (Thorpe, Florence, and Seiber 2000).

31
Because such conversions affect revenue sources as well as the objective function of hospitals,

they are likely to have an impact on disclosure management. Another area for future research is

to explore disclosure management by various types of nonprofits within the same industry such

as religious nonprofits vis a vis private nonprofits. Because managerial ideology is an important

factor affecting nonprofit behavior (Rose-Ackerman 1987), there are likely to be differences in

disclosure management across the types of nonprofits.

32
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35
 TABLE 1
Descriptive Statistics
(dollar amounts in $thousands)
_____________________________________________________________________________________________

Panel A: California Nonprofit Hospitals

Description Mean Median Std. Dev.

Financial variables:
Private donations 1,251 114 4,075
Program revenues 87,116 69,582 77,784
Assets 208,209 91,954 643,638
Net income margin 0.04 0.04 0.10
Liabilities 101,498 46,646 294,312

Other variables:
Beds 209 190 136
Medicare 45.41% 46.63% 14.78%
Medi-Cal 20.82% 15.76% 16.56%
Occupancy 59.54% 58.05% 18.74%
Charity 2.39% 1.49% 3.28%
LOS 6.24 4.47 7.95

Panel B: Larger Sample of Educational, Medical, and Charitable Nonprofits

Description Mean Median Std. Dev.

Educational organizations (n =25,501)
Private donations 4,501 1,746 10,045
Program revenues 17,612 6,008 49,873
Fundraising expenses 493 183 927
Price 1.23 1.11 0.40
Age 36.52 38.94 17.40
Assets 71,711 24,722 149,498
Net income margin 0.18 0.13 0.20

Medical organizations (n= 37,602)

Private donations 1,106 170 5,319
Program revenues 47,588 20,715 75,193
Fundraising expenses 90 0 798
Price 1.08 1.00 0.26
Age 32.10 34.92 18.95
Assets 62,056 30,011 86,711
Net income margin 0.11 0.05 0.21

36
 TABLE 1
Descriptive Statistics
Panel B (Continued): Larger Sample of Educational, Medical, and Charitable Nonprofits

_____________________________________________________________________________________________

Charitable organizations (n = 48,017)

Private donations 3,114 427 9,757
Program revenues 4,198 243 13,724
Fundraising expenses 259 0 976
Price 1.12 1.00 0.28
Age 30.89 26.98 21.37
Assets 21,544 11,284 35,032
Net income margin 0.16 0.08 0.29

________________________________

Notes: Private donations are those not received from governmental or other granting agencies. The primary source
of private donations is from individuals and corporations. Program revenues are from the sales of products and
services. Fundraising expenses are any expense incurred to generate or maintain donations. Net income margin is
net income scaled by total revenues. Beds is the number of staffed beds. Medicare (Medi-Cal) is the proportion of
medicare (Medi-Cal) patients to total patients. Occupancy is the actual patient days divided by available patient
days. Charity is charity care expenses divided by total revenues. LOS is the average length of stay in days from
admission to discharge. Price is 1 / (1 - Fundraising expenses / Private donations). Age is the age of the nonprofit in
years. All amounts are from the OSHPD report or the IRS 990.
_____________________________________________________________________________________________

37
 TABLE 2
Paired Two-Sample t-test of Expense Allocations
(Dollar amounts in $thousands)
____________________________________________________________________________________________________________________________________

Sample of California Hospitals:

Program service expenses Program service ratio

Per IRS 990 Per OSHPD Difference Per IRS 990 Per OSHPD Difference

California hospitals (n = 719) 71,104 58,211 13,893* 82.8% 67.9% 14.9%*

Larger Sample of Educational, Medical, and Charitable Nonprofits:

Fundraising expenses Fundraising ratio

Per IRS 990 As estimated Difference Per IRS 990 As estimated Difference

Educational (n = 25,501 ) 493 2,320 1,827* 2.8% 21.0% 18.0%*

Medical (n = 37,602 ) 90 258 168* 1.5% 5.2% 3.7%*

Charitable (n = 48,017 ) 259 558 299* 3.3% 13.3% 10.0%*

______________________

Notes: The IRS 990 is a nonprofits’ publicly available annual information return. The OSHPD report is a state-level regulatory report for California hospitals only.
Program service expenses are those devoted to accomplishing the nonprofit’s primary charitable purpose. The amounts of estimated fundraising expenses are from
Table 3. The Program service ratio is the amount of program service expenses scaled by total expenses (i.e., the sum of program service, administrative, and
fundraising expenses). The Fundraising ratio is the amount of fundraising expenses scaled by total expenses (i.e., the sum of program service, administrative, and
fundraising expenses).
* Significant at the one-percent level
____________________________________________________________________________________________________________________________________

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 TABLE 3
Regression Analysis Used to Estimate Nonprofit Fundraising Expenses
_____________________________________________________________________________________________

Private donationsit = α + β1 Fundraising expensesit-1 + β2 Priceit-1 + β3 Ageit-1 + β4 Program revenues it-1 + εi..
_____________________________________________________________________________________________

α β1 β2 β3 β4 Adj. n
R2

Educational nonprofits 0.12 1.94 -0.01 -0.00 -0.05

0.41 22,708
(88.5) (73.1) (-13.3) (-32.3) (-44.8)

Medical nonprofits 0.07 4.29 -0.01 -0.00 -0.01

0.49 31,891
(118.9) (433.5) (-24.3) (-190.4) (-60.6)

Charitable nonprofits 0.33 5.58 -0.09 -0.00 -0.02

0.43 38,776
(119.6) (378.3) (-41.7) (-85.9) (-20.7)

_______________________

Notes: Private donations are those not received from governmental or other granting agencies. The primary source
of private donations is from individuals and corporations. Program revenues are from the sales of products and
services. Fundraising expenses are any expense incurred to generate or maintain donations. Price is 1 / (1 -
Fundraising expenses / Private donations). Age is the age of the nonprofit in years. All data are from the IRS 990.
All models use asset-scaled variables and control for first-order autocorrelation and general heteroscedasticity ( i.e.,
AR(1) GARCH (1,1) model). Influential observations that had a Cook’s D statistic greater than 1 were deleted. t
statistics are in parentheses.

* All coefficients are significant at the five percent level.

_____________________________________________________________________________________________

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 TABLE 4
Analysis of Nonprofits that Report Zero Fundraising Expenses
and Report Earning Private donations

____________________________________________________________________________________________________________________________________

Number Percent Average Web sites Percent of

Full reporting zero reporting zero private Web sites Web sites with web sites with
sample fundraising and fundraising donations Searched found evidence of evidence of
donations and donations ($) fundraising fundraising
California
122 95 57% 1,251,000 95 95 19 20%
Hospitals

Educational
2,706 663 25% 3,650,000 66 38 26 68%
Nonprofits

Medical
4,555 2,090 46% 1,385,000 209 91 13 14%
Nonprofits

Charitable
6,693 2,242 33% 1,751,000 224 125 72 58%
Nonprofits

____________________

Notes: The full samples examined included all unique nonprofits from the most recently available year of data (i.e., 1998). The number of web sites searched was
the full sample of California hospitals and a randomly chosen sample of 10 percent of the other nonprofit organizations. We considered evidence of fundraising
activities to be requests for donations from individuals or providing instructions to individual donors on how to give. A list of web sites searched is attached in
Appendix A.

____________________________________________________________________________________________________________________________________

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 TABLE 5
Regression Analysis of Characteristics Associated With Program Service Expense Allocations
California Nonprofit Hospitals
_____________________________________________________________________________________________

Program allocationsit = α + β1 Size it + β2 Margin it + β3 Donationsit + β4 LOSit + β5 Medicare it

+ β6 Medi-Calit + β7 Occupancyit + β8 Charityit + εit
_____________________________________________________________________________________________

Variable Coefficient t-statistic

Size 0.00001 0.20

Margin -0.029 -0.50

Donations 0.212 2.61***

LOS -0.00005 -0.06

Medicare -0.116 -2.64***

Medi-Cal -0.071 -1.76*

Occupancy 0.096 3.20***

Charity 0.365 2.01**

Intercept 0.167 4.97***

Adjusted R2 0.07

N 601

________________________________________

Notes: Program allocations are the estimated amount of expenses that a nonprofit has allocated to the program
services category. Size is total assets in $ millions. Margin is net income scaled by total revenues. Donations are
private donations that are those not received from governmental or other granting agencies, scaled by total revenues.
The primary source of private donations is from individuals and corporations. LOS is the average length of stay
from admission to discharge. Medicare (Medi-Cal) is the proportion of medicare (Medi-Cal) patients to total
patients. Occupancy is the actual patient days divided by available patient days. Charity is charity care expenses
divided by net revenues. All amounts are from the OSHPD report or the IRS 990. The model controls for first-order
autocorrelation and general heteroscedasticity ( i.e., AR(1) GARCH (1,1) model).

*, **, *** Significant at the ten percent, five percent, and one-percent level, respectively (two-tail).
_____________________________________________________________________________________________

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 TABLE 6
Regression Analysis of Characteristics Associated With Fundraising Expense Allocations
Educational, Medical, and Charitable Nonprofits

_____________________________________________________________________________________________

Fundraising allocationsit = α + β1 Size it + β2 Margin it + β3 Donationsit + β4 Liabilities it + εit.

_____________________________________________________________________________________________

Educational Nonprofits Medical Nonprofits Charitable Nonprofits

Variable Coefficient t-statistic Coefficient t-statistic Coefficient t-statistic

Size -.00002 -8.05*** -0.00001 -3.76*** -0.0002 -14.18***

Margin 0.341 130.22*** 0.138 101.09*** 0.225 131.95***

Donations 0.664 290.68*** 0.239 157.14*** 0.192 128.33***

Intercept -0.064 -92.63*** -0.009 -26.86*** -0.025 -35.69***

Adjusted R2 0.87 0.62 0.48

N 24,912 36,968 46,952

________________________________________

Notes: Fundraising allocations are the estimated amount of expenses that a nonprofit has allocated out of the
fundraising category. Size is total assets in $ millions. The primary source of private donations is from individuals
and corporations. Margin is net income scaled by total revenues. Donations are private donations that are not
received from governmental or other granting agencies, scaled by total revenues. All amounts are from the IRS 990.
All models control for first-order autocorrelation and general heteroscedasticity ( i.e., AR(1) GARCH (1,1) model).

*, **, *** Significant at the ten percent, five percent, and one-percent level, respectively (two-tail).
_____________________________________________________________________________________________

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 Appendix A
Nonprofit Organization Web Pages Searched for Evidence of Fundraising Expenses
_____________________________________________________________________________________________

California hospital web pages with evidence of fundraising expenses:

Nonprofit name
ANAHEIM HOSPITAL
BARTON MEMORIAL HOSPITAL
CHILDREN’S HOSPITAL OF ORANGE COUNTY
CITY OF HOPE NATIONAL MEDICAL CENTER
DAMERON HOSPITAL ASSOCIATION
EMANUEL MEDICAL CENTER
FOOTHILL PRESBYTERIAN HOSPITAL
GOLETA VALLEY COTTAGE HOSPITAL
LONG BEACH MEMORIAL MEDICAL CENTER
MARIN GENERAL HOSPITAL
NOVATO COMMUNITY HOSPITAL
PRESBYTERIAN INTERCOMMUNITY HOSPITAL
SANTA BARBARA COTTAGE HOSPITAL
SEQUIOA HEALTH SERVICES
ST. JOSEPH HOSPITAL
ST. JUDE HOSPITAL
SUTTER MERCED MEDICAL CENTER
TORRANCE MEMORIAL MEDICAL CENTER
WHITE MEMORIAL MEDICAL CENTER

Sample of educational nonprofit web pages with evidence of fundraising expenses:

Nonprofit name
ASHLAND UNIVERSITY
WILMINGTON COLLEGE
CLEMSON ADVANCEMENT FDN FOR DESIGN & BUILDING
KRISHNAMURTI FOUNDATION OF AMERICA
HARCUM COLLEGE
ROWAN COLLEGE FOUNDATION
ELISABETH MORROW SCHOOL INC
DWIGHT-ENGLEWOOD SCHOOL
PRINCETON DAY SCHOOL
CHAPIN SCHOOL
GEORGIAN COURT COLLEGE
UNIVERSITY AT BUFFALO FDN INC
ELMIRA COLLEGE
D'YOUVILLE COLLEGE
ALBANY MEDICAL COLLEGE
JAPAN INTERNATIONAL CHRISTIAN UNIVERSITY FOUNDATION INC
MITCHELL COLLEGE
SALEM STATE COLLEGE FOUNDATION INC
BECKER COLLEGE
ASSUMPTION COLLEGE
CARDINAL STRITCH UNIVERSITY INC
AVE MARIA COLLEGE
MIAMI UNIV FDN INC
BISHOPS UNIVERSITY FDN
BROWARD COMMUNITY COLLEGE FDN INC
MOUNT SINAI SCHOOL OF MEDICINE OF CITY UNIV OF NEW YORK

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Sample of medical nonprofit web pages with evidence of fundraising expenses:

Nonprofit name
ST LUKES EPISCOPAL HOSPITAL
FRED HUTCHINSON CANCER RESEARCH CENTER
RHODE ISLAND HOSPITAL
ISLAMIC MEDICAL ASSN OF NORTH AMERICA INC
ST JOHNS RIVERSIDE HOSPITAL
GARDEN CITY HOSPITAL OSTEOPATHIC
VNA CARE NETWORK INC
MAINE COAST REGIONAL HEALTH FACILITIES
KIN ON HEALTH CARE CENTER
SKAGGS COMMUNITY HOSPITAL ASSN
BAPTIST HEALTHCARE SYSTEM INC
MOUNT SINAI HOSPITAL
ENH RESEARCH INSTITUTE

Sample of charitable nonprofit web pages with evidence of fundraising expenses:

Nonprofit name
NATIONAL BOY SCOUTS OF AMERICA FDN
NEW YORK STATE HISTORICAL ASSOCIATION
BOYS HOME OF NORTH CAROLINA INC
IQRA INTL EDUCATIONAL FDN
COMMUNITY FDN OF SARASOTA CO INC
ARIZONA COMMUNITY FDN INC
COASTAL BEND COMMUNITY FOUNDATION
CENTRAL NEW YORK COMMUNITY FOUNDATION INC
NATIONAL HUMANITIES CENTER
COMMUNITY FOUNDATION OF BROWARD
ST LOUIS COMMUNITY FDN
NEW YORK TIMES NEEDIEST CASES FUND
INDIANAPOLIS NEIGHBORHOOD HOUSING PARTNERSHIP
TIDEWATER JEWISH FDN INC
ELKS NATIONAL FDN
TROY FOUNDATION
HUMBOLDT AREA FOUNDATION
FREMONT AREA FOUNDATION
ARKANSAS ARTS CENTER FOUNDATION
OREGON JEWISH COMMUNITY FOUNDATION
MILWAUKEE SYMPHONY ORCHESTRA FOUNDATION TRUST
ALLEY THEATRE
AURORA FDN
MADISON COUNTY COMMUNITY FDN

44
Sample of charitable nonprofit web pages with evidence of fundraising
expenses (continued):

Nonprofit name
LONG BEACH AQUARIUM OF THE PACIFIC
GOOD SHEPHERD FUND
INDIANA SPORTS CORP
CHICAGO SYMPHONY & LYRIC OPERA FACILITIES FUND
LAMBS FARM
PARKS AND WILDLIFE FOUNDATION OF TEXAS INC
CAL FARLEYS BOYS RANCH FOUNDATION
NEBRASKA CHILDREN'S HOME SOCIETY
NATIONAL CHURCH RESIDENCES
NATIONAL COUNCIL OF TEACHERS OF MATHEMATICS
SOUTHWEST MINNESOTA FOUNDATION
GOODWIN HOUSE FDN INC
ALABAMA SHAKESPEARE FESTIVAL ENDOWMENT TRUST
NEW HOPE CHARITIES INC
WILDLANDS TRUST OF SE MASSACHUSETTS
SOCIETY FOR ASIAN ART
IOWA STATE FAIR FOUNDATION
NEW YORK STATE ASSN FOR RETARDED CHILDREN INC\SUFOLK
ATLANTIC 10 CONFERENCE
INDIANAPOLIS SYMPHONY ORCHESTRA FDN
NATIONAL COUNCIL OF STATE GARDEN CLUBS INC
BGTM INC
CINEMA CHICAGO
BUSINESS COMMITTEE FOR THE ARTS INC
US LACROSSE FOUNDATION INC
CATHEDRAL HOME FOR CHILDREN
AMERICAN SOCIETY OF CIVIL ENGINEERS
HUMANE ANIMAL WELFARE SOCIETY OF WAUKESHA
LA HABRA BOYS & GIRLS CLUB
ABILENE BOYS RANCH INC
HOPE FOR THE CHILDREN
NATURAL AREA PRESERVATION ASSOC
MENORAH PARK FOUNDATION
LEGAL AID BUREAU, INC
JAYCEES INTERNATIONAL (JCI) FOUNDATION, INC
ROGER HOUTSMA WORLD OUTREACH
UNITED CEREBRAL PALSY ASSN OF WESTCHESTER CNTY INC
ALBRIGHT CARE SERVICES
FLORIDA CHILDERN'S FORUM INC
UNITED STATES GOLF ASSOCIATION FDN
VENICE FOUNDATION, INC
RANCHO SANTA ANA BOTANIC GARDEN
MUSTARD SEEDS & MOUNTAINS INC
CANTERBURY PLACE
PLEASANT RUN CHILDRENS HOMES FDN INC
ROSS RAGLAND THEATRE
INTERNATIONAL BUREAU FOR EPILEPSY
GREYSTONE PROGRAMS INC

45