Financing constraints in nonprofit organisations: A ‘Tirolean’ approach

Journal of Corporate Finance 17 (2011) 640–648

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Journal of Corporate Finance j o u r n a l h o m e p a g e : w w w. e l s ev i e r. c o m / l o c a t e / j c o r p f i n

Financing constraints in nonprofit organisations: A ‘Tirolean’ approach Marc Jegers ⁎ Vrije Universiteit Brussel, Microeconomics of the Profit and Non-Profit Sectors, Pleinlaan 2, B-1050 Brussel, Belgium

a r t i c l e

i n f o

Article history: Received 26 October 2009 Received in revised form 12 November 2010 Accepted 18 November 2010 Available online 26 November 2010

JEL classification: G30 L31 Keywords: Nonprofit organisations Financial constraints

a b s t r a c t For the first time a stylised model, in the tradition of corporate finance models for profit organisations described by Tirole (2006), is developed in order to understand the existence of financial constraints in nonprofit organisations and their relationship with the presence of agency problems. Financial constraints can be expected to arise when there are no substantial opportunities to increase revenues from fundraising and when nonprofit managers might not be willing to exert high fundraising efforts. Furthermore, under these circumstances more agency problems lead to lower debt levels. In situations without expected financial constraints, more agency problems are shown to go together with higher debt levels. Extending watchdog agencies' assessment methods to include default payments can limit or even eliminate financial constraints. The model also allows to understand why larger and chain affiliated organisations should suffer less from financing constraints. The very scant empirical literature's findings on the matter are shown to be reconcilable with the model's predictions. © 2010 Elsevier B.V. All rights reserved.

1. Introduction Without any doubt, the technicalities of nonprofit organisations' financial management do not differ from those of profit firms, leaving aside dividend decisions, which are not relevant because of the nondistribution constraint reigning in the nonprofit organisations' functioning (Hansmann, 1987). This does not imply that a specific nonprofit financial theory is not conceivable, though such a theory has not yet been formulated. In a few early papers, such as Sloan et al. (1988) and Wedig (1994), attempts are made to apply standard financial theory to nonprofit organisations, but these can be deemed conceptually flawed as their foundations (portfolio selection to arrive at an optimal risk–return combination for the investor, with ensuing systematic risk levels for the portfolio components and their required returns) are meaningless in a nonprofit context, exactly because of the nondistribution constraint making investments in (portfolios of) ‘shares’ of nonprofit organisations not really a financially rational thing to do. Therefore, it comes as no surprise that Tirole's authoritative textbook on the theory of corporate finance (2006) does not mention nonprofit organisations at all. It can be conjectured that the reason for this is that the incentive mechanisms in nonprofit organisations fundamentally differ from those governing profit firms, making the development of a finance theory overarching institutional forms conceptually very improbable. The present paper proposes some building blocks that might serve as a basis for a nonprofit finance theory in ‘Tirolean’ style. The nonprofit organisation's utility is modeled to be dependent on activity level, budget size, and managerial disutility of fundraising efforts. The higher the impact of activity level on organisational utility, the less agency costs between board (favouring high activity levels) and management (preferring high budgets). High agency costs will make the organisation issue more debt (to increase not only the budget but also the activity level), but can also result in more financing constraints as shirking can turn out to be the optimal strategy for the manager, a strategy rationally anticipated by the potential lenders. This will be the case when

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there are no substantial opportunities to increase revenues from fundraising. When no financial constraints can be expected, more agency costs will go together with higher debt levels. The paper is organised as follows: the next section presents the model. Conditions under which financing constraints can arise are derived as well as the impact of the presence of agency problems, after which some solutions to reduce or eliminate financing constraints, within the model's framework, are suggested. 2. The model 2.1. Organisational objectives As originally modeled by Steinberg (1986), organisational utility is a combination of the board's objective (activity level) and the managerial objective (budget level). Although this might be too schematic a representation of a complex reality, it has gained wide acceptance in the economic literature on nonprofit organisations. Consequently, organisational utility is defined as the weighted average of an activity indicator and a budget indicator. k is the importance attached to activity, and (1-k) the importance attached to the budget level, k reflecting the relative bargaining power of the board versus its management. The main intuition behind this operationalisation is that managers prefer large gross budgets, whereas boards prefer as much activity as possible. k, which is assumed to be observable from outside the organisation, reflects the eventual compromise between both. Low values of k will be labelled, maybe too sharply, as values describing 'high agency problem' organisations. An alternative interpretation of k is the following: higher levels of k describe managers whose utility is more affected by reaching the board's objective (activity) and less by achieving strictly personal objectives (here budget) when compared to lower levels of k. This interpretation justifies that what follows managerial decisions (on effort) are guided by their effect on organisational utility, and does not contradict the agency gap meaning of k. As usual, activity is measured by its cost, in order to be expressed in the same units as the budget. We also assume that the participation constraint of management will always be met. 2.2. The model's timing We propose a one-period model without discounting in which expected organisational utility is maximised. At the end of the period (t = 1) the organisation ceases to exist. The organisation is able to reach a maximal activity level y0 for which all the available funds are required, taking into consideration the endowment, revenues and subsidies on the one hand (S(y), with S’(y) ≥ 0 and S”(y) ≤ 0), and costs on the other hand (C(y), with C’(y) N 0 and C”(y) N 0). This implies that S’(y) b C’(y) for y N y0. Without loss of generality, we assume that the activity is performed at t = 1, and that C and S accrue at the same moment. As in this case budget and activity levels are identical, organisational utility is assuming risk neutrality: U0 = kCðy0 Þ + ð1−kÞCðy0 Þ = Cðy0 Þ Expanding activity levels can only be realised by borrowing (at an exogenously determined real interest rate r) at the beginning of the period, be it in an indirect way: the fact of having obtained a loan incites potential donors to donate (at t = 1), if requested to do so, if they consider this to be a signal of trustworthyness. Without knowing the organisation obtained a loan, donors would be more reluctant to entrust (more) money to the organisation. As increasing activity levels above y0 results in a gap between C and S, additional funds are necessary to compensate for this, and to generate financial resources for repayment including interests. Therefore, managerial effort is required to elicit these donations. As usual, managerial effort, the level of which is committed to at t = 0, is not contractable. At the end of the period, there is no money left, as it is all spent on activities and (possibly partial) debt and interest payments. To simplify the analysis, it is also assumed that the organisation has limited liability, preventing further legal steps in case of (partial) default. 2.3. Assumptions Management commits itself to one out of two possible unobservable effort levels to solicit funds: high and low. This comes at a disutility ‘a’ for a high level, and a disutility zero for a low level, as exerting this low level of effort is considered to be part of the manager's job. Note that the combination of this low effort and the fact of having obtained a loan already generate additional funds. Fundraising efforts by board members are assumed to be given, not entailing disutility, and independent from managerial fundraising efforts. High effort levels lead to high level of funds raised (fM) with probability x, and a low level (fm) with probability (1-x). These probabilities are w and (1-w) respectively for low effort levels, obviously with w b x. The expected fundraising levels therefore are FH = xfM + (1-x)fm and FL = wfM + (1-w)fm . All these values are assumed to be known by everybody involved. Management, having committed itself to a high or low non-verifiable effort level, can obtain loans DH and DL respectively (DH N DL). The concomitant (observable) activity levels enabled by these loans are yH and yL. We confine ourselves to cases where yH is greater than yL, which are the more realistic ones, as potential donors would not understand that borrowing more would lead to a lower

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t=0

t=1

DH,DL effort choice

FH,FL yH,yL -C(yH),-C(yL) S(yH),S(yL) -(1+r)DH, -(1+r)DL actual effort Fig. 1. The model's timing.

activity level. A similar reasoning explains why we can assume that yL N y0. All relevant factors are depicted in Fig. 1, which also represents the model's timing. We also assume that low effort will not suffice to fully generate DH(1 + r) at t = 1. Therefore, we have, in expected value terms: ð1 + rÞDL = SðyL Þ + DL + FL − CðyL Þ b ð1 + rÞDH = SðyH Þ + DH + FH − CðyH Þ

ð1Þ

or rDL = SðyL Þ + FL − CðyL Þ b rDH = SðyH Þ + FH − CðyH Þ from which, with ΔF = FH − FL = (x−w)(fM−fm), ΔS = S(yH) − S(yL) and ΔC = C(yH) − C(yL), and taking into consideration the fact that C exceeds S at an increasing rate for increasing activity levels ΔF N ðSðyL Þ − CðyL ÞÞ − ðSðyH Þ − CðyH ÞÞ = ðΔC – ΔSÞ N 0

ð2Þ

To keep the model tractable and without compromising its main implications, we assume that for all combinations of actual effort level and activity level the funds available allow yL or yH to be fully performed. For this, it is sufficient to assume SðyH Þ + DL + FL − CðyH Þ ≥ 0 Finally, we only consider cases in which the utility obtained exceeds U0, meaning that having no debt is never preferred to be indebted. 2.4. Utility implications with no moral hazard When there is no moral hazard in the relationship with the lender the manager will exert the fundraising effort promised. Suppose a low effort level is announced. Then, the activity level is represented by C(yL), whereas the gross budget is (S(yL) +DL +FL), which, using (1), can be rewritten as C(yL) +(1 +r)DL. Therefore, organisational utility is UL = kCðyL Þ + ð1−kÞðCðyL Þ + ð1 + rÞDL Þ = CðyL Þ + ð1−kÞð1 + rÞDL In the same vein, announcing and showing high fundraising effort lead to UH = CðyH Þ + ð1−kÞðð1 + rÞDH – aÞ In both cases, the bank is safeguarded against default payment as the amounts lent correspond to the actions the manager claims to take. 2.5. Utility implications with moral hazard A priori, a moral hazard can be observed in two situations: the manager announcing low effort to attract donations but exerting high effort (with ensuing utility U-L), and the other way around (with ensuing utility U-H). As yH and yL are observable, the announced activity levels have to be minimally met. The fundraising effort, however, is not observable. In the first case, which occurs when it leads to a higher utility for the organisation than when fulfilling the expectations, there is no problem for the bank. The amount borrowed must meet SðyL Þ + DL + FL − CðyL Þ = ð1 + rÞDL

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whereas (S(yL) + DL + FH − C(yL)) N (S(yL) + DL + FL − C(yL)) is available now. Therefore, the lender has no reason to constrain funding whenever a low fundraising effort is announced. The additional funds raised (ΔF) will be used to increase the activity level above yL, and simultaneously increase the organisation's budget. Furthermore, increasing activity levels might result in increasing revenues or subsidies, unless this is impossible (e.g. because of ex-ante contracting on only yL to be funded) or not pursued (e.g. by providing the additional activities as pure charity). In order not to overload the model, we will assume S remains unchanged (S(yL)). So, (kΔF + (1-k)ΔF) = ΔF has to be added to organisational utility. Therefore, U−L = CðyL Þ + ΔF + ð1−kÞðð1 + rÞDL – aÞ It is easy to see that U-L N UL if and only if (1-k)a b ΔF: the more cumbersome high fundraising efforts are (high values of a), and the less impact they have on raising funds (small ΔF), the lower the probability the manager will depart from the announced fundraising policy. This effect will be exacerbated in organisations for which managerial objectives are dominant (low value of k), as the fundraising disutility is fully borne by the manager. In the second case, the manager announces to make important efforts to obtain donations. Organisational utility when reneging on this commitment is U-H. As far as the activity level is concerned, it will still be yH because of its observability. The budget will be (S(yH) + DH + FL), or, equivalently, (1 + r)DH + C(yH) − ΔF. Therefore, U−H = kCðyH Þ + ð1−kÞðð1 + rÞDH + CðyH Þ − ΔFÞ = CðyH Þ + ð1−kÞðð1 + rÞDH – ΔFÞ U-H N UH if and only if a N ΔF. High effort disutility and limited effect of the higher effort on the funds raised, make it more probable the efforts promised will not be produced. The bank will have lent an amount DH assuming SðyH Þ + DH + FH − CðyH Þ = ð1 + rÞDH but only (S(yH) + DH + FL − C(yH)) b (S(yH) + DH + FH − C(yH)) will be available, leading to a partial default payment. Summarising, there are three possible parameter configurations leading to different choices to be made by the manager: – ΔF b (1-k)a: here UL N U-L and U-H N UH, so the choice is between UL and U-H – (1-k)a b ΔF b a: here U-L N UL and U-H N UH, so the choice is between U-L and U-H – a b ΔF: here U-L N UL and UH N U-H, so the choice is between U-L and UH These are summarised in Fig. 2. The conditions for U-H N UL, U-H N U-L, and UH N U-L are derived in Appendix A. It turns out that U-H N UL is always true, whereas the conclusions in the last two cases are more involved: – when (1-k)a b ΔF b a we will have U-H N U-L if k b (ΔS + a – ΔF)/(ΔS + a – ΔC), a condition always met when ΔC N ΔF – when a b ΔF we will have UH N U-L if k b ΔS/(ΔF + ΔS – ΔC), also met whenever ΔC N ΔF 2.6. Financial constraints As shown in the previous section, financial constraints can only arise when DH is applied for, and when the manager might have an incentive to renege on his high effort commitment. This hinges upon the value of a, managerial effort disutility, known by the manager but not by the potential lender. The latter will have an a priori idea about a's distribution, and hence its expected value, upon which it will base its decision whether to grant the loan requested from it by the organisation. When the potential lender is convinced that the probability of a exceeding ΔF is small, there are no financial constraints, as either UH or U-L are then expected to be optimal for the organisation: when it applies for DH, it will be expected to produce high effort, even so when it applies for DL. The lower the value of k, the higher the probability DH will be applied for, suggesting a positive relationship between the level of debt and the presence of agency problems (captured by low values of k). Indirect support for this conclusion can be found in the papers by Jegers and Verschueren (2006) and Jegers (2011), where, in samples of

(1-k)a

a ΔF

UL or U-H

U-L or U-H

U-L or UH

Fig. 2. Organisational choices for different values of ΔF.

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22,766 Californian npos (data pertaining to 1999) and 844 Belgian npos (for 2007) respectively, potential agency problems go together with higher leverage values. In both papers, the implied mechanism consists of debt used as an instrument to restrict management behaviour, whereas in the current paper the underlying mechanism differs. The empirical results are compatible with both explanations, without proving the one and/or the other to be true. However, financial constraints arise when the potential lender perceives a high probability of a exceeding ΔF. From the conditions derived in the previous section, it is clear that whenever ΔC N ΔF, the manager will be expected to commit himself to a high fundraising effort, which will be honoured only when a b ΔF. So, the bank perceives the possibility of (partial) default payment which it might want to avoid. Hence a financing constraint: even in cases in which the organisation is willing to exert high effort (implying the a priori distribution held by the bank does not convey a's real value), it will not obtain DH. This is comparable to the financing constraint studied in profit organisations, where they result in profitable projects not being funded. Consequently, (yH – yL) activity units will not be produced. When ΔC ≤ ΔF, the outcome depends on the value of k. If the organisation applies for DL, this would imply that (1-k)a b ΔF and that k is sufficiently high not to meet the conditions spelled out in the previous section. In all other cases, DH will be asked for by the organisation, again leading to the possibility of reneging, and again inducing financial constraints. Note that here high values of k make financing constraints less probable, suggesting a negative relationship between the level of debt and agency problems, contrary to the cases for which a b ΔF. Intuitively, this can be explained by assuming that potential creditors, faced with possible morally hazardous behaviour, distrust more the intentions of management dominated organisations, whereas this would be less worrying when it is known that reneging cannot be optimal. 2.7. Avoiding financial constraints In the present section, it will be shown that a way to mitigate the financing constraint problem is to have an institutional setting that implies the possibility of a utility penalty (a’) for the organisation the manager of which is not making the high fundraising efforts promised (see succeeding discussion for some examples of how this might work in reality). If only a low effort is promised, there is no point in assuming a utility penalty for reneging other than the effort disutility, as this would imply a high effort is shown. We assume a’ will be experienced whenever, after having promised a high fundraising effort, fm is observed. The expected utilities are then for not reneging and reneging respectively: UH’ = kCðyH Þ + ð1−kÞðð1 + rÞDH + CðyH Þ – aÞ – ð1−xÞa’ = CðyH Þ + ð1−kÞðð1 + rÞDH – aÞ – ð1−xÞa’ U–H’ = kCðyH Þ + ð1−kÞðð1 + rÞDH + CðyH Þ – ΔFÞ – ð1−wÞa’ = CðyH Þ + ð1−kÞðð1 + rÞDH – ΔFÞ – ð1−wÞa’ It is easy to see that U-H’ N UH’ if and only if a – a’(x−w)/(1-k) N ΔF. The condition for U-L N UL remains unchanged: (1-k)a b ΔF. For notational convenience, define α = a’(x−w)/(1-k). In Appendix B it is shown that introducing a utility penalty reduces the scope for reneging on high effort promises, an effect exacerbated for higher values of k (relatively more activity oriented organisations), making α greater. When (a−α) b 0, reneging is never rational. High values of α can be observed in cases in which organisational misbehaviour is widely documented, e.g. through watchdog agencies, which already exist in a number of countries and use a number of standards to assess the financial health of nonprofit organisations (Bhattacharya and Tinkelman, 2009; Silvergleid, 2003). An easy to implement component of an overall standard could be notification about default payments, though this was not (yet) applied by the 11 US agencies listed by Silvergleid (2003: 12–16). For the lender, informing the agencies about reneging organisations is almost costless, and the impact of society knowing this might be very high in terms of reputation and funding, possibly leading to α ≥ a, making financial constraints disappear. Therefore, the role of watchdog agencies could be easily broadened beyond informing potential donors, by deterring organisations from not exerting promised fundraising efforts, and thereby reducing or eliminating financing constraints. The results obtained by Calem and Rizzo (1994) can also be explained in the context of the present paper's model. In a sample of 1396 private nonprofit general care US hospitals for the 1985–1989 period they found larger and chain-affiliated hospitals to be less financially constrained. Increased visibility of larger hospitals makes a’ substantial (the ‘political cost’ phenomenon, comparable to watchdog postings), whereas monitoring procedures and common interests within chains constrain members borrowing from other members from not fulfilling the financial conditions they agreed upon. In case of default, disciplining measures also result in high a’ values. 3. Summary and conclusions A stylized corporate finance model, based on expected value expressions, is developed in order to understand the existence of financial constraints in nonprofit organisations. Because of these constraints, organisational activity levels are contained despite the organisation's creditworthiness, resulting in a suboptimal social welfare level. The model's conclusions can be summarised by presenting a number of testable (ceteris paribus) hypotheses, though testing will not always be straightforward: 1. In nonprofit markets known to be characterised by high additional fundraising opportunities (high ΔF) and/or managers expected not to bother too much to exert high fundraising efforts (low expected a), there will be no financing constraints.

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2. In nonprofit markets known to be characterised by high additional fundraising opportunities (high ΔF) and/or managers expected not to bother too much to exert high fundraising efforts (low expected a), more agency problems (low k) will go together with higher debt levels. 3. In nonprofit markets known to be characterised by low additional fundraising opportunities (low ΔF) and managers expected to bother to exert high fundraising efforts (high expected a), there will be fundraising constraints. 4. In nonprofit markets known to be characterised by low additional fundraising opportunities (low ΔF) and managers expected to bother to exert high fundraising efforts (high expected a), more agency problems (low k) will go together with lower debt levels. 5. In an institutional context in which not complying with high fundraising effort promises is more widely publicised, nonprofit organisations will be less financially constrained. 6. Larger and/or chain-affiliated nonprofit organisations will be less financially constrained. All this is of course very premature, as the proof of the pudding is in the empirical eating. It is encouraging that the conclusions of the very scant empirical literature's findings on the matter to date can be understood in the framework developed in the present paper. Acknowledgements Encouraging and profound comments by the anonymous referee and the journal's editor, Jeffry Netter, are gratefully acknowledged. They allowed me to substantially improve the paper's quality and coherence. Appendix A A.1. U-H N UL This implies CðyH Þ + ð1−kÞðð1 + rÞDH – ΔFÞ N CðyL Þ + ð1−kÞð1 + rÞDL from which CðyH Þ − CðyL Þ + ð1−kÞðð1 + rÞðDH − DL Þ – ΔFÞ N 0 Using (1) this results in CðyH Þ − CðyL Þ + ð1−kÞðSðyH Þ − CðyH Þ + ΔF – SðyL Þ + CðyL Þ – ΔFÞ = kΔC + ð1−kÞΔS N 0 ΔC and ΔS being positive, this condition will always be met. A.2. U-H N U-L This implies CðyH Þ + ð1−kÞðð1 + rÞDH – ΔFÞ N CðyL Þ + ΔF + ð1−kÞðð1 + rÞDL – aÞ from which CðyH Þ − CðyL Þ − ΔF + ð1−kÞðð1 + rÞðDH – DL Þ + a – ΔFÞ N 0 Using (1) again, this can be written as CðyH Þ − CðyL Þ − ΔF + ð1−kÞðSðyH Þ − CðyH Þ + ΔF – SðyL Þ + CðyL Þ + a – ΔFÞ = kΔC − ΔF + ð1−kÞðΔS + aÞ = kðΔC – ΔS – aÞ – ΔF + ΔS + a N 0 As in the case a N ΔF, we have, with (2): (ΔC – ΔS – a) b (ΔC – ΔS – ΔF) b 0, from which kbðΔS + a – ΔFÞ = ðΔS + a – ΔCÞ As by definition k ≤ 1, ΔC N ΔF makes this condition always hold, given the facts that a N ΔF and the denominator is positive.

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A.3. UH N U-L This implies CðyH Þ + ð1−kÞðð1 + rÞDH – aÞ N CðyL Þ + ΔF + ð1−kÞðð1 + rÞDL – aÞ from which CðyH Þ − CðyL Þ – ΔF + ð1−kÞðð1 + rÞðDH − DL ÞÞ N 0 Using (1) again this can be written as follows: CðyH Þ − CðyL Þ – ΔF + ð1−kÞðSðyH Þ − CðyH Þ + ΔF – SðyL Þ + CðyL Þ Þ = kðΔC – ΔFÞ + ð1−kÞΔS = kðΔC – ΔF – ΔSÞ + ΔS N 0 (ΔC – ΔF – ΔS) being negative, this can be written as kbΔS = ðΔF + ΔS – ΔCÞ If ΔC N ΔF this condition will always be met. Appendix B We should look at two different situations: (a−α) b (1-k)a and (a−α) N (1-k)a. B.1. (a−α) b (1-k)a There are three possible parameter configurations leading to different choices to be made by the organisation: − ΔF b (a−α): here UL N U-L and U-H’ N UH, so the choice is between UL and U-H’ − (a−α) b ΔF b (1-k)a: here U-L b UL and U-H’ b UH, so the choice is between UL and UH − (1-k)a b ΔF: here U-L N UL and UH N U-H’, so the choice is between U-L and UH These choices are depicted in Fig. A1. The condition under which UH is higher than U-L has already been derived in Appendix 1: k b ΔS/(ΔF + ΔS – ΔC). The necessary and sufficient condition to have U-H’ N UL in the first case is derived as follows: CðyH Þ + ð1−kÞðð1 + rÞDH – ΔFÞ – a’ N CðyL Þ + ð1−kÞð1 + rÞDL or ΔC + ð1−kÞðð1 + rÞðDH −DL Þ – ΔFÞ – a’ N 0 or kΔC + ð1−kÞΔS – a’ N 0 or kΔC + ð1−kÞðΔS−αÞ N 0

a-α

(1-k)a ΔF

UL or U-H’

UL or UH

U-L or UH

Fig. A1. Organisational choices for different values of ΔF ((a−α) b (1-k)a).

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(1-k)a

647

a-α ΔF

UL or U-H’

U-L or UH

U-L or UH

Fig. A2. Organisational choices for different values of ΔF ((a−α) N (1-k)a).

Higher values of α increase the probability that this condition is not met, reducing the probability of reneging. Furthermore, if α N a, ΔF can never be smaller than (a−α), making reneging never optimal. For the sake of completeness, the condition of having UH N UL (second case) derives from CðyH Þ + ð1−kÞðð1 + rÞDH – aÞ N CðyL Þ + ð1−kÞð1 + rÞDL or ΔC + ð1−kÞðð1 + rÞðDH −DL Þ−aÞ N 0 or kΔC + ð1−kÞðΔS + ΔF−aÞ N 0 Whether this condition is met or not does not affect the probability of reneging on high effort promises. B.2. (a−α) N (1-k)a Also now, there are three possible parameter configurations leading to different choices to be made by the organisation (Fig. A2): − ΔF b (1-k)a: here UL N U-L and U-H’ N UH, so the choice is between UL and U-H’ − (1-k)a b ΔF b (a−α): here U-L N UL and U-H’ N UH, so the choice is between U-L and U-H’ − (a−α) b ΔF: here U-L N UL and UH N U-H’, so the choice is between U-L and UH Only the second case leads to a new comparison to be made. The condition for U-H’ to exceed U-L follows from: CðyH Þ + ð1−kÞðð1 + rÞDH – ΔFÞ – a’ N CðyL Þ + ΔF + ð1−kÞðð1 + rÞDL – aÞ or ΔC + ð1−kÞðð1 + rÞðDH −DL Þ – ΔF + a – αÞ N 0 or kΔC − ΔF + ð1−kÞðΔS + a – αÞ N 0 Also here, larger values of α (meeting of course (1-k)a b ΔF b (a−α)) decrease the probability of reneging. B.3. Conclusion Comparing with a situation without a reneging disutility amounts to assessing the impact on the probability of reneging and the ensuing financial constraints of a growing α, starting at α = 0, the situation analysed in Sections 2.5 and 2.6. For α = 0, no financial constraint will be expected for ΔF N a. For α ≠ 0 (and obviously N0), this set is extended to ΔF N (a−α), and equal to the set of all positive real numbers for α N a. Furthermore, for ΔF b (1-k)a, reneging on high effort promises is not always optimal anymore, which it is for α = 0. So, the introduction of a reneging disutility comes with a reduction of the probability of financial constraints arising. References Bhattacharya, R., Tinkelman, D., 2009. How tough are Better Business Bureau/Wise Giving Alliance financial standards? Nonprofit Volunt. Sec. Q. 38, 467–489. Calem, P.S., Rizzo, J.A., 1994. Financing constraints and investment: new evidence from hospital industry data. Federal Reserve Bank of Philadelphia—Economic Research Division. Working Paper 94-9. Hansmann, H.B., 1987. Economic theories of nonprofit organization. In: Powell, W.W. (Ed.), The Nonprofits Sector: a Research Handbook. Yale University Press, New Haven, CN, pp. 27–42. Jegers, M., 2011. On the capital structure of non-profit organisations: a replication and extension with Belgian data. Financ. Accountab. Manage. 27, 18–31. Jegers, M., Verschueren, I., 2006. On the capital structure of non-profit organisations: an empirical study for Californian organisations. Financ. Account. Manage. 22, 309–329.

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