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An examination of the financial structure of not-for-profit hospitals engaging in joint ventures: is tax-exempt status in jeopardy?

The purpose of this study was to examine the inherent financial characteristics of not-for-profit hospitals that engaged in joint ventures with for-profit hospitals. Heightened scrutiny of these transactions by the Internal Revenue Service (IRS) warranted this investigation. According to the IRS, over 54 percent of the audits under the Coordinated Examination Program (CEP) were aimed at healthcare organizations (Wright, 2000). Inquiry has led the IRS to revoke the tax-exempt status of some not-for-profit hospitals engaged in joint ventures. Redlands Surgical Services, Inc. of California is one example where a not-for-profit hospital failed to meet tax-exempt status standards due to a joint venture with a for-profit partner (Wright, 1999). The IRS argued the entity lacked effective control of the joint venture to provide continued charity care and significant private benefit was conferred to the for-profit partner (Wright & Stokeld, 2001). Both the Tax Court and the Ninth Circuit Court upheld the IRS's decision to revoke exempt status (Wright & Stokeld, 2001). Despite this win, the IRS continues to battle over joint ventures, recently losing a high-profile case against St. David's Healthcare of Texas (St. David's Healthcare System v. United States, 2003; Stokeld, 2004). Despite the IRS's inconsistent success in the courts against not-for-profit hospitals, it continues to focus on joint ventures within the healthcare industry (Harris, 2003; Stokeld, 2003; Stokeld & Gary, 2004).

The US House Ways and Means Committee recently announced plans to investigate the preferential tax treatment granted certain hospitals (Tieman, 2004). Revoking tax-exempt status raises policy questions for both donors and other tax-exempt entities, particularly whether or not the joint venture not-for-profit hospital exhibits characteristics different from other not-for-profit hospitals that choose not to joint venture. If hospitals are viewed as moving away from their charitable mission and into joint ventures, contributions may suffer. Furthermore, the potential tax burden of losing exempt status may negatively affect hospital operations.

This study focused on the inherent financial structure of the not-for-profit hospital partners and was an attempt to begin a dialogue surrounding the financial performance of not-for-profit hospitals engaged in joint ventures (hereafter JV hospitals). Comparisons were made with not-for-profit hospitals not engaging in joint ventures (hereafter Non-JV hospitals). This study also compared the financial structure of JV hospitals that were scrutinized by the IRS (hereafter JV-Audit hospitals) and those JV hospitals that were not audited (hereafter Non-Audit hospitals).

To the author's knowledge, prior research has not examined the financial structure of JV hospitals or JV-Audit hospitals. Charitable donors, other hospitals, oversight agencies, and policymakers will continue to examine whether joint ventures contribute to a reduced focus on charitable services. This study's analysis of financial structure may assist management in discussions surrounding both the tax and non-tax aspects of entering joint ventures.

JOINT VENTURE INCENTIVES

Joint ventures, in general, are undertaken for numerous reasons, depending on the motivations of the individual partners. Reasons cited in the literature for organizations entering joint ventures include: (a) a new line of business and/or market, (b) competition, (c) technological transfer, (d) international diversification, (e) partial divestiture, and (f) market power/market share (Finnerty, Owers, & Rogers, 1986; Kogut, 1988). Foster and Meinhard (2002) point out that transaction cost theory emphasizes the need to achieve efficiency is a major underlying motivation for collaborating. Additional motivating factors include the ability to provide new or continued services, reduce financial risk, expand the quality of services provided and increase cost savings (Tsilas, 1997; Salins, Kindell, & Friedlander, 1998; Tuckman, 1998; Sansing, 2000). Specific organizational characteristics may also impact a firm's decision to collaborate, such as size, age, and the mandate of the organization (Foster & Meinhard, 2002).

Specifically for the healthcare industry, joint ventures are commonly formed to operate ancillary healthcare services, such as MRI facilities and ambulatory surgery centers (Salins et al., 1998). Furthermore, hospitals seek to collaborate in order to gain access to capital, achieve economies of scale, gain access to managed care contracts and reduce expenses from shared overhead (Byrd & McCue, 2003; Mahon, 2003). These transactions offer management the ability to collaborate to increase cost savings, without the pressures of radical changes such as complete mergers (Bazzoli, LoSasso, Amould, & Shalowitz, 2002). Marlin, Huonker, & Sun (2002) suggested that hospitals must differentiate its products and services, and joint ventures provided this opportunity. The American Institute of Certified Public Accountants (AICPA) asserts one reason for healthcare providers to partner with for-profits is to acquire significant tangible property and equipment (AICPA, 2002). According to Mahon (2003), the movement toward using joint ventures in collaboration efforts was due to the shift in Medicare reimbursements from a cost-based to a fixed, per case system, which altered the financial incentives of hospitals. The consolidation of the industry has led management to fight for resources, and develop alternative strategies for raising money (Byrd & McCue, 2003). Due to various economic and organizational constraints, joint ventures represent an example of strategic restructuring that have become a more popular option for hospital management.

Despite the numerous reasons why not-for-profit hospitals seek joint ventures, reasons for IRS scrutiny have not been consistent in the courts. At the 2000 AICPA National Health Care Industry Conference, managers from the Tax Exempt/Government Entities Division of the IRS discussed details of the IRS coordinated examination program (Wright, 2000). It was disclosed that during audits the IRS examines the kinds of activities the joint venture will engage in when the provision of healthcare is not undertaken. When charity care is provided, the IRS scrutinizes the joint venture's business plan and its definition of charity care. IRS agents also examine whether or not tax-exempt hospital assets are transferred to the joint venture based on fair market value (Wright, 2000). Another important aspect to the IRS is the promotion of community health. In the St. David's case, the IRS argued that promotion of healthcare was not 'per se' charitable, and that the hospital needed to provide sufficient indigent care. The tax courts appear to also value the issue of control, which centers on whether the activities of the joint venture further the interests of the for-profit partner (St. David's Healthcare System v. United States, 2003). If the not-for-profit partner retains control, then it is presumed that not-for-profit activities will be enhanced, thus furthering an exempt purpose (St. David's Healthcare System v. United States, 2003). IRS investigations are based on the facts and circumstances of the specific joint venture, thus management must be aware of these issues when choosing collaborative structures.

FINANCIAL CHARACTERISTICS OF NOT-FOR-PROFIT HOSPITALS

Existing literature has investigated the overall financial performance of not-for-profit hospitals (Cleverley & Rohleder, 1985; Zeller, Stanko, & Cleverley, 1996; Watkins, 2000; Krishnan, Yetman, & Yetman, 2002; Younis, Forgione, Khan, & Barkoulas, 2003). Zeller et al. (1996) used factor analysis in order to explore financial ratios that accurately summarized hospital financial performance. Their results revealed seven financial characteristics of hospital performance, including profitability, capital structure, liquidity, and debt coverage. Watkins (2000) further expanded the literature of hospital financial performance by investigating financial and non-financial variables, particularly patient days, admissions per bed and case mix index. Her results indicated non-accounting information also contributed to the measurement of hospital financial performance. Discussions of not-for-profit hospital financial performance center on comparisons to for-profit hospitals, because under certain circumstances the two organizational forms compete for the same resources (Lewin, Derzon, & Margulies 1981; Watt, Renn, Hahn, Derzon, & Schramm 1986; Hoerger, 1991; Sear, 1991; Cordes & Weisbrod, 1998; Gentry & Penrod, 2000; Younis et al., 2003).

The financial performance variables analyzed in this study included capital structure, profitability, commercial activity and charity care. Prior research has analyzed the capital structure policy of not-for-profit hospitals (Wedig, Hassan, & Morrisey, 1996; Ligon, 1997; Wheeler, Smith, Rivenson, & Reiter, 2000; Magnus, Smith, & Wheeler, 2003). Not-for-profit hospitals are not afforded the opportunity to raise capital through equity markets therefore they must seek out access in the tax-exempt debt markets (Wheeler et al., 2000). According to Wedig et al. (1996), not-for-profit hospitals are capable of including more debt in their capital structure due to favorable interest rates available through this market. Despite the opportunity to have more debt, Wheeler et al. (2000) reported that the average capital structure of not-for-profit hospitals remained stable over the past decade. The debt to asset ratio is a common measure used in the literature (Watt et al., 1986; Wedig et al., 1996; wheeler et al., 2000) and was used in this study to explore capital structure through the following hypothesis:</p> <pre> [H.sub.1]: There is a significant difference in debt ratios of JV

hospitals and Non-JV hospitals, based on measures obtained from Form

990 tax return data. </pre> <p>Profitability analysis within the not-for-profit healthcare sector often centers on comparisons with for-profit hospitals (Forgione, Schiff, & Crumbley, 1996; Younis et al., 2003). Results have consistently determined that not-for-profit hospitals exhibited lower profitability than for-profit hospitals (Pattison & Katz, 1983; Watt et al., 1986; Pattison, 1986; Hoerger, 1991; Sear, 1991; Forgione et al., 1996; Gentry & Penrod, 2000; Younis et al., 2003). According to Watt et al. (1986) these profitability measures help determine the success of management's strategies regarding financial performance. Profitability is an important financial variable to examine within the not-for-profit sector, particularly because "profit is nonetheless a primary factor which affects the attainment of their mission" (Zeller et al., 1996, p. 165). This study explored the financial health of JV hospitals through the following hypothesis:</p> <pre> [H.SUB.2]: There is a significant difference in profitability between JV and Non-JV hospitals, based on measures obtained from Form 990 tax return data. </pre> <p>This study measured profitability using return on fund balance (ROFB), which is equivalent to return on equity in the for-profit sector, return on assets (ROA) and profit margin (MARGIN). These represent common measures used in prior literature (Gentry & Penrod, 2000; Forgione et al., 1996; Younis et al., 2003).

Research conducted within the not-for-profit sector examined commercial activity due to a growing number of not-for-profit organizations being viewed as competing with for-profit organizations in the healthcare industry (Tuckman, 1998; Weisbrod, 1998). This 'commercialism' exhibited by not-for-profit organizations has led researchers to argue not-for-profits are indistinguishable from for-profit organizations (Weisbrod, 1998). Researchers have not come to a consensus on a single definition of 'commercialism' in the not-for-profit sector, and empirical research measures commercialism in a variety of ways (Cordes & Weisbrod, 1998; Greenlee & Bukovinsky, 1998; Tuckman, 1998; Yetman, 2001). Some of these measures include (1) total unrelated business income (UBI), (2) charitable contributions as a percentage of total revenues, commonly referred to as the contribution and grants ratio and (3) whether or not the organization files a Form 990-T tax return (which is required if the not-for-profit organization has at least $1,000 of gross unrelated business income).

Empirical research has indicated that a not-for-profit organization's industry and size affect its propensity to engage in commercial activities and certain not-for-profits shift costs from tax-exempt activities to taxable ones (Cordes & Weisbrod, 1998; Yetman, 2001). Results also illustrated that not-for-profits in the health services industry were more likely to report revenue subject to the unrelated business income tax (UBIT). Furthermore, larger not-for-profit organizations were also more likely to file a Form 990-T tax return (Cordes & Weisbrod, 1998). Based on these empirical findings concerning commercial activity within the sector, the following hypothesis was proposed:</p> <pre> [H.sub.3]: There is a significant difference in the commercial activity between JV and Non-JV hospitals, based on measures obtained from Form 990 tax return data. </pre> <p>For purposes of this study, commercial activity was measured using (a) UBI as a percentage of total revenue and (b) contributions and grants as a percentage of total revenue (contributions and grants ratio). A higher UBI ratio was expected for JV hospitals based on Cordes and Weisbrod's (1998) finding that healthcare not-for-profit organizations were more likely to report unrelated business income revenue. Regarding the contributions and grants ratio, it was expected that JV hospitals would report lower ratios than Non-JV hospitals. This assertion was based on the Cordes and Weisbrod (1998) finding of a negative relationship between the source of donation and commercial activity revenue.

The aspect of charity care is of high importance when discussing not-for-profit hospitals and joint ventures. Most hospitals have received tax-exempt status under Section 501(c)(3) of the Internal Revenue Code (IRC). In granting tax exemptions, the IRS requires nonprofit organizations to have certain characteristics, including (but are not limited to): (a) the organization serves a common good, (b) the organization is not a for-profit entity, (c) the net earnings of the organization do not benefit the owners, and (d) the organization does not exert political influence (IRC Section 501(c)(3); Hopkins, 1998; Swords, 1998). In analyzing joint ventures, the IRS commonly relies on a two-prong test consisting of (1) the charitable purpose test and (2) the private benefit test (Petroff, 1998). The charitable purpose test analyzes whether the joint venture furthers a charitable purpose, while the private benefit test analyzes whether the arrangement results in more than incidental private benefit (Tsilas, 1997; Peregrine & Sullivan, 1998;

Petroff, 1998; Korman, Balsam, & Patterson, 2000).

Investigating the level of charity care of JV hospitals is pertinent to both donors and oversight agencies, particularly considering recent scrutiny by state and local governments (Maiuro, Schneider, & Bellows, 2004). Donors desire hospitals to increase charity care in order to substantiate the entity's tax-exempt status and its goal to provide for the community (Eldenburg & Vines, 2004).

Prior empirical research has measured charity care in a variety of ways. Most common measures include uncompensated care, bad debt expense, charity care as a percentage of total revenue, or as a percentage of total expenses (Ferris & Graddy, 1999; Nicholson, Pauly, Burns, Baumritter, & Asch, 2000; Eldenburg & Vines, 2004). Beginning in 1990, not-for-profit hospitals report the level of charity care provided to the community in the notes to the financial statements (Eldenburg & Vines, 2004). Due to the IRS's scrutiny of JV hospitals and the government's emphasis on the level of charity care provided by these hospitals, the following hypothesis was proposed:</p> <pre> [H.sub.4]: There is a significant difference in charity care between JV and Non-JV hospitals, based on measures obtained from Form 990 tax return data and audited financial statements. </pre> <p>Charity care is recognized as "care acknowledged as being for the medically indigent" (Ferris & Graddy, 1999, p. 24). For purposes of this study, charity care was measured as total charity care as a percentage of program service expense. Program service expenses are directly related to the entity's exempt purpose. Total charity care was obtained from the audited financial statements and program service expense was obtained from the Form 990 tax return. This study sought to obtain a measure of the level of charity care relative to what was spent toward the hospital's exempt purpose activities. This measurement followed presentation established on the Form 990, where each entity is required to describe its program service accomplishments (i.e. exempt purpose achievements), and what funds were spent on those programs.

METHOD Measures

Financial characteristics of not-for-profit hospitals were used to determine the variables of interest. The constructs examined in this study were debt, profitability, commercial activity, and charity care. Debt was operationally defined as the debt to total assets ratio (DEBT%), measured as total liabilities divided by total assets. The operational definitions of profitability were (1) Return on Assets (ROA) = net income divided by average total assets; and (2) Return on Fund Balance (ROFB) = net income divided by average fund balance.

Commercial activity included the following measures: (I) UBI% = total unrelated business income divided by total revenue and (2) CONTRIB% = total contributions / total revenue. Charity care (CHARITY) was defined as total charity care divided by total program service expense.

This study used Form 990 tax return data for the sample not-for-profit hospitals for the period 1994 through 1998 because joint ventures gained popularity within the health sector during that period (Petroff, 1998). Furthermore, during that period the IRS announced its efforts to audit transactions conducted by not-for-profit hospitals (Holmes, 1998; Petroff, 1998).

Form 990 tax returns report revenues, expenses, functional expense allocations, balance sheet items, changes in net assets or fund balance for not-for-profit organizations, and are typically prepared based on the audited financial statements of the entity. According to Froelich, Knoepfle, & Pollak, (2000), Form 990 tax return data are a "reliable source of information for basic income statement and balance sheet entries" (Froelich et al., 2000, p. 251). Despite documented reliability and preparation based on audited financial statements, potential errors may exist in the data due to the lack of verification of each data item (National Center for Charitable Statistics, 1998; Gordon, Greenlee, & Nitterhouse, 1999).

Tax return data have been used on a limited basis in prior research of not-for-profit hospitals, because of data accessibility restrictions. This limitation has been partially overcome due to publicly available datasets from the National Center for Charitable Statistics (NCCS). The NCCS draws returns from the IRS Statistics of Income (SOI) Sample Files, containing over 300 variables for samples of over 10,000 organizations (National Center for Charitable Statistics, 1998). The SOI sample files contain the Form 990 tax return data for 501(c)(3) organizations with assets over $10 million.

The use of tax return data for this study was relevant for numerous reasons. First, the IRS uses this type of data to screen the activities reported by hospitals and to evaluate its performance. Second, donors and various oversight agencies (such as the Better Business Bureau Wise Giving Alliance) rely on publicly available tax return data to measure and compare organizational performance. Furthermore, management must be aware of the tax issues surrounding transactions that have an impact on the organization's future financial health. Focusing solely on traditional non-tax measures, such occupancy rates and market share, does not allow management to evaluate the entire impact of joint ventures on an entity's tax-exempt status.

Sample Selection

In order to identify the JV hospital sample, a search of Factiva (a collaboration of the Dow Jones News Retrieval System and Reuters) and Lexis-Nexis was conducted, resulting in over 300 articles for the time-period 1994-1998. The resulting articles were read for specific content, and only those articles that contained the announcement of a joint venture between a not-for-profit and for-profit hospital were selected for sample inclusion. This analysis process resulted in 47 not-for-profit hospitals announcing a joint venture with a for-profit partner. Twenty-four hospitals were eliminated from the sample for numerous reasons, including: (1) the identified not-for-profit partner was not a hospital, (2) the announced joint venture did not occur within the examined time frame, or (3) complete tax return data for the organizations were missing.

The JV hospital sample of 23 included hospitals announcing joint ventures with forprofit hospitals because emphasis of this study was on the innate financial characteristics of not-for-profit hospitals engaged in these types of activities. The success or failure of the actual joint venture was not a focus of this study, however, the financial impact of the joint venture on the hospital's position may be investigated in future research. The Non-JV hospital sample (n = 67) represents a sample of hospitals not engaged in joint ventures, controlled for size, teaching status, and location, which represent common variables used in the literature (Zeller et al., 1996; Watkins, 2000; Younis et al., 2003).

The JV-Audit sample includes seven hospitals that have undergone IRS audit during the time period investigated. This was a small sample, yet it reflects a realistic sample of hospitals that have undergone IRS audit due to joint venture issues. For analysis purposes, this sample of audited hospitals was compared to the remaining sixteen hospitals in the JV sample, representing the Non-Audit hospitals.

RESULTS

JV vs. Non-JV hospitals

Descriptive statistics in Panel A of Exhibit 1 revealed the average DEBT% for the JV hospital group was 40.06%, with a median of 46.14% and a standard deviation of 22.30%. The debt to asset ratio for JV hospitals ranged from 3.44% to 76.42%. For the Non-JV sample, an average debt ratio of 44.68% was obtained. The KolmogorovSmimov (K-S) test for normality was performed on all variables (Hollander & Wolfe, 1999). Results of the K-S test revealed the data were not normally distributed therefore nonparametric tests were used to compare the financial structure of the hospital groups. Results of the Wilcoxon Rank Sum test revealed debt ratios were not statistically different between the two groups (W = 973, p = 0.25).

The examination of profitability revealed sample Non-JV hospitals reported significantly higher averages on most measures. Average ROA for the JV hospitals was 1.63% and 4.80% for the Non-JV group (W = 854, p = 0.03). Non-JV hospitals also reported significantly higher ROFB (6.47%) than the JV group (2.90%) (W = 874, p = 0.05). The profitability measure that did not reveal a significant difference was profit margin, despite an average of 13.64% for Non-JV hospitals compared to 0.26% for the JV sample (W = 926, p = 0.13).

Analysis of commercial activity indicated average UBI% for the JV hospital group was 0.55%, with a median of 0.13% and a standard deviation of 0.81%. The Non-JV sample reported average UBI% of 0.88%, with a median of 0.31% and a standard deviation of 1.76%. Nonparametric tests did not indicate a significant difference in the commercial activity conducted by the two hospital groups (W = 1007, p = 0.35).

The contribution and grants ratio, CONTRIB% averaged 4.45% for the JV hospitals with a median of 0.29% and standard deviation of 18.46%. Average CONTRIB% for Non

JV hospitals was 4.08%, with a standard deviation of 11.23% and median of 0.41%. Statistical tests did not reveal a significant difference between the hospitals (W = 959, p = 0.21), which was not consistent with hypothesis [H.sub.3]. Analysis of charity care revealed only marginally significant differences between the two hospital groups. Average charity care for the JV hospital sample was 61.15%, with a median of 3.33%. The Non-JV hospitals reported average charity care of 9.70%, with a range of zero percent to 82.22%. Nonparametric tests indicated a marginally significant difference between the hospital groups (W = 1185, p = 0.10).

Logistic regression was also performed in order to determine whether the hospital types could be distinguished through the financial measures chosen. This method aided in determining the likelihood of a not-for-profit hospital engaging in a joint venture. The full model for this analysis included the debt to asset ratio, profit margin, commercial activity (UBI% and CONTRIB%), and charity care, with teaching status and size as control variables. Panel A of Exhibit 2 reported a likelihood ratio chi-square value of 23.66 for the full model with a corresponding p-value of 0.001. This indicated the financial measures chosen, as a group, allowed for somewhat better classification between the sample JV and Non-JV hospitals. Despite the existence of a significant model, the parameter estimates revealed two variables were significant, including profit margin (p = 0.05) and charity care (p = 0.09). These results were consistent when the model was revised to include an indicator variable for the presence (or lack thereof) of unrelated business income.

JV-Audit vs. Non-Audit hospitals

This study additionally examined the financial characteristics of those JV hospitals that were audited by the IRS. Panel B of Exhibit 1 reported the descriptive results of the JV-Audit and Non-Audit hospitals. Descriptively, the JV-Audit hospitals reported higher profitability than the Non-Audit firms. For example, JV-Audit hospitals reported average ROA of 4.22% while Non-Audit hospitals reported an average of 0.49% (W = 90, p = 0.35). Average ROFB was 7.36% for the JV-Audit group and 0.95% for the Non-Audit hospitals (W = 89, p = 0.38). Profit margin was also not statistically different between the two groups--JV-Audit hospitals reported an average of 5.67%, while Non-Audit hospitals reported an average profit margin of -2.11% (W = 82, p = 0.46).

Analysis of the capital structure of audited hospitals indicated average debt ratios were 38.55% for the JV-Audit sample firms. This was not statistically different from the 40.72% average for the Non-Audit hospitals (W = 82, p = 0.46). In terms of commercial activity, neither hospital group reported average UBI% above one percent (0.34% for JV-Audit and 0.64% for Non-Audit hospitals), and this difference was not significant (W = 87, p = 0.43). JV-Audit hospitals reported average charity care of 18.61%, while NonAudit hospitals reported an average of 79.77% (W = 90, p = 0.35).

Due to the small sample size (n = 23) for this comparison, the Non-Audit hospital sample was expanded to include all of the Non-JV sample hospitals. Research conducted via Lexis-Nexis determined that none of the original sample Non-JV hospitals were subject to IRS audit during the time period investigated. Results based on this larger sample size (n = 90), reported in Panel C of Exhibit 1, did not yield significant differences between the hospital groups.

Logistic regression analysis for the JV-Audit and Non-Audit hospitals was presented in Panel B of Exhibit 2. The full model for this analysis included the debt to asset ratio, profit margin, commercial activity (UBI% and CONTRIB%), and charity care, with control variables of teaching status and size. The model was not significant (p > 0.20), and resulted in the lack of significant findings for the parameter estimates. Stepwise logistic regression procedures were performed in order to possibly obtain a more parsimonious model. The lack of significant findings for the stepwise procedures indicated that the financial structure variables chosen did not assist in classifying sample hospitals between the audit and non-audit groups. The model was revised to include a dichotomous variable for charity care--whether the level of charity care provided was significantly different from zero. Results from this analysis were consistent with those in Panel B of Exhibit 2. These findings were consistent when the sample size was expanded to include all original sample hospitals (n = 90).

DISCUSSION

Limitations of Study

One limitation of this study was reliance on a single source for the joint venture announcement date. It is possible not-for-profit hospitals announced in other trade or industry publications other than the Dow Jones News System. It is also possible that not-for-profit hospitals chose not to announce joint ventures until negotiations were complete and the joint venture began operations. The accuracy of the data was another limitation to this study. Analysis was performed on information provided in the NCCS database, but potential errors could exist in the data (Gordon et al., 1999).

Implications

Descriptive analyses revealed the sample hospitals were not highly leveraged and did not significantly differ in terms of debt structure. Management may have considered the opportunity to enter a joint venture more favorably since the entity was not heavily leveraged. Differences were observed in specific financial performance measures, such as profitability. Results indicated that for the time period examined, the sample JV hospitals reported lower profitability than the Non-JV hospitals. Lower profitability for these sample hospitals illustrated some form of financial difficulty during the period prior to entering the joint venture. Sample hospitals may have viewed a joint venture as an opportunity to increase efficiency. Furthermore, these results supported arguments that there were innate differences in the financial performance between the hospital groups. This study's findings may allow management to become more aware that joint ventures may trigger IRS scrutiny in the future.

Examination of commercial activity indicated sample hospitals did not heavily rely on unrelated business activities as a source of revenue. These low percentages indicated hospitals were not involved in extensive commercial activities that were subject to the unrelated business income tax. Sample hospitals also did not generate large percentages of revenues from outside donations. Cordes and Weisbrod (1998) found that public donors have an aversion to not-for-profit organizations engaging in commercial activities. Given this argument, further research is needed to determine if this aversion to commercial activities applies in the joint venture arena.

JV hospitals were found, on average, to report higher charity care as a percentage of program service expenses than the Non-JV hospitals. This may be an indication of continued importance of hospitals providing significant charity care to the public.

Comparisons of JV-Audit and Non-Audit hospitals did not reveal significant differences among any of the financial variables. It is possible that the variables used in this study did not greatly influence the IRS's decision to audit hospitals involved in joint ventures. Future research may assist in determining whether the individual facts and circumstances of each joint venture transaction may assist in predicting the likelihood a hospital is audited by the IRS.

Despite the lack of a statistical difference in charity care between the audited and non-audited hospitals, results indicated that JV-Audit hospitals did not report high levels of charity care as a percentage of reported program service expenses. Future research incorporating a case study approach may allow further evidence concerning whether reported levels of charity care were a contributing factor in the IRS decision to audit hospital operations. A case study approach may also help determine the organizational motivations underlying the selection of a joint venture, rather than other collaborative structures.

CONCLUSION

Considering recent calls to investigate the merit of tax-exempt status received by certain not-for-profit organizations, this research will assist policy makers in the evaluation of not-for-profit hospitals. Joint ventures between hospital groups are a significant trend in the industry, and more research should be conducted in this area due to the IRS concern that certain not-for-profit hospitals abused their tax-exempt status by participating in joint ventures with for-profit partners. The dramatic step of revoking tax-exempt status sends a signal to the industry that this will continue to be an issue of major concern to the IRS. Constituents, including donors and other hospitals, will continue to question whether joint ventures cause exempt entities to lose their focus on charitable activities.

Results of this study provided preliminary evidence of characteristics associated with hospitals involved in joint ventures. Based on the sample investigated, these findings can be used by researchers to further examine the joint venture arena within the healthcare sector. If a hospital is considering engaging in a joint venture then these results highlight certain characteristics that appear to be associated with commercial activities. The perception of increased commercial activity may place the organization's tax-exempt status in jeopardy. Anecdotal evidence suggests that oftentimes management may consider revocation of tax-exempt status as a remote possibility, but recent scrutiny in the joint venture area indicates the possibility of more cases undergoing federal audit investigations (Gibson, 2004; Tieman, 2004). The IRS scrutiny of these types of transactions may encourage management to fully examine both the tax and non-tax implications of entering a joint venture with a for-profit hospital.

This paper is based in part on my dissertation at Virginia Tech. I would like to thank my chairman, W. Eugene Seago, and my other committee members, Robert Brown, Debra Callihan, Jim Yardley and Raymond Major. I also appreciate comments from the editor and two anonymous reviewers. I gratefully acknowledge the financial support of the KPMG Ph.D. Project.

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Pamela C. Smith

The University of Texas at San Antonio

Address for correspondence: Pamela C. Smith, Department of Accounting, College of Business, The University of Texas at San Antonio, 6900 North Loop 1604 West, San Antonio, TX 78249-0632 USA, Pamela.Smith@utsa.edu.
EXHIBIT 1
COMPARISON OF HOSPITAL FINANCIAL CHARACTERISTICS

PANEL A. JV AND NON-JV HOSPITALS

Variable Type (a) Mean Median Std. Dev.

DEBT% JV 40.06% 46.14% 22.30%
 Non-JV 44.68% 46.08% 22.91%
ROA JV 1.63% 2.75% 8.10%
 Non-JV 4.80% 5.02% 5.73%
ROFB JV 2.90% 8.72% 16.61%
 Non-JV 6.47% 9.06% 20.91%
MARGIN JV 0.26% 5.51% 30.14%
 Non-JV 13.64% 6.48% 23.99%
UBI% JV 0.55% 0.13% 0.81%
 Non-JV 0.88% 0.31% 1.76%
CONTRIB% JV 4.45% 0.29% 18.46%
 Non-JV 4.08% 0.41% 11.23%
CHARITY JV 61.15% 3.33% 227.3%
 Non-JV 9.70% 1.69% 20.38%

Variable Wilcoxon Rank Sum Statistic

DEBT% JV W = 973, p = 0.25
 Non-JV
ROA JV W = 854, p = 0.03
 Non-JV
ROFB JV W = 874, p = 0.05
 Non-JV
MARGIN JV W = 926, p = 0.13
 Non-JV
UBI% JV W = 1007, p = 0.35
 Non-JV
CONTRIB% JV W = 959, p = 0.21
 Non-JV
CHARITY JV W = 1185, p = 0.10
 Non-JV

Notes:

(a) JV = joint venture not-for-profit hospitals (n = 23)

Non-JV = not-for-profit hospitals not engaging in joint ventures
(n = 67)

Definitions of Variables:

DEBT% = Total Liabilities / Total Assets

ROA = Net Income / Average Total Assets

ROFB = Net Income / Average Fund Balance

MARGIN = Net Income / Total Revenue

UBI% = Total Unrelated Business Income / Total Revenue

CONTRIB% = Total Contributions / Total Revenue

CHARITY = Total Charity Care / Program Service Expense

PANEL B: JV-AUDIT vs. NON-AUDIT HOSPITALS (N = 23)

Variable Type (a) Mean Median Std. Dev.

DEBT% Audit 38.55% 48.55% 18.29%
 Non-Audit 40.72% 43.60% 24.37%
ROA Audit 4.22% 5.13% 5.11%
 Non-Audit 0.49% 2.41% 9.01%
ROFB Audit 7.36% 11.45% 7.779
 Non-Audit 0.95% 6.86% 19.16%
MARGIN Audit 5.67% 6.90% 6.72%
 Non-Audit -2.12% 4.59% 35.98%
UBI% Audit 0.34% 0.29% 0.35%
 Non-Audit 0.64% 0.06% 0.92%
CONTRIB% Audit 0.41% 0.33% 0.53%
 Non-Audit 6.28% 0.27% 22.10%
CHARITY Audit 18.61% 7.70% 30.09%
 Non-Audit 79.779 3.35% 272.40%

Variable Type (a) Wilcoxon Rank SumStatistic

DEBT% Audit
 Non-Audit W = 82, = 0.46
ROA Audit
 Non-Audit W = 90, p = 0.35
ROFB Audit
 Non-Audit W = 89, = 0.38
MARGIN Audit
 Non-Audit W = 82,p = 0.46
UBI% Audit
 Non-Audit W = 87,p = 0.43
CONTRIB% Audit
 Non-Audit W = 83, = 0.48
CHARITY Audit
 Non-Audit W = 90,p = 0.35

Notes:

(a) Audit = JV hospitals that were subject to IRS audit (n = 7)

Non-Audit = JV hospitals that were not subject to IRS audit (n = 16)

PANEL C: JV-AUDIT VS. NON-AUDIT (w = 90)

Variable Type (a) Mean Median Std. Dev.

DEBT% Audit 38.569 48.55% 18.29%
 Non-Audit 43.91% 46.08% 23.10%
ROA Audit 4.22% 5.13% 5.11%
 Non-Audit 3.97% 4.94% 6.65%
ROFB Audit 7.36% 11.45% 7.77%
 Non-Audit 5.41% 8.98% 20.58%
MARGIN Audit 5.67% 6.91% 6.72%
 Non-Audit 10.61% 6.46% 27.19%
UBI% Audit 0.34% 0.29% 0.35%
 Non-Audit 0.83% 0.17% 1.63%
CONTRIB% Audit 0.41% 0.32% 0.53%
 Non-Audit 4.50% 0.32% 13.84%
CHARITY Audit 18.61% 7.70% 30.099
 Non-Audit 23.21% 1.95% 121.10%

Variable Type (a) Wilcoxon Rank Sum Statistic

DEBT% Audit W = 283, t = 0.29
 Non-Audit
ROA Audit W = 299, of = 0.38
 Non-Audit
ROFB Audit W = 294, of = 0.35
 Non-Audit
MARGIN Audit W = 288, n = 0.32
 Non-Audit
UBI% Audit W = 316, of = 0.48
 Non-Audit
CONTRIB% Audit W = 285, of =0.31
 Non-Audit
CHARITY Audit W = 382,p = 0.17
 Non-Audit

Notes:

(a) Audit = JV hospitals that were subject to IRS audit (n = 7)

Non-Audit = Sample hospitals that were not subject to IRS audit
(n = 83)

EXHIBIT 2
LOGISTIC REGRESSION

PANEL A: JV AND NON-JV HOSPITAL SAMPLE

[Status.sub.i] = [[beta].sub.0] + [[beta].sub.1]DEBT% + [[beta].sub.2]
[MARGIN.sub.i] + [[beta].sub.3] CONTRIB%.sub.i] +
[[beta].sub.4] [UBI%.sub.i] + [[beta].sub.5] [CHARITY.sub.i] +
[[beta].sub.6] [SIZE.sub.i] + [[beta].sub.7] [TEACH.sub.i] +
[[epsilon].sub.1]

 Parameter
Variable estimate p-value

Intercept 0.5861 0.52
DEBT% -2.4677 0.15
MARGIN -7.4897 0.05
UBI% -32.9414 0.25
CONTRIB% -16.4126 0.27
CHARITY 1.9096 0.09
SIZE 0.7986 0.19
TEACH -1.5180 0.19

Notes:

The sample consists of 90 hospitals (23 JV hospitals and 67 Non-JV
hospitals).

Variable Definitions:

Status = 1 if JV hospital, 0 otherwise

DEBT% = Total Liabilities / Total Assets

MARGIN = Net Income / Total Revenue

UBI% = Total Unrelated Business Income / Total Revenue

CONTRIB% = Total Contributions / Total Revenue

CHARITY = Total Charity Care / Program Service Expense

SIZE = 1 if total assets greater than sample median, 0 otherwise

TEACH = 1 if a teaching hospital, 0 otherwise

PANEL B: .N-AUDIT Vs. NON-AUDIT HOSPITAL SAMPLE

[Audit.sub.i] = [[beta].sub.0] + [[beta].sub.1] [DEBT%.sub.i] +
[[beta].sub.2] [MARGIN.sub.i] + [[beta].sub.3] [CONTRIB%.sub.i] +
[[beta].sub.4] [UBI%.sub.i] + [[beta].sub.5] [CHARITY.sub.i] +
[[beta].sub.6] [SIZE.sub.i] + [[beta].sub.7] [TEACH.sub.i] +
[epsilon.sub.i]

 Parameter
Variable estimate p-value

Intercept -0.5793 0.69
DEBT% -0.5235 0.83
MARGIN -0.3698 0.95
UBI% -38.1595 0.64
CONTRIB% -14.5604 0.61
CHARITY 0.7064 0.67
SIZE 0.8030 0.45
TEACH -11.0976 0.97

Notes:

The sample consists of 23 hospitals (7 JV-Audit hospitals and 16
Non-Audit hospitals).

Variable Definitions:

Audit = 1 if considered a JV-Audit hospital, 0 otherwise

DEBT% = Total Liabilities / Total Assets

MARGIN = Net Income / Total Revenue

UBI% = Total Unrelated Business Income / Total Revenue

CONTRIB% = Total Contributions / Total Revenue

CHARITY = Total Charity Care / Program Service Expense

SIZE = 1 if total assets greater than sample median, 0 otherwise

TEACH = 1 if a teaching hospital, 0 otherwise
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Author:Smith, Pamela C.
Publication:Research in Healthcare Financial Management
Geographic Code:1USA
Date:Jan 1, 2005
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