One potentially interesting dimension of heterogeneity among consumers is the difference in the ability to monitor suppliers. Consumers who are bad at monitoring would then select non-profit firms to deal with. If governments are particularly weak at monitoring contracts (because of their own well known incentive problems), they will specialize in dealing with non-profit firms.

Examples and Discussion

Not for profit status is not the only means of softening incentives. Other institutional arrangements may supplement (or replace) it. For example, entrepreneurs with a particularly low known taste for perquisites, or whose consumption of perquisites can be restricted by a higher authority, might make particularly effective operators of non-profit firms. This may be the reason why so many non-profits such as schools and hospitals are operated by or affiliated with particular religions that restrict consumption.

Another device that serves the same purpose is a governing board consisting of people who are unable to consume perquisites, uninterested in the consumption of perquisites, or, perhaps ideally, are donors to the institution and therefore have an interest in restricting the consumption of perquisites. In fact, not-for-profit institutions typically have such governing boards. The benefits of the not-for-profit status for quality, then, can be amplified through additional devices reducing the value of perquisites to the decision makers. add comment

Two further mechanisms that can help guarantee quality in either for- or not-for-profit firms are reputations and ex post competition. If a firm can establish a reputation for producing high quality and not engaging in cost and quality reducing innovations, it may be able to attract consumers at high prices regardless of its status. American universities, for example, try hard to maintain reputations for quality, as do the for-profit luxury car-makers.

Competition may further the same goal as well. Consider the ex post appropriation problem that results from worker investment in specific human capital (as in Rotemberg and Saloner, 1990). A firm can protect the worker by locating in an area where a large number of other employers also demand this particular form of human capital. When competition reduces risks of ex post appropriation, competition among for-profit firms may again render non-profit status unnecessary.

Silicon Valley is a good example of this phenomenon. In the absence of such competition, however, the non-profit status becomes all the more essential. For example, universities in the US have traditionally served local markets (Hoxby, 1997) and only one university of a particular quality level often still serves a given metropolitan area. There is then little local competition for the services of professors who invest heavily in university-specific human capital. If universities were able to expropriate the rents from such investments, professors would refuse to invest. Non-profit status protects professors against this problem.