NOT-FOR-PROFIT ENTREPRENEURS: A Taste for Quality

These examples raise the obvious question: what are the markets in which reputation and/or competition suffice for quality assurance by for-profit firms, and what are the markets where the not-for-profit status is necessary? Non-profit status is usually only necessary when the potential expropriation problem — and the disutility to consumers or donors from reduced quality — are very large. In the case of donations in particular, where the donor cannot take the money back or switch, the non-profit status might be essential. This logic might explain why we see non-profit hospitals (they deal with life and death and rely on donations) but not non-profit doctors (it is easier to switch or get a second opinion, and there are no donations). This logic might also explain why universities are non-profit (rely on donations) while vocational schools are not (no donations). Finally, this logic might explain why, for most goods where quality matters, market mechanisms are good enough for assuring quality production by for-profit firms.

A Taste for Quality

Not-for-profit entrepreneurs often care about the quality of the good they are producing and not just the cash or perquisite returns. Indeed, many entrepreneurs who start non-profits appear to be do-gooders and idealists who genuinely care about their altruistic causes (Rose-Ackerman 1996). At the same time, Bill Gates appears to care deeply about making computing easy for everyone, yet Microsoft is a for-profit firm, so having a mission is not in itself the whole story. In this section, we describe some issues arising from entrepreneurial taste for quality.
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We begin by assuming that entrepreneurs’ taste for producing a quality product is observable and ask whether entrepreneurs with a greater taste for quality are more likely to choose non-profit status. We assume that the utility of an entrepreneur is:

Proposition 4: Assume mK'”(E)w6810-3
likely that entrepreneurs prefer the non-profit status (i.e. inequality (4) holds). If there is a distribution of degrees of altruism, then the more altruistic entrepreneurs choose the non-profit status and the less altruistic ones choose the for-profit status.

According to this proposition, non-profit firms produce higher quality products, as quality-altruists actually prefer. This, however, is not true in all cases, because there is a countervailing effect. Entrepreneurs with a greater taste for quality, which is known to all, may be able to earn greater revenues, which makes the for-profit status more appealing. The technical assumption rules out the possibility that very high altruism individuals find it unnecessary to use non-profit status to commit to high quality. Presumably, Mother Theresa could assure everyone of her commitment to quality of care for the indigent even if she ran a for-profit firm.

In many situations, consumers do not directly observe the producers’ commitment to quality. Non-profit status may then signal that the entrepreneur cares more about quality relative to pecuniary rewards. Examples of this inference exist both in the health and the schooling industries, where consumers may be suspicious of for-profit firms because such firms may be more willing to cut services to raise profits. While we do not present a model in which non-profit status serves as a signal of altruism, such a model is straightforward to construct (the single-crossing property holds here). This point suggests that non-profit status is even more important in situations where individuals’ altruism is not readily recognized.