Non-profit organizations - Institutional Economics

Non-Profit Organizations

Non-profit organizations (NPOs) are organizations that do not aim at profit; Voluntary organizations that provide goods and services, whose production usually refers to the duties of the state. These are the so-called merit goods - goods, the consumption of which is considered desirable in the society. Demand for these benefits exists because both the private market and the state produce these goods in insufficient quantities. Non-profit organizations provide food and social services to the poor, encourage art, support medical research, provide educational services, etc.

Non-profit organizations can take many forms. They can exist on donations (for example, organizations "Red Cross" or "Salvation Army"), or receive the bulk of their income by setting prices for their services (nursing homes, hospitals, American Automobile Association). Some organizations combine both ways of financing (for example, American universities receive donations and fees for services).

Non-profit organizations also differ in how they organize control. Some of them may be controlled by donors, but often donors have no right to control the organization, in this case, control is exercised by the board of directors. Many hospitals and nursing homes in America belong to this category.

Why does an enterprise choose the legal form of a non-profit organization? In some cases, consumers can not accurately assess the quality of the goods they want to purchase, either because of the circumstances under which the goods are purchased, or because of the very nature of these goods. In these cases, the disciplining effect of the market on the producer of the goods, focused on making a profit, will not be enough - the manufacturer will be able to assign exorbitant prices for goods of inferior quality, which will lead to a decrease in the welfare of consumers. In such situations, consumers can win if they deal not with profit-oriented private enterprises, but with non-profit organizations. A non-profit-making producer can also raise prices and reduce the quality of the goods provided, as well as a manufacturer that seeks maximum profit without fear of reprisals from consumers. However, the producer, not profit-oriented, will lack incentives to such behavior - after all, he can not take advantage of the resulting profit. Thus, the advantage of a producer that is not profit-oriented is that the market discipline is replaced by the additional protection given to the consumer by another, broader "contract" - the legal obligation of the organization to devote all earned profits to the production of services. Waiver of residual income provides an opportunity for a firm to commit itself not to deceive donors, customers and employees.

Let us explain these arguments by the following example. Suppose there is an organization called "CARE", which receives funds from philanthropists. The organization finances the production of a simple service - transportation and distribution of food and essential commodities to those in need in developing countries. Why is this service produced by a non-profit organization, rather than a normal commercial company? Why would not philanthropists pay a certain amount of money to a commercial firm that delivers the goods and distributes them among those who need them? The fact is that people who receive these benefits have no connection with those who pay for them. Therefore, customers will not be able to find out whether the goods were actually delivered. If the organization CARE was a normal commercial firm, its owners would have strong incentives to perform paid services in bad faith, or not at all, but simply to assign a fee. After all, it is unlikely that any of the customers will ever go to a distant country to find out whether the goods were delivered, how many, when they were delivered and whether they were received by those to whom they were intended. A similar situation can not occur in the case of ordinary market transactions: if you order food for your children, you can control their delivery. Therefore, people who want to help those in need in developing countries prefer to deal with non-profit organizations that do not work for profit, and they will be able to trust them because of the legal restrictions that are imposed on the activities of these firms.

There is no right to residual income in non-profit organizations: they can earn profit, but it is not subject to distribution, if the net profit was received, then it must be saved and entirely directed to financing those services for the sake of production of which this non-profit organization was created . Absence of the right to residual income in non-commercial organizations allows to avoid the problem of agency relations between the donor and the applicant for residual income. Residual income goes to the clientele of these organizations and is partially appropriated by opportunistically leading managers. The only limitation for them in NCOs is the need to maintain a good relationship on the part of donors. In NCOs there is no right to sell a company, and the right of control belongs to the members of the organization. Such a distribution of property rights in a non-profit firm means that these organizations are not subject to takeovers. This means that the stock market does not assess the quality of the work of managers and because of the lack of external control, the problem of agency relations between those who provide funds and managers is exacerbated. The quality of their management is not assessed in the stock market, and the incentive forms of remuneration for the chief managers in the NPO can be prohibited by law. In addition, the NCO is characterized by an unprecedented degree of autonomy for the chief executive officer and the board of directors.

Opportunistic behavior of managers in non-profit organizations is manifested in too high wages, beautifully furnished offices, a short working day, etc. Here, nepotism flourishes (the appointment of relatives to leading positions in the organization, regardless of the level of their qualifications).

Since these organizations have no right to residual income, they lack the incentive to adapt effectively to the external environment. But here there is a substitute for residual income - such a substitute can be a community of interests, a common value system. Altruism of internal agents is the cause of low control costs in agency relationships and protects donors and clientele from expropriation and contributes to the survival of these organizations. But in the competition of organizational forms for survival, the most successful are those forms of non-profit organizations in which the management (implementation) of the most important decisions and their control are divided.

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