Nonprofits and Pass-Throughs: Performance Comparison

Abstract

This paper’s purpose is to compare nonprofits with pass-throughs in terms of valuation, leverage, and growth. To achieve this purpose, we use the Capital Structure Model. This model determines maximum firm valuation through incorporating real data (tax rates, credit spreads, and historical growth rates). Since this is the first study to offer our particular set results on valuation, leverage and growth, our findings are value-additive in terms of the comparative research on nonprofits and pass-throughs. The new and scientific value of our findings are further established by robust tests that modify values for key variables. Major findings include the following. Nonprofits have over a fifty percent valuation advantage over pass-throughs and achieve a four times greater increase in dollar value when going from nongrowth to growth. The latter accomplishments are attained with a smaller before-tax plowback ratio and less retained earnings. Such achievements occur because nonprofits are not taxed on earnings retained for growth. While nonprofits have somewhat greater optimal leverage ratios than pass-throughs, they gain a bit less in dollars added from debt unless growth rates increase as projected when tax rates are lowered. Nonprofits gain less percentage-wise from debt because their unlevered firm value is greater than pass-throughs.

Nonprofits and C Corporations: Performance Comparison

“…These studies focus on US ownership types. The most recent CSM research investigates and compares the performance of the US nonprofit (NP) ownership form and the US FP ownership form consisting of the PT ownership type (Hull and Van Dalsem 2021). This paper extends the comparative ownership performance research by being the first CSM study to compare the performances of NPs and CCs as measured by debt choice, valuation, leverage gain, and growth-related outcomes.…”

“…The same borrowing costs for NPs and FPs enable the CSM to compute outcomes so that comparisons between ownership forms can be made and conclusions can be drawn that are based on contrasting tax rates assigned to different ownership forms. Hull and Van Dalsem (2021) offer four arguments that support the notion that the outcomes for NPs and PTs can be based on parallel risk classes. Their arguments also apply to this study of NPs and CCs.…”

“…In addition, most NP and FP revenue comes from small subsets of the largest NPs and the largest FPs. As noted by Hull and Van Dalsem (2021), since NPs depend on FP earnings for funding, NPs have their welfare influenced by same market forces as FPs. They also point out that NPs and FPs compete within the same industries.…”

“…Finally, NPs and FPs are alike in having payroll taxes and in producing financial statements that report assets, liabilities, revenues, and expenses. Hull and Van Dalsem (2021) write that NPs have three major tax benefits (albeit these benefits would not apply for any for-profit activity by an NP). First, NPs are tax-exempt, which means they can avoid the FP forms of taxes such as federal, state, county, municipal, property, and sales.…”

“…Given the nature of this paper's extension of recent CSM research on comparing the performance of ownership forms (Hull 2020b;Hull and Van Dalsem 2021), its design and contents resemble this research. Due to our focus on CC tax rates (as opposed to PT tax rates), we only apply the CSM of Hull (2018) that focuses on CCs and so we use this version of the CSM as our method to determine optimal outcomes for NPs and CCs.…”