Thursday, July 3, 2008

Does the Nondistribution Constraint Inhibit Profit-Seekers?

We have recently posted a rash of stories about insiders caught with their hands in the proverbial cookie jars.  And, truth be told, I have had clients who wanted to start a business and get rich using nonprofits to get seed money from grants available only to 501(c)(3) organizations.  These would-be entrepreneuers usually assume that they can pay themselves handsomely, directly or through fringe benefits, to get around the prohibition against private inurement.  My stock advice is that you might get away with it for awhile, but greed has a way of taking over and soon enough the cards will come crashing down. 

Greed amongst wayward nonprofit insiders is not only "not good" but it also seems quite universal.  Two researchers from Prague, Petra Brhlikova and Andreas Ortmann recently posted The Impact of the Nondistribution Constraint and its Enforcement On Entrepreneurial Choice, Price, and Quality.  Here is the interesting abstract:

We study the conditions under which it is rational for a representative entrepreneur to start a nonprofit firm. Taking as point of departure a model of entrepreneurial choice proposed by Glaeser and Shleifer (2001), we analyze consequences of weak enforcement of the non-distribution constraint on entrepreneurial choice and price and quality of the product. We find that the nonprofit organizational form becomes unequivocally more attractive to entrepreneurs if enforcement of the non-distribution constraint is weak. We also find that the quality delivered by nonprofit firms is lower under weak enforcement than that of the nonprofit firm under strict enforcement, but higher than the quality delivered by a for-profit firm. We discuss the implications and limitations of our results.

Interesting.  The abstract suggests that for-profit wolves in nonprofit clothing guage the extent to which they can "get away with it" in deciding whether to use a nonprofit or for-profit to get rich.  I guess that's just rational "economic" behavior.


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