UNDERSTANDING NONPROFITS’ USE OF DEBT INSTRUMENTS TO FINANCE CAPITAL PROJECTS: PERSPECTIVES FROM THE LANSCAPE OF NONPROFIT BOND FINANCE, NONPROFIT CAPITAL STRUCTURE, AND TAX-EXEMPT BOND CREDIT RATINGS

Abstract

This dissertation delves into the significant challenges nonprofit organizations face in accessing tax-exempt bond markets—a vital resource for financing their capital projects and expanding services, particularly in capital-intensive sectors like hospitals and housing-related nonprofits. Although these bonds are intended to provide cost-effective capital for public service entities, nonprofits encounter greater borrowing obstacles than governmental entities, a phenomenon insufficiently studied due to data limitations. To bridge this research gap, my study leverages a unique dataset combining IRS 990 Schedule K forms and municipal bond data, thereby enriching our comprehension of nonprofit financing in the bond market. The overarching question of this research is why nonprofits choose particular debt instruments over others for their capital funding needs and to identify the barricades that hinder more nonprofits from leveraging the municipal bond market efficiently. The first essay examines the nonprofit bond issuance landscape, identifying disparities in interest rates, underwriter fees, and bond rating acquisition among various nonprofit sectors. Notably, charter schools and senior housing nonprofits face higher interest and issuance costs and exhibit lower tendencies to obtain bond ratings, pivotal for signaling creditworthiness and reducing interest rates. Furthermore, there's a uniformly low tendency across all subsectors to obtain credit enhancements, indicating nonprofits' difficulties in persuading credit enhancement agencies willing to take over their default. The reluctance to secure bond ratings and credit enhancements highlights a systemic issue within nonprofit financing, potentially escalating financial risks. The second essay scrutinizes nonprofits' financial decisions concerning mortgages, tax-exempt bonds, and insider loans through the lens of static trade-off (STT) and pecking order theories (POT). Analysis via a Heckman selection model indicates that nonprofits with more diverse revenue streams and with stable source of income have increased usage of mortgages with lower issuance costs and greater repayment flexibility, aligning with STT. Conversely, these nonprofits are less inclined to use tax-exempt bonds, a finding that aligns POT. The results challenge conventional capital structure theories and underscoring the need for novel theoretical perspectives. The third essay explores the impacts of nonprofits' financial conditions on their bond credit ratings. Ordered probit regression with the Heckman selection correction reveal that nonprofits’ tendency towards financial leanness contributes to low bond crediting ratings. Specifically, minimized profits, operating revenue, and cash flows, combined with over-dependence on donations and program revenue lead to weaker credit ratings. This scenario reveals a paradox where financial prudence, intended to foster donor confidence, inadvertently signals limited debt repayment capacity to credit rating agencies, inflating borrowing costs. Collectively, these essays contribute significantly to understanding the financial barriers impeding nonprofits' effective use of tax-exempt bonds, underscoring a high-risk perception regarding nonprofit bonds among investors and financial agencies. The insights garnered from this dissertation also underscore critical areas for future research and policymaking, aimed at facilitating more equitable and efficient capital access for nonprofits, thereby enhancing their ability to serve marginalized communities and fulfill their mission-driven objectives.