Advances in Accounting 58 (2022) 100612

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Advances in Accounting
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Ownership type and earnings management in U.S. hospitals☆

James N. Cannon a, Melvin A. Lamboy-Ruiz b, Olena V. Watanabe c, *
a
Utah State University, United States of America
b
Georgia Southern University, United States of America
c
Iowa State University, United States of America

A R T I C L E I N F O A B S T R A C T

Keywords: We examine variation in accrual-based and real earnings management in U.S. hospitals by ownership type, using
Hospitals a stable comprehensive sample of hospitals from 2011 through 2016. We expect managers' reporting incentives
Earnings management to differ between ownership type (for-profit versus non-profit), resulting in differing uses of accrual and real
Non-profit organizations
earnings manipulations. First, we document that non-profit hospitals exhibit lower levels of both income-
increasing and income-decreasing earnings manipulations than for-profit hospitals do. Second, we find that
compared to non-profit hospitals, for-profit hospital managers use discretionary accruals (in particular) to create
larger reserves when pre-managed earnings are high and to increase reported earnings more when pre-managed
earnings are low. Together, these findings suggest that, relative to non-profit hospital managers, for-profit
hospital managers have incentives to report higher and more consistent earnings.

1. Introduction maximization incentives set by capital providers, non-profits have

This study examines how ownership type (for-profit versus non-
profit) shapes accrual and real earnings management in U.S. hospi­
tals.1 Given the economic and social significance of the hospital sector,
representing approximately $3 trillion, 17.5%, and $9523 per capita of
the 2014 U.S. gross domestic product (Eldenburg, Krishnan, & Krishnan,
2017), it is important to study hospitals' reporting quality. When eval­
uating reporting quality of U.S. hospitals, contrasting for-profit and non-
profit hospitals is relevant because, while for-profits face profit-
break-even profitability expectations that result from offsetting in­
centives to sustain operations, on the one hand, and to serve under­
privileged constituencies, on the other (Balakrishnan, Eldenburg,
Krishnan, & Soderstrom, 2010; Eldenburg, Gunny, Hee, & Soderstrom,
2011).2
In direct contrast to for-profit organizations, non-profits are pro­
hibited from distributing residual income to internal or external stake­
holders (Eldenburg, Gaertner, & Goodman, 2015). However, despite this
mission constraint, empirical evidence has reliably demonstrated that

☆
We thank the Editor and the anonymous referee, Mark Bagnoli, Katheryn Jervis, Sue Ravenscroft, Casey Rowe, Naomi Soderstrom, Susan Watts, and the
anonymous reviewers for the 2020 AAA Annual Meeting and the 2020 AAA Diversity Section Meeting for their insightful comments and suggestions. We also thank
participants at the workshops at Cornell University, Iowa State University, Oklahoma State University, Purdue University, University of Illinois–Chicago, the 2013
AAA Government and Non-profit Midyear Meeting, the 2013 AAA Annual Meeting, and the 2016 AAA Management Section Midyear Meeting.
* Corresponding author.
E-mail address: watanabe@iastate.edu (O.V. Watanabe).
1
Unlike for-profit hospitals, non-profit hospitals do not have a standard set of owners, so perhaps referring to hospital mission would more aptly identify the
differences in non-profit and for-profit hospital behavior. However, to be consistent with the terminology used in existing literature (e.g., Eldenburg et al., 2017), we
delineate these two types of hospitals with the term ownership.
2
In contrast to the limited earnings management research in the healthcare industry, there is a substantial stream of empirical literature that documents accrual
and real earnings management across industries in for-profit settings (see the review in Dechow et al., 2010).

https://doi.org/10.1016/j.adiac.2022.100612
Received 22 September 2021; Received in revised form 20 May 2022; Accepted 10 June 2022
Available online 24 June 2022
0882-6110/© 2022 Elsevier Ltd. All rights reserved.
J.N. Cannon et al.
non-profit hospitals and other non-profit organizations have incentives
to maintain economic viability by improving their operating perfor­
mance, which often effectively emulates the incentive contracts of for-
profit firms (Brickley & Van Horn, 2002; Duggan, 2000; Eldenburg
et al., 2011; Nguyen & Soobaroyen, 2019). At the same time, non-profit
hospital managers are subject to institutional pressures from patients,
donors, employees, and government authorities to offer social benefits
(Krishnan & Yetman, 2011). Thus, non-profit managers may attract
unwanted regulatory and/or social attention if they report high earn­
ings.3 A manager who wishes to avoid such examination is motivated to
report low earnings. Therefore, their optimal reporting target may be at
or only slightly above zero. Empirical evidence to date documents that
non-profit managers do engage in accrual-based and real earnings ma­
nipulations to reach predetermined targets (e.g., Eldenburg et al., 2011;
Leone & Van Horn, 2005; Vansant, 2015).
However, there have been concerns expressed in the media and
among government officials that non-profit hospitals may be behaving
like their for-profit counterparts by taking advantage of tax exemptions
to maximize earnings (e.g., Everson, 2005; Kassab, 2016; Phillips, 2007;
Rosenthal, 2013; Sesana, 2014), particularly after the implementation of
the Affordable Care Act (ACA) which may have increased revenue for
hospitals from insured patients (Diamond, 2017; Japsen, 2015). Such
concerns motivate us to draw a clear distinction between earnings
management behavior in for-profit and non-profit hospitals. In this
paper, we investigate how accrual-based and real activities earnings
management differ between for-profit and non-profit hospitals. Specif­
ically, we compare the magnitudes of income-increasing and income-
decreasing accrual earnings manipulations, real patient service cost
earnings management, and real discretionary cost earnings
management.
To perform our analyses, we examine data from a large stable sample
of U.S. for-profit and non-profit hospitals from 2011 through 2016. First,
we examine pre-managed and reported earnings (return on sales, or
ROS) of each ownership type in total and by the quintile of pre-managed
ROS.4 We observe that positive pre-managed ROS is statistically signif­
icantly higher in for-profits hospitals (quintiles 2–5); while negative pre-
managed ROS is significantly lower in for-profit hospitals (quintile 1). In
contrast, across all quintiles, for-profit hospital managers report signif­
icantly higher and smoother ROS than do non-profit managers. Specif­
ically, the standard deviation of reported ROS is lower than the standard
deviation of pre-managed ROS in for-profits, while for non-profits there
is no difference in the dispersion of pre-managed and reported ROS.
Second, in our multiple regression analysis, we find that non-profit
hospitals engage in lower levels of both income-increasing and
income-decreasing discretionary accruals and real activities earnings
manipulations than for-profit hospitals do.5 Further, we find that for-
profit hospitals adjust their negative pre-managed earnings up to a
greater degree than non-profit hospitals do (quintile 1 of pre-managed
3 including for-profit hospitals, have a primary goal of providing owners a
In some cases, state governments have perceived the under-provision of
public benefits to be sufficiently significant to challenge and subsequently
revoke a hospital's non-profit status. For instance, in 2008, the Illinois Fourth
District Court of Appeals ruled that Provena Covenant Medical Center did not
provide enough charity care in 2002 to merit $1.1 million in property tax
exemption (in Provena Covenant Medical Center v. the [Illinois] Department of
Revenue). The ruling by the appellate court was upheld on March 18, 2010, by
the Illinois Supreme Court (see http://www.illinoiscourts.gov/opinions/supre
mecourt/2010/march/107328.pdf). Further, a recent study by Bai, Zare,
Eisenberg, Polsky, and Anderson (2021), demonstrates that hospitals' charity
care expenditures do not seem to align with their charitable mission.
4 generating ability.
While hospitals do not report sales, but rather service revenues, for con­
venience we refer to net income scaled by net revenues as return on sales.
5
By “lower levels,” we imply that those income-increasing accruals are closer
to zero in magnitude. Similarly, lower levels of income-decreasing accruals are
also closer to zero in magnitude. The same interpretation holds for real activ­
ities earnings management.
2
Advances in Accounting 58 (2022) 100612
ROS). In contrast, for higher levels of pre-managed ROS (quintiles 3, 4
and 5), for-profit hospitals engage in income-decreasing earnings man­
agement to a greater degree than non-profit hospitals. Together with our
analyses of earnings dispersion, these findings suggest that non-profit
hospitals' managers use less earnings manipulation to increase or
decrease earnings than do for-profit managers, and that for-profit
managers have greater incentives to report consistent earnings than
non-profit managers have.
Our study contributes to the existing literature in that it provides
generalizable large-sample evidence of divergent earnings management
behavior between non-profit and for-profit hospitals in the U.S. Most of
the existing empirical literature focuses on one state, such as California
or Maryland (e.g., Heese, 2018; Vansant, 2015; Vermeer, Edmonds, &
Asthana, 2014), and non-profit hospitals alone (e.g., Eldenburg et al.,
2011; Leone & Van Horn, 2005; Vansant, 2015). In contrast, we examine
over a period of six years a constant set of hospitals from 50 states and
the District of Columbia. By directly contrasting earnings management
practices in for-profit hospitals with such practices in non-profit hospi­
tals, we provide evidence of how hospital ownership type influences
reporting behavior. Specifically, we confirm a potential societal benefit
to non-profit ownership––namely, that managers are less prone to
earnings management.
The rest of the paper proceeds as follows. In section two, we review
existing literature and set up our hypotheses. Section three describes our
empirical model and variables. In section four we describe our sample
selection. We present empirical findings in section five, and in section six
we summarize our study and report our conclusions.
2. Literature review and hypotheses development
2.1. Ownership type and earnings management
Accounting literature argues that managers use both accrual and real
activities manipulations to meet predetermined financial targets (e.g.,
Bartov, 1993; Burgstahler & Dichev, 1997; Dechow, Richardson, &
Tuna, 2003; Degeorge, Patel, & Zeckhauser, 1999; Herrmann, Inoue, &
Thomas, 2003; Roychowdhury, 2006). Moreover, a majority of corpo­
rate managers surveyed stated that the primary reason companies
manage earnings is to meet predetermined benchmarks (Dichev, Gra­
ham, Harvey, & Rajgopal, 2013; Graham, Harvey, & Rajgopal, 2005).
Furthermore, experimental evidence shows that for-profit company ex­
ecutives and recruiting professionals prefer to hire accounting managers
with dark personality traits (i.e., high narcissism, high Machiavel­
lianism, low idealism), presumably because people with such traits are
more likely to engage in earnings management (Buchholz, Lopatta, &
Mass, 2019; Harris, Jackson, Owens, & Seybert, 2021; Van Scotter &
Roglio, 2020).
Whether managers of non-profit organizations face incentives to
manage earnings in a fashion similar to those of for-profit organizations
is less clear (Eldenburg et al., 2017). Managers of for-profit entities,
return on their investment, as communicated by reporting a steady
stream of increasing earnings (Demerjian, Lewis-Western, & McVay,
2020). While non-profit hospitals are not constrained by the objective to
generate a return on equity (Conrad, 1984; Forgione, 1999), they are
rarely able to rely on subsidies and donations alone but must also rely on
patient service revenues to sustain their operations (Balakrishnan et al.,
2010; Eldenburg et al., 2017). Notably, the ACA implemented in 2012
includes a reduction in subsidies received through the DSH program
(Kaiser Family Foundation, 2017), further limiting hospitals' revenue-
However, stakeholders also expect managers of non-profit hospitals
J.N. Cannon et al.
to provide public benefits. In exchange for providing public benefits, a
non-profit organization is exempt from paying taxes.6 Given that tax
exemption is a benefit from the government in exchange for distributing
profits in the form of uncompensated care, non-profit hospital stake­
holders do not expect such hospitals to generate and retain high earn­
ings. In fact, experimental evidence shows that respondents react
negatively to a non-profit's tax-exempt status when it reports high profits
(Wilkicki, 2001). If a non-profit hospital's manager were to report
excessive profits, the hospital would risk having to pay federal excise tax
or even losing its federal or state tax-exempt status. Therefore, to remain
true to their mission and yet to appear to be financially viable, non-profit
managers' optimal strategy might be to report zero or very small positive
earnings. Indeed, Leone and Van Horn (2005) show that non-profit
hospitals use discretionary spending and discretionary accruals to
manage earnings to near-zero reported levels. Wen, Huang, Shen, and
Zhang (2019) find that non-profit Taiwanese hospitals not only
manipulate discretionary real expenditures, but also manipulate core
activity expenditures to meet earnings benchmarks.
In a related study that examines a sample of California non-profit
hospitals, Eldenburg et al. (2011) show that hospital managers manip­
ulate earnings by adjusting costly activities in non-core areas, that is,
expenditure manipulations and asset management to achieve small
positive income or to avoid large positive income. Eldenburg et al.
(2011) argue that non-profits try to avoid reporting high income in order
to escape scrutiny from government officials and other stakeholders. In a
similar setting, Vansant (2015) argues for and provides evidence
consistent with nonprofit hospital managers' use of income-increasing
discretionary accruals to report higher profits when charity care meets
or exceeds external stakeholders' expectations. Therefore, empirical
evidence to date supports the argument that managers of non-profit
hospitals use both accrual-based and real activities earnings manage­
ment tools to meet zero or profitable benchmark expectations.
In contrast to our expectation that non-profit hospitals manage
earnings to a lower target than for-profit hospitals do, a paper by Ver­
meer et al. (2014) examines the aggressiveness of financial reporting in a
sample of Maryland non-profit and for-profit firms using actuarial as­
sumptions for defined benefit pension plans.7Vermeer et al. (2014) show
that non-profit managers select more aggressive actuarial assumptions
than for-profit managers, effectively reducing pension liabilities and
inflating reported earnings. The authors argue that this aggressiveness is
due to the lack of regulatory oversight of non-profits compared to for-
profits.
However, Vermeer et al. (2014) acknowledge that, in contrast with
other industries, non-profit and for-profit hospitals face similar regula­
tory oversight. This similarity in oversight provides us the opportunity
to build on the work done by Vansant (2015), which examines accrual
earnings management in non-profit hospitals, and by Vermeer et al.
(2014), which compares a specific accrual estimate between for-profits
and non-profits from various industries (and consequently, various
regulatory environments). Further, we augment our comparison of
earnings management practices between for-profit and non-profit hos­
pitals by introducing real activities earnings management, following
work done by Eldenburg et al. (2011). Using the healthcare industry in
which regulatory oversight is relatively consistent (Eldenburg et al.,
2017) and in which managers have access to both accruals-based and
real activities earnings management tools, we are better able to isolate
6
Specifically, non-profit hospitals and healthcare centers are exempt from
paying income, property, and sales tax in exchange for providing community
benefits, such as uncompensated care, education, and outreach programs.
7
Pension plan assumptions require a significant degree of judgment on a
manager's part. Furthermore, this judgment can have a significant impact on
reported earnings. For example, a modest change in an estimate, such as the
expected return on plan assets, can significantly affect reported earnings
(Bergstresser, Desai, and Rauh, 2006; Webster, 2004).
3
Advances in Accounting 58 (2022) 100612
the effect of differing ownership type on reporting behavior.
2.2. Income-increasing earnings management
Given stakeholders' different expectations for earnings from for-
profit and non-profit hospitals, we anticipate that the non-profit man­
ager's task of reporting earnings at or slightly above zero would require a
different strategy of earnings management than the for-profit manager's
task of consistently reporting positive earnings. For instance, both non-
profit managers and for-profit managers may find themselves in a situ­
ation where (pre-managed) economic earnings are slightly below zero. A
non-profit manager may wish to increase reported earnings to zero in
order for the firm to appear as a going concern. Once assured that the
non-profit hospital is economically viable, the hospital's stakeholders
may interpret the lack of profitability as evidence that the hospital is
spending resources to benefit the community. In contrast, a for-profit
manager's stakeholders are unlikely to accept zero reported earnings
because that signals a poor return on their financial investment, so a for-
profit manager has an additional incentive to report positive earnings.
Continuing our discussion of incentives relating to performance,
efficient compensation contracts have the ability to align managerial
effort with stakeholders' interests (Banker, Lee, Potter, & Srinivasan,
1996; Hemmer, 1993; John & John, 1993; Mehran, 1995; Wallace,
1997). Consequently, we expect that for-profit hospital managers are
partially compensated based on earnings, given that for-profit organi­
zations' stakeholders are generally interested in receiving a financial
return on their investment. Thus, in addition to providing a return to
owners, we also expect for-profit hospital managers to engage in
income-increasing earnings management to maximize their personal
compensation, (e.g., Guidry, Leone, & Rock, 1999; Healy, 1985;
Holthausen, Larcker, & Sloan, 1995).
Like for-profit managers, non-profit managers may also have in­
centives to be efficient operationally (Leone & Van Horn, 2005; Vansant,
2015). Eldenburg and Krishnan (2008) argue and find evidence that in
response to compensation incentives, non-profit managers demand in­
formation about cost reduction and about equipment and operating
expenditures. Moreover, existing empirical evidence also suggests that
non-profit CEOs' compensation is related to financial performance
(Brickley & Van Horn, 2002; Eldenburg & Krishnan, 2008; Lambert &
Larcker, 1995). Furthermore, Eldenburg et al. (2015) show that finan­
cial performance measures are prevalent within incentive compensation
structures in large non-profit hospitals. The authors argue that a more
competitive environment and greater cost pressures have increased non-
profit hospitals' reliance on profit-based compensation contracts.
Consistent with their argument, Eldenburg et al. (2011) provide evi­
dence that non-profit managers respond to profit-based compensation
incentives by using real activities manipulations that reduce
expenditures.
However, unlike for-profit hospital managers, non-profit managers
also have incentives to conform to their hospitals' mission to provide
community benefits. Eldenburg et al. (2015) show that while for-profit
managers' compensation is negatively associated with the level of
charity care provided, non-profit managers are not penalized through
compensation for charity care offerings. In addition, there is some evi­
dence that non-profit managers' compensation can be based on measures
that reduce earnings (Preyra & Pink, 2001). Thus, on average, we expect
non-profit managers to manipulate earnings using income-increasing
methods to a lesser degree than for-profit managers do. We formulate
hypothesis H1a as follows:
H1a. : Income-increasing earnings management is lower in non-profit
hospitals than in for-profit hospitals.
2.3. Income-decreasing earnings management
Consider a situation where both for-profit and non-profit managers
J.N. Cannon et al.
have positive (pre-managed) economic earnings. In this case, a for-profit
manager's stakeholders may interpret the positive economic earnings as
evidence that the hospital is providing an adequate return on their
financial investment. In contrast, a non-profit manager's stakeholders
may infer from the profitability that the non-profit hospital is not ful­
filling its responsibility to provide community benefits to the degree that
it could or should. Furthermore, profitable non-profit hospitals may be
pressured by third-party payers to reduce reimbursable charges and/or
may find a decrease in contributions by donors who do not see profitable
hospitals to be a charity in need (Leone & Van Horn, 2005). Thus, on
average, we expect non-profit managers to use income-decreasing
earnings management methods to a greater degree than for-profit
managers do, as formally hypothesized below:
H1b. : Income-decreasing earnings management is higher in non-profit
hospitals than in for-profit hospitals.
2.4. Inter-period earnings management
Our preceding discussion takes the perspective of a single period's
performance. It is possible, though, that managers manipulate earnings
to more consistently meet stakeholders' expectations over time (DeFond &
Park, 1997; Demerjian et al., 2020). Consider a situation where both a
non-profit and a for-profit hospital have negative pre-managed earnings.
Both the non-profit and for-profit managers may consider taking a “big
bath” by creating reserves intended to increase or smooth future earn­
ings by booking additional income-decreasing accruals or by engaging in
additional spending in that period of losses (Kirschenheiter & Melamud,
2002). However, in an earlier study, Holthausen et al. (1995) find no
evidence that CEOs manage earnings downward when they do not meet
performance benchmark minimums. Conversely, Haggard, Howe, and
Lynch (2015) show that earnings do become smoother after managers
engage in big bath behavior.
While it is likely that for-profit hospital managers and their stake­
holders benefit from reporting a smooth series of consistently growing
earnings (Demerjian et al., 2020), we expect that these incentives are
generally smaller for non-profit managers and their stakeholders for two
reasons. First, we do not expect that non-profit managers need to
manage earnings upward to the same degree that for-profit managers do
to satisfy stakeholders. Second, there is likely to be less scrutiny applied
to a non-profit that reports negative earnings than to a for-profit hospital
that does. Consequently, when pre-managed earnings are negative, we
expect non-profit managers to engage in income-increasing earnings
management to a lesser degree than for-profit managers do.
H2a. : In cases of pre-managed losses, income-increasing earnings man­
agement is lower in non-profit hospitals than in for-profit hospitals.
Now consider a situation where both a for-profit and a non-profit
hospital have large positive pre-managed earnings. The for-profit and
non-profit managers may consider creating reserves intended to defer
current earnings into future periods by booking income-decreasing ac­
cruals or by engaging in additional spending (Guidry et al., 1999; Healy,
1985; Holthausen et al., 1995). However, although non-profit managers
may have an incentive to demonstrate that their hospitals are econom­
ically viable, we do not expect non-profit managers to derive benefit
from deferring current earnings into the future, as might be the case if
non-profit managers used income-decreasing accruals that reverse in a
future period. In contrast, for-profit hospital managers derive benefits
from maintaining a steady stream of consistently growing earnings
(Demerjian et al., 2020). Consequently, when pre-managed earnings are
high, we expect non-profit managers to engage in income-decreasing
earnings management to a lesser degree than for-profit managers do.
H2b. : In cases of high pre-managed profits, income-decreasing earnings
management is lower in non-profit hospitals than in for-profit hospitals.
4
Advances in Accounting 58 (2022) 100612
3. Measurement of variables and model specification
Our main variables of interest are proxies for earnings management
using discretionary accruals and real activities manipulations.
3.1. Discretionary accruals manipulations
Following Heese (2018), we use the Jones (1991) discretionary ac­
cruals model to calculate discretionary accruals by estimating the
following regression by hospital:
ACCt /At− = α0 + α1 1/At− 1 + α2 ΔNETREV t /At− 1 + α3 PPEt /At− 1 + εt (1)
1
where ACCt/At− 1 is total accruals scaled by beginning-of-year total as­
sets. Following Hribar and Collins (2002), we compute total accruals
(ACCt) as the change in current assets less change in current liabilities
adjusted for depreciation expense, change in cash, and change in short-
term debt (i.e., ΔCA – ΔCL – ΔCASH + ΔSTDEBT – DEP EXP).8ΔNE­
TREVt/At− 1 is change in net patient revenue scaled by the beginning-of-
year total assets balance. PPEt/At− 1 is gross property, plant, and equip­
ment also scaled by beginning-of-year total assets. The residuals from
model (1) proxy for abnormal accruals (AM), also referred to as
discretionary accruals.
3.2. Real activities manipulations
To estimate abnormal real activities, we use a model employed by
Roychowdhury (2006), Zang (2012), and Heese (2018). We employ the
model to measure abnormal patient service costs and abnormal discre­
tionary expenses by firm9:
PATSERV t /At− = β0 + β1 1/At− 1 + β2 NETREV t /At− 1 + τt (2)
1
DISX t /At− = γ 0 + γ 1 1/At− 1 + γ2 NETREV t− 1 /At− 1 + υt (3)
1
where PATSERVt/At− 1 is patient service costs scaled by beginning-of-
year total assets and DISXt/At− 1 is discretionary expenditures (sum of
R&D and general and administrative expenses), scaled by beginning-of-
year total assets. NETREVt/At− 1 is net revenue scaled by beginning-of-
year total assets. The residual from model (2) is our proxy for
abnormal patient service costs, and the residual from model (3) is our
proxy for abnormal discretionary expenses.10 We split abnormal patient
service costs and abnormal discretionary expenses into separate proxies
for real earnings management because we expect that managers make
different trade-offs when deciding whether to adjust patient-service-
related costs or discretionary expenditures. Specifically, we expect
that hospital managers are less likely to reduce costs related to revenue-
generating patient care activities in an effort to increase reported
earnings. In contrast, managers may add discretionary costs, less likely
to generate revenue, as they strive to decrease reported earnings.
Because positive discretionary costs and expenditures are opposite in
their impact on earnings from positive values of discretionary accruals,
consistent with Roychowdhury (2006) and Heese (2018), we multiply
discretionary patient service costs and discretionary expenditures by
negative one to obtain our measures of real earnings management (RM1t
and RM2t). Hence, an increase (decrease) in AMt and an increase
(decrease) in RM1t or RM2t imply an increase (decrease) in earnings.
8
We employ a balance sheet approach to compute total accruals, because
MCRs do not include a statement of cash flows.
9
While Heese (2018) uses a predictive model for discretionary expenditures,
he does not use real earnings management through patient service costs.
10
Zang (2012) measures real earnings management as the sum of abnormal
production costs and abnormal discretionary expenses. Instead of production
costs, we use patient service costs, which are the costs of medical care provided
to all patients. The values used for patient service costs are the gross costs re­
ported by hospitals, prior to any adjustments that may include accruals.
J.N. Cannon et al.
3.3. Hospital ownership measure
Our dependent variable, designed to test H1a, H1b, and H2a, H2b, is
a dichotomous variable NFP, which is set to one if the hospital is a non-
profit organization, and zero if the hospital is a for-profit organization
(Eldenburg & Krishnan, 2008).
3.4. Model specification
To test our hypotheses we estimate the following ordinary least
squares (OLS) regression11:
EM t = δ0 + δ1 NFP + δ2 NOAt–1 + δ3 Market Sharet− 1 + δ4 Sizet
+ δ5 ROAt–1 + δ6 Occupancy Ratet + δ7 ALOSt + δ8 CMI t + δ9 %DSH t
+ δ10 TEACH + δ11 RURAL + δ12 RELIGIOUS + δ13 UCCt
∑ ∑
+ δj Yeart + δk Statet + φt (4)
In model (4), EMt assumes the value of each of our measures for
earnings management, estimated using models (1), (2), and (3). We
separate abnormal accruals that increase earnings from those that
decrease earnings, and label them Pos_AMt and Neg_AMt, respectively.
Similarly, we separate real activities manipulations into those that have
positive and negative impacts on earnings. We label income-increasing
and income-decreasing patient care cost manipulations and discre­
tionary cost manipulations Pos_RM1t, Neg_RM1t, Pos_RM2t, and
Neg_RM2t, respectively. NFP is a dichotomous variable identifying hos­
pital ownership as defined in the preceding section. The estimate δ1
captures a difference in earnings management in non-profit hospitals,
compared to for-profit hospitals.
The rest of the variables in the model represent a set of controls for
alternative explanations or confounding constructs.
NOAt-1 (asset intensity) is net operating assets measured at the
beginning of the year divided by the previous year's net revenues. Net
operating assets are equal to shareholders' equity (total fund balance in
non-profits) minus cash and marketable securities, and minus total lia­
bilities. We expect parameter estimates on NOAt-1 that indicate a larger
degree of accruals earnings management because the magnitude of net
operating assets captures managers' flexibility to utilize asset-based ac­
cruals in earnings management (Barton & Simko, 2002; Heese, 2018).
Conversely, we expect parameter estimates on NOAt-1 that indicate a
smaller degree of real activities earnings management because it cap­
tures the opportunity to substitute accruals management for real activ­
ities management.
Market Sharet− 1 is the lagged ratio of a hospital's net revenue to the
total revenue of all hospitals in the county.12Market Sharet− 1 is a proxy
for market‑leader status in the industry, to control for the positive effect
of leadership on hospitals' ability to acquire funding (Geiger & Ittner,
1996). We further expect that greater market share is associated with
less relative performance evaluation that forms expectations for hospi­
tals' earnings targets (Eldenburg & Krishnan, 2008). Both of these effects
suggest that greater Market Sharet− 1 is associated with less earnings
manipulation.
Sizet is the natural log of total assets.13 We include Sizet to control for
governance, monitoring, and other size-related firm characteristics that
11
The hospital-year is our unit of observation. Although every observation's
value fluctuates by hospital, some variable values are constant across time
(NFP, TEACH, RURAL, RELIGIOUS) and others are measured with a lag (NOA,
Market Share, ROA). Thus, we include the subscript t as a time indicator but do
not include a hospital subscript.
12
We find in untabulated tests that our inferences remain unchanged if we use
the revenue-based Herfindahl-Hirschman index instead of Market Sharet− 1 in
our OLS estimations.
13
In additional untabulated tests, we use the number of occupied beds as a
proxy for hospital size instead of assets when estimating model (4). These tests
do not alter our inferences.
5
Advances in Accounting 58 (2022) 100612
might reduce earnings management (Dong, 2016; Eldenburg et al.,
2011; Heese, 2018; Morrisey, Wedig, & Hassan, 1996). Prior studies
have found that for-profit hospitals are smaller than non-profit hospitals,
further emphasizing the importance of controlling for size in our ana­
lyses (Forgione, 1987; Forgione, Schiff, & Crumbley, 1996).
ROAt–1 is calculated by dividing the previous year's net income by
total assets as of the beginning of the previous year. We include ROAt–1
to account for the influence of firms' previous performance in setting a
benchmark for current-period earnings (Heese, 2018). We expect man­
agers to be generally under more pressure to manage earnings upward
when their previously reported performance was high and under more
pressure to manage earnings downward when previous performance
was low, to avoid ratcheting earnings expectations upward (Leone &
Rock, 2002).
Occupancy Ratet captures operating efficiency by dividing the num­
ber of patient-days by the number of staffed bed-days, calculated as
available beds × 365 days (Eldenburg & Krishnan, 2008; Heese, 2018).
Eldenburg et al. (2011) provide some evidence that real activities
earnings management is associated with operating efficiency. It is
possible that managers are hesitant to cut costs for fear of reducing ef­
ficiency. It is also possible that managers feel they have more flexibility
in cutting costs as demand falls when they are making efficient use of
their resources.
ALOSt (average length of stay) is the total number of patient-days
divided by patient discharges. We include ALOSt because the time
spent in the hospital per patient influences capacity utilization, perfor­
mance, costs, and managers' expenditures on accounting information
(Bai, 2013; Eldenburg & Krishnan, 2008; Lynk, 1995), all of which might
influence managers' use of accruals and real activities earnings man­
agement. Prior studies have found that for-profit hospitals have shorter
average lengths of stay than non-profit hospitals, emphasizing the need
to include ALOSt in the model (Forgione, 1987; Forgione et al., 1996).
CMIt (case mix index) is a measure of the intensity of patient
healthcare needs serviced by hospital-year, obtained from the CMS. We
include CMIt in our earnings management analyses because we believe
that variation in the mix of services rendered might influence those real
activities managed, and their trade-off with accruals earnings manage­
ment (Heese, 2018). Eldenburg et al. (2017) observe that for-profit
hospitals have less intensive case mixes than non-profit hospitals,
emphasizing the importance of including CMIt in our analyses (Forgione,
1987; Forgione et al., 1996).
%DSHt is a proxy for the number patients served who are considered
indigent. It is possible that some of these patients could pay out of pocket
for a portion of the medical services they received. However, we expect
that the payments received might be lower or incomplete relative to
payments received from insurance providers, putting downward pres­
sure on earnings (Molnar, 2004; Rundle & Davies, 2004). Consequently,
we include %DSHt to account for any effect the downward pressure
might have on earnings management.
TEACH, RURAL, and RELIGIOUS are indicator variables set to the
value of one if the hospital is associated with healthcare education,
located in a rural community, and affiliated with a religious institution,
respectively.14 We include these control variables to account for char­
acteristics common to these types of hospitals that might influence
earnings, earnings targets, earnings management flexibility, and
consequently earnings management behavior (Eldenburg & Krishnan,
2008; Heese, 2018).
UCCt (proportion of uncompensated care) is measured by dividing
uncompensated care costs by net revenues (Lamboy-Ruiz, Cannon, &
Watanabe, 2019). We include the proportion of uncompensated care to
account for charity care offerings that might otherwise appear to be real
14
None of the hospitals in our sample changed their rural, religious or
teaching hospitals status, therefore we do not use subscript “t” for variables
TEACH, RURAL or RELIGIOUS.
J.N. Cannon et al. Advances in Accounting 58 (2022) 100612

activities earnings management. Further, consistent with the argument Table 1

made by Vansant (2015), we include UCCt to capture managers' use of Sample Selection.
charity care to manage earnings to meet a particular target. Screening procedure Number of hospital-year
Finally, we include bi-directional (income-increasing and income- observations
decreasing) measures of real earnings management using patient care All reports available in Healthcare Cost Report
costs (RM1t) and discretionary costs (RM2t) as control variables when Information System for U.S. hospitals (50 states and
31,329
explaining managers' use of accruals earnings management. We do this D.C.) with stable ownership available for years
to account for the timing of managers' earnings management decisions. 2011–2016
Less: reports from government hospitals (6913)
That is, managers make their real activities earnings management de­ 24,416
cisions throughout the reporting operational period, while they engage Less: reports from specialty hospitals (9585)
in accruals earnings management after the period's operations have 14,831
concluded (Zang, 2012). Less: reports with reporting periods of less or >12
(621)
months
We also include state indicator variables to control for idiosyncratic
14,210
factors that might differ among states, including unknown regulations Less: reports with negative total assets and/or negative
that might influence the financial reporting environment and/or earn­ (1548)
gross and net patient revenues
ings benchmarks of hospitals, hence affecting their earnings manage­ 12,662
ment decisions. We include year indicator variables to control for Less: reports for hospitals that have fewer than 6
(1958)
observations for years 2011–2016
general economic conditions in each year. We estimate all OLS re­ 10,704
gressions using robust standard errors clustered at the hospital level to Less: reports with missing values for control variables (768)
account for any correlation between a given hospital's residuals across Final sample of 1656 unique hospitals 9936
years (Petersen, 2009).

entities that cannot rely solely on government subsidies to sustain op­

4. Sample selection and descriptive statistics
erations (Balakrishnan et al., 2010; Eldenburg et al., 2017; Kallapur &
Eldenburg, 2005). Next, we remove 9585 reports from specialty hospi­
We obtain hospital financial data from the Healthcare Cost Report
tals, whose production functions, patient mix, and government re­
Information System of the CMS. This database contains financial state­
imbursements differ from those of acute care general hospitals
ments and operational data for most U.S. hospitals and is one of the
(Eldenburg et al., 2011). Next, we remove 621 reports that cover either
primary public sources of comprehensive hospital financial information
fewer or >12 months per year. This report pattern is usually indicative
(Eldenburg et al., 2017). CMS collects hospital financial information
of hospitals that initiate/end their contract with the CMS, change their
annually in the form commonly known as the MCR.15 Hospitals submit
fiscal-year period, or change their ownership type (CMS, 2007). As the
an MCR to a Medicare Administrative Contractor in order to receive
next data screening, we remove MCRs with negative total assets, nega­
updated prospective payments for the following year. Due to continuous
tive gross patient revenue, and/or negative net patient revenue. We
revisions and appeals of cost reports during the reimbursement process,
require six observations for each unique hospital in our sample to ensure
the database is not static and contains only the last report submitted.16
that each hospital is present through the entire sample period. Thus, we
We follow existing literature (e.g., (Eldenburg, Hermalin, Weisbach,
remove 1958 reports from hospitals that are missing observations from
& Wosinska, 2004); Eldenburg et al., 2015; Vansant, 2015; Lamboy-Ruiz
2011 through 2016. Lastly, we remove hospital-years with missing
et al., 2019) by focusing on non-federal, general short-term acute hos­
values necessary to compute control variables. Our final sample contains
pitals, which represent 60% of all U.S. hospitals, share the same largest
9936 hospital-year observations, covering 1656 hospitals. We winsorize
client (i.e., the federal government), and have a common reimbursement
all continuous control variables at the 1% and 99% levels to control for
methodology. We begin our sample period in 2011 because this allows
potential outliers.
us to use MCRs filed under the same, most recent MCR format to mini­
Table 2, panels A and B present the sample distribution and earnings
mize the likelihood of using incomparable data.17 We outline the sample
management variable descriptive statistics by ownership type and by
selection process in Table 1.
year. The numbers of non-profit and for-profit hospitals in the sample
There are 31,329 report-years for all U.S. hospitals (excluding U.S.
are 1206 and 450, respectively. We observe that the absolute magni­
territories) with stable ownership from 2011 through 2016. We first
tudes of the for-profit hospitals' earnings management proxies are
remove 6913 reports of government hospitals. Non-profit hospitals,
greater in each year and across years than are the non-profit hospitals'
while sharing certain characteristics with government hospitals (i.e.,
earnings management proxies. In panel C, we display the distribution of
their missions include social objectives), are typically self-sustaining
hospitals by state. Five states account for 34.8% of the sample: California
(900 observations), Texas (834 observations), Florida (606 observa­
tions), Pennsylvania (594 observations), and Ohio (528 observations).
15
MCRs are submitted using various forms, containing preset worksheets, We address states with a disproportionately large number of observa­
similar to IRS tax forms. In Appendix A we reference to specific worksheets and tions in our sample in the robustness analysis section of our paper.
line items on the forms where we obtain relevant financial information. In Table 3, panels A and B we present non-profit and for-profit
16
At the end of the year, Medicare reconciles its prepayments to hospitals and
hospitals' summary statistics, respectively, for the variables used in the
the billings submitted by the hospitals with the hospital's cost report. A hospital
OLS model (4). On average, non-profit hospitals in our sample report
can appeal Medicare's final decision by submitting a new cost report. Medicare
can also request an amended report from hospitals. We obtained the latest mean positive and negative discretionary accruals (Pos_AMt and Neg_­
update of the data used in this study from the CMS database on February 2, AMt) of 0.035 and− 0.035 that are more than twice the magnitude of the
2018. means, ±0.014 and ±0.016, of the respective real activities earnings
17
MCR format changed in 2010. Prior to 2010, hospitals used the 1996 management (Pos_RM1t, Pos_RM1t and Neg_RM1t, Neg_RM1t), as a pro­
reporting format, which did not disaggregate charity care costs and bad debt portion of total assets. However, given that the mean sample return on
expense components of uncompensated care costs, among other things (Lam­ total assets (ROAt-1) is 0.066, the economic magnitudes of all earnings
boy-Ruiz et al., 2019). The 2010 MCR format has improved the presentation management measures are meaningful, ranging from 21% to 53% of
and disclosure of uncompensated care costs, which are part of patient service average return on total assets. Turning to for-profit hospitals, we observe
costs that we use to estimate one of our real earnings manipulations proxies.
much higher mean values of Pos_AMt and Neg_AMt of 0.129 and − 0.129,
While a majority of hospitals still submitted MCRs using the 1996 format in
respectively. Similar to non-profit hospitals, we see that discretionary
2010, by 2011 all hospitals used the new MCR format.

6
J.N. Cannon et al. Advances in Accounting 58 (2022) 100612

Table 2
Descriptive statistics.
Panel A: Frequency of observations, and earnings management measures for non-profit hospitals by year

Fiscal Year N % Pos_AMt Pos_RM1t Pos_RM2t Neg_AMt Neg_RM1t Neg_RM2t

2011 1206 16.67% 0.028 0.016 0.018 − 0.029 − 0.010 − 0.014

2012 1206 16.67% 0.034 0.015 0.016 − 0.039 − 0.012 − 0.018
2013 1206 16.67% 0.037 0.013 0.018 − 0.037 − 0.015 − 0.016
2014 1206 16.67% 0.045 0.014 0.019 − 0.033 − 0.016 − 0.016
2015 1206 16.67% 0.038 0.013 0.013 − 0.037 − 0.015 − 0.018
2016 1206 16.67% 0.028 0.011 0.013 − 0.037 − 0.015 − 0.016
Total / Average 7236 100.00% 0.035 0.014 0.016 − 0.035 − 0.014 − 0.016

Panel B: Frequency of observations, and earnings management measures for for-profit hospitals by year

Fiscal Year N % Pos_AMt Pos_RM1t Pos_RM2t Neg_AMt Neg_RM1t Neg_RM2t

2011 450 16.67% 0.106 0.032 0.044 − 0.098 − 0.018 − 0.029

2012 450 16.67% 0.113 0.028 0.042 − 0.137 − 0.021 − 0.035
2013 450 16.67% 0.170 0.024 0.048 − 0.138 − 0.026 − 0.044
2014 450 16.67% 0.148 0.027 0.041 − 0.151 − 0.026 − 0.051
2015 450 16.67% 0.118 0.022 0.039 − 0.141 − 0.028 − 0.054
2016 450 16.67% 0.120 0.016 0.047 − 0.109 − 0.030 − 0.029
Total / Average 2700 100.00% 0.129 0.025 0.044 − 0.129 − 0.025 − 0.040

Panel C: Sample distribution by state

State N % State N %

AK 24 0.24% MT 48 0.48%
AL 96 0.97% NC 150 1.51%
AR 156 1.57% ND 18 0.18%
AZ 156 1.57% NE 84 0.85%
CA 900 9.06% NH 66 0.66%
CO 168 1.69% NJ 180 1.81%
CT 132 1.33% NM 84 0.85%
D.C. 24 0.24% NV 78 0.79%
DE 24 0.24% NY 318 3.20%
FL 606 6.10% OH 528 5.31%
GA 216 2.17% OK 198 1.99%
HI 36 0.36% OR 120 1.21%
IA 108 1.09% PA 594 5.98%
ID 42 0.42% RI 30 0.30%
IL 462 4.65% SC 132 1.33%
IN 252 2.54% SD 66 0.66%
KS 162 1.63% TN 282 2.84%
KY 234 2.36% TX 834 8.39%
LA 168 1.69% UT 132 1.33%
MA 234 2.36% VA 234 2.36%
MD 132 1.33% VT 30 0.30%
ME 60 0.60% WA 126 1.27%
MI 282 2.84% WI 252 2.54%
MN 198 1.99% WV 84 0.85%
MO 216 2.17% WY 24 0.24%
MS 156 1.57% Total 9936 100.00%

Notes:Panels A and B present overall and annual means of earnings management measures by hospital ownership type. Pos_AMt (Neg_AMt) is positive (negative)
discretionary accruals, proxied by the residuals from the discretionary accruals model of Jones (1991). Pos_RM1t (Neg_RM1t) is income-increasing (− decreasing) real
earnings manipulations, proxied by the residuals from the expected patient service cost model (2) multiplied by − 1. Patient service cost includes costs of providing
patient services for inpatient routine services, ancillary services, ambulatory services, and outpatient services, scaled by the beginning-of-year total assets. Pos_RM2t
(Neg_RM2t) is income-increasing (− decreasing) real earnings manipulations, proxied by the estimated residuals from the expected discretionary expenditures model
(3) multiplied by − 1. Discretionary expenditures are the sum of R&D and general and administrative expenses, scaled by the beginning-of-year total assets. Panel C
presents sample composition by state (including District of Columbia).

accruals are much larger in absolute magnitude that either the mean
patient service cost (+0.026, − 0.025) or discretionary cost (+0.044,
− 0.042) manipulations. Together, these descriptive statistics suggest
that for-profit managers make greater use of earnings management
relative to non-profit managers.
The non-profit hospitals in our sample are large-sized hospitals, with
average assets of approximately $203 million (mean Sizet is 19.127), and
control 47.6% of the local market share, while the for-profit hospitals
have average total assets of $56 million (mean Sizet is 17.836) and
control 37.0% of their market share. As might be expected given their
different missions, non-profit hospitals have a larger proportion of assets
to revenue (mean NOAt–1 is 1.069) and smaller returns on assets (mean
ROAt–1 is 0.066), when compared with for-profit hospitals (mean NOAt–1
is 0.648 and mean ROAt–1 is 0.225).
Non-profit hospitals have somewhat greater utilization (mean Oc­
cupancy Ratet of 0.679) than do for-profit hospitals (mean Occupancy
Ratet of 0.542). However, both patient lengths of stay and case mix in­
tensity are relatively comparable (non-profit and for-profit mean ALOSt
of 4.385 and 4.026, and mean CMIt of 1.517 and 1.554, respectively).
We also observe that while non-profit hospitals serve a smaller pro­
portion of uninsured patients than do for-profit hospitals (mean %DSHt
of 0.268 compared with 0.288), the mean proportion of uncompensated

7
J.N. Cannon et al. Advances in Accounting 58 (2022) 100612

Table 3 might be expected, none of the for-profit hospitals are affiliated with
Summary Statistics. religious organizations. Finally, non-profit hospitals are much more
Panel A: Summary statistics—non-profit hospitals likely to engage in healthcare education and research (mean TEACH of
subsample 0.424) than are for-profit hospitals (mean TEACH of 0.184).
Variable N Mean Median Std. 25th 75th
Dev. Pctl Pctl 5. Empirical analysis
Pos_AMt 3633 0.035 0.017 0.053 0.006 0.040
Pos_RM1t 3614 0.014 0.007 0.020 0.003 0.016 5.1. Univariate analysis
Pos_RM2t 3617 0.016 0.009 0.023 0.003 0.020
Neg_AMt 3603 − 0.035 − 0.017 0.053 − 0.041 − 0.007 Fig. 1 provides a visual representation and Table 4 presents a uni­
Neg_RM1t 3622 − 0.014 − 0.007 0.021 − 0.016 − 0.003
variate analysis of differences in our earnings management proxies be­
Neg_RM2t 3619 − 0.016 − 0.008 0.024 − 0.019 − 0.003
NFP 7236 1.000 1.000 0.000 1.000 1.000 tween non-profit and for-profit hospitals. First, consistent with our H1a,
NOAt–1 7236 1.069 0.921 0.594 0.665 1.323 mean and median values of Pos_AMt, Pos_RM1t, and Pos_RM2t are lower
Market 7236 0.476 0.370 0.380 0.112 1.000 in non-profit hospitals than in for-profit hospitals, with significant dif­
Sharet–1 ferences at p-values of <0.01. Second, contrary to our expectation stated
Sizet 7236 19.127 19.179 1.179 18.345 19.947
ROAt–1 7236 0.066 0.051 0.126 0.013 0.101
in H1b, mean and median values of Neg_AMt, Neg_RM1t, and Neg_RM2t
Occupancy 7236 0.679 0.695 0.232 0.514 0.839 are less negative in non-profit hospitals than in for-profit hospitals (all p-
Ratet values <0.01). Taken together, this is the first set of evidence that non-
ALOSt 7236 4.385 4.305 0.971 3.806 4.828 profit hospital managers engage in less income-increasing and income-
CMIt 7236 1.517 1.508 0.266 1.340 1.687
decreasing earnings management activities than do for-profit hospital
%DSHt 7236 0.268 0.244 0.144 0.177 0.328
TEACH 7236 0.424 0.000 0.494 0.000 1.000 managers.
RURAL 7236 0.759 1.000 0.428 1.000 1.000
RELIGIOUS 7236 0.235 0.000 0.424 0.000 0.000 5.2. Correlations
UCCt 7236 0.042 0.034 0.031 0.020 0.054

Table 5 presents the Pearson correlation coefficients among the

variables of interest. Pos_AMt, Pos_RM1t, and Pos_RM2t have negative
Panel B: Summary statistics—for-profit hospitals subsample and significant correlation coefficients with NFP (ρ = − 0.25, − 0.19, and
Variable N Mean Median Std 25th Pctl 75th Pctl − 0.31), while Neg_AMt, Neg_RM1t, and Neg_RM2t each have a positive
Dev and significant correlation with NFP (ρ = 0.25, 0.19, and 0.28). These
Pos_AMt 1347 0.129 0.026 0.296 0.009 0.098 correlations are consistent with univariate analyses reported in Table 4.
Pos_RM1t 1340 0.026 0.015 0.039 0.006 0.032 Given several high correlations among our test and control variables,
Pos_RM2t 1316 0.044 0.022 0.061 0.008 0.055
we test for potential multicollinearity by estimating variance inflation
Neg_AMt 1353 − 0.129 − 0.027 0.300 − 0.091 − 0.009
Neg_RM1t 1360 − 0.025 − 0.013 0.039 − 0.031 − 0.005
factors in our OLS analysis; none are greater than five.
Neg_RM2t 1384 − 0.042 − 0.019 0.063 − 0.049 − 0.007
NFP 2700 0.000 0.000 0.000 0.000 0.000 5.3. Test of hypotheses H1a and H1b
NOAt–1 2700 0.648 0.585 0.350 0.437 0.765
Market Sharet–1 2700 0.370 0.203 0.381 0.049 0.688
Table 6 reports estimation results for model (4), which we use to test
Sizet 2700 17.836 17.927 1.032 17.164 18.582
ROAt–1 2700 0.225 0.164 0.285 0.043 0.353 the association between earning management and ownership type. The
Occupancy 2700 0.542 0.520 0.263 0.327 0.753 dependent variables in columns (1), (2), (3), and (4), (5), and (6) are
Ratet income-increasing discretionary accruals (Pos_AMt), patient care cost
ALOSt 2700 4.026 4.097 1.194 3.356 4.675
manipulations (Pos_RM1t), discretionary cost manipulations (Pos_RM2t),
CMIt 2700 1.554 1.510 0.370 1.285 1.723
%DSHt 2700 0.288 0.257 0.200 0.145 0.374 and income-decreasing discretionary accruals (Neg_AMt), patient care
TEACH 2700 0.184 0.000 0.388 0.000 0.000 cost manipulations (Neg_RM1t), and discretionary cost manipulations
RURAL 2700 0.747 1.000 0.435 0.000 1.000 (Neg_RM2t), respectively. Our OLS estimations reflect an adjusted R-
RELIGIOUS 2700 0.000 0.000 0.000 0.000 0.000 squared between 9% and 17%.
UCCt 2700 0.035 0.027 0.032 0.013 0.047
In columns (1) and (3), the estimated coefficients on the indicator
Notes: This table presents summary statistics of variables used in the OLS re­ variable NFP are − 0.085 and − 0.022, and are statistically significant at
gressions. All variables are defined in Appendix A. the 1% level, indicating that non-profit hospitals exhibit lower income-
increasing discretionary accruals and discretionary cost manipulations
care of non-profit hospitals is 20% higher than that of for-profit hospitals relative to for-profit hospitals. These results provide evidence in support
(mean UCCt of 0.042 compared with 0.035).18 These differences suggest of H1a.
that for-profit hospitals serve a greater proportion of self-paying patients The estimated coefficients in columns (4) and (6) are 0.084 and
than do non-profit hospitals. 0.018, and are statistically significant at the 1% level. These results
Finally, we observe that the mean proportions of non-profit and for- indicate that non-profit hospitals exhibit lower income-decreasing
profits hospitals found in rural locations are comparable (mean RURAL discretionary accruals and discretionary cost manipulations relative to
of 0.759 and 0.747, respectively). Also, approximately 23.5% of non- for-profit hospitals. This evidence leads us to reject H1b and is consistent
profit hospitals are affiliated with a religious institution whereas, as with the notion that non-profit hospital managers do not have greater
incentives than for-profit hospital managers do to reduce earnings.
We observe in columns (2) and (5) no difference in the use of either
18 positive or negative patient-service-related (RM1) real earnings man­
Our means of uncompensated care costs scaled by net revenues for non-
agement between non-profit and for-profit hospitals. It appears that
profits and for-profits are somewhat similar to the 4.8% and 4.2% means re­
ported by Schuhmann (2008). We note, however, that Schuhmann's sample was where real earnings management does take place it occurs within
from 2003 to 2007 and that his data were extracted from MCRs under the 1996 discretionary (R&D and other general and administrative) expense
format. Our mean of the scaled uncompensated care costs in non-profits is the rather than in service-critical expense categories.
same as the 4.2% reported by Lamboy-Ruiz et al. (2019) for a sample of hos­ Overall, these empirical findings reflect that non-profit hospital
pitals from 2011 to 2014. managers have less incentive to create either positive or negative

8
J.N. Cannon et al. Advances in Accounting 58 (2022) 100612

0.150

Average value of the earnings management metric

0.125
0.100
0.075
0.050
0.025
0.000
(0.025)
(0.050)
(0.075)
(0.100)
(0.125)
(0.150)
Pos_AM Pos_RM1 Pos_RM2 Neg_AM Neg_RM1 Neg_RM2

Mean FP Mean NFP

Fig. 1. Earnings management by for-profit (FP) and non-profit (NFP) hospitals.

Table 4
Univariate comparisons.
Variable FP NFP NFP − FP

N Mean Median N Mean Median Diff.: Means Diff.: Medians Difference: Means Difference: Medians

T–stat Z–stat

Pos_AMt 1347 0.129 0.026 3633 0.035 0.017 − 0.094 − 0.009 − 11.59 *** − 11.59 ***
Pos_RM1t 1340 0.026 0.015 3614 0.014 0.007 − 0.012 − 0.008 − 10.69 *** − 16.03 ***
Pos_RM2t 1316 0.044 0.022 3617 0.016 0.009 − 0.027 − 0.014 − 15.96 *** − 20.38 ***
Neg_AMt 1353 − 0.129 − 0.027 3603 − 0.035 − 0.017 0.093 0.010 11.35 *** 11.03 ***
Neg_RM1t 1360 − 0.025 − 0.013 3622 − 0.014 − 0.007 0.011 0.006 10.38 *** 14.27 ***
Neg_RM2t 1384 − 0.042 − 0.019 3619 − 0.016 − 0.008 0.025 0.011 14.57 *** 18.23 ***

Notes: ***, **, and * denote significance at the 1%, 5%, and 10% levels (two-tail), respectively. This table presents comparisons of means (t-test) and medians
(Wilcoxon rank-sum test) of our earnings management measures for non-profit and for-profit hospitals. All variables are defined in Appendix A.

reserves to manipulate future earnings than do for-profit managers. Our
findings are significant not only statistically, but also economically. In
particular, for-profits exhibit higher income-increasing (− decreasing)
discretionary accruals of 8.5% (8.4%) of assets, and higher income-
increasing (− decreasing) discretionary costs-based real earnings man­
agement of 2.2% (1.8%) of assets.
Turning to control variables, we observe that several of the controls
are insignificant in the regression (e.g., Market Sharet-1, Occupancy Ratet,
ALOSt, RURAL, RM1t, and RM2t). We attribute their lack of significance
to our by-hospital estimation procedure for earnings management
behavior. Said another way, our earnings management models allow
parameters to vary by hospital, accounting for variation between
hospital-specific characteristics.
We do observe that previous year's net operating assets (NOAt-1) and
hospital size (Sizet) have negative associations with income-increasing
earnings management, and positive associations with both income-
decreasing real activities earnings management proxies. These pat­
terns suggest that asset intensity and size dampen hospitals' need to
engage in earnings management. Previous year's profitability (ROAt-1) is
only associated with income-decreasing discretionary cost manipula­
tions, suggesting that hospital managers use fewer income-decreasing
discretionary cost manipulations when previous-period profitability
was high. This relationship is consistent with hospitals using the previ­
ous period's earnings as a benchmark for current reported earnings.
The intensity of hospitals' case mix (CMIt) is significant across all
earnings management types and behaviors. However, the intensity is
associated with fewer income-increasing and income-decreasing
discretionary accruals and discretionary cost manipulations, but more
income-increasing and income-decreasing patient care cost manipula­
tions. This pattern suggests that case mix intensity provides hospital
managers with more flexibility to manipulate patient care cost, relaxing
the need to manage accruals and/or discretionary costs.
The proportion of uninsured patients (%DSHt) is associated with
greater use of income-increasing and income-decreasing discretionary
cost manipulations. Similarly, teaching hospitals (TEACH) engage in
more real activities earnings management, both income-increasing and
income-decreasing. It is possible that those hospitals caring for fewer
insured patients and that are affiliated with education have greater
variation in profitability, putting pressure on those hospitals to engage
in non-reversing earnings management.
We find that religiously affiliated hospitals (RELIGIOUS) tend to use
more accruals and discretionary cost manipulations to both increase and
decrease earnings. It is possible that these hospitals have an additional
oversight constituency that prefers predictable and consistent streams of
earnings. Alternatively, managers in religious hospitals may have higher
expectations placed on them relative to other non-profits. For instance,
Ballou and Weisbrod (2003) find that CEOs of religiously affiliated
hospitals receive the highest base salary among government, secular
non-profit, and religious non-profit hospitals.
Finally, we see that income-increasing accruals and patient care cost
manipulations are lower with marginal significance (p < 0.10) for hos­
pitals that provide more uncompensated care. Similarly, income-
decreasing discretionary costs are lower (p < 0.05) for hospitals that
provide more uncompensated care. Recall that there exist hospital types
with offsetting incentives to sustain operations through profitability and
to provide charity care (Balakrishnan et al., 2010; Eldenburg et al.,

9
J.N. Cannon et al. Advances in Accounting 58 (2022) 100612

2011). The significance of the UCCt control variable is consistent with

0.03
this type of incentive structure.

1.00
18

5.4. Test of hypotheses H2a and H2b

¡0.10

Notes: This table presents Pearson correlations for variables used in the OLS models. All bolded values represent statistical significance at the 0.10 level or above. All variables are defined in Appendix A.
0.03
1.00
17

In order to understand better the differences in for-profit and non-

profit hospital's earnings management when pre-managed earnings are

¡0.05
0.31
0.06
1.00
negative or high, we estimate pre-managed levels of return on net sales
16

(ROS). Because our earnings management proxies are scaled by

beginning-of-year assets, we first estimate pre-managed return on assets

− 0.01
− 0.01
0.14

0.22
(ROA) by calculating reported ROA and subtracting from it signed

1.00
15

discretionary accruals and both proxies for real activities. We then

multiply pre-managed ROA by a ratio of beginning-of-year assets to net

¡0.17

¡0.26
revenue, resulting in pre-managed ROS. We then split each hospital

0.31
0.40
0.06
1.00
14

type's pre-managed ROS into annual quintiles (where quintile 1 is the

lowest level of earnings, and quintile 5 is the highest level of earnings)
and perform cross-sectional OLS estimations of model (4) for each
0.05
0.29
0.31
0.22
0.02
0.03
1.00
13

quintile.
¡0.02 Fig. 2a presents mean for-profit and non-profit hospitals' pre-
managed ROS by quintile. Negative pre-managed ROS appears higher
0.50
0.35
0.12
0.45
0.38
0.10
1.00
12

(quintile 1), while positive pre-managed ROS appears lower (quintiles

2–5), in non-profit hospitals. In untabulated tests, we find these differ­
ences to be significant at p-values <0.01. In Fig. 2b, we display reported
¡0.14

¡0.12
¡0.06

¡0.09
¡0.14
0.24

0.08
1.00
0.01

ROS by ownership type, and note that non-profit managers report lower
11

ROS across all quintiles. These differences are also statistically signifi­
cant (p-values <0.01). Because we notice a linear pattern of for-profits'
¡0.14

¡0.10
0.68
0.35
0.40
0.03
0.47
0.33
0.16
1.00

mean reported earnings across quintiles, we then perform untabulated

10

tests of differences in pre-managed and reported ROS standard de­

viations by hospital ownership type. We find that the standard deviation
¡0.09
¡0.09
¡0.21
¡0.16
¡0.31
¡0.03
¡0.19
¡0.60

of reported ROS is lower than the standard deviation of pre-managed

0.15
1.00

0.00

ROS in for-profits, while for non-profits, there is no difference in the

9

standard deviation of pre-managed and reported ROS.

¡0.26

¡0.09

In Fig. 2c we present pre-managed ROS and reported ROS for both

− 0.01

− 0.01

− 0.01
0.07
0.50

0.11
0.04

0.05

0.08
1.00

for-profit and non-profit hospitals by quintile of pre-managed ROS.

8

Consistent with H2a and H2b, we observe the greatest degree of earnings
management differences between for-profit and non-profit hospitals in
¡0.36

¡0.05
¡0.06
0.33
0.12
0.45

0.25
0.15

0.22

0.28
0.09
1.00

0.01

quintiles 1 and 5. Further, it seems that in quintiles 1 and 2 (negative and

7

small positive earnings), both types of hospitals engage in income-

increasing earnings management, while in quintiles 4 and 5, they
¡0.04

¡0.17

− 0.02

exhibit patterns of “cookie jar” reserves by managing positive earnings

0.28
0.22

0.26

0.15
0.03
0.11

0.08
0.05
0.05
1.00

0.00
6

downward.
We next report OLS estimations of differences in earnings manage­
¡0.10

¡0.03
− 0.01

ment between for-profit and non-profit hospitals by quintile of pre-

0.26
0.19
0.26
0.03
0.31

0.18
0.09

0.08
0.03
0.05
1.00

0.00

managed ROS in Table 7. Because we observe in Fig. 2c generally uni­

5

directional earnings management behavior by quintile, we combine our

positive and negative earnings management metrics, and report only
¡0.03

¡0.11

¡0.06

− 0.01
0.13
0.20
0.25
0.12

0.17

0.10
0.03
0.06

0.07
0.06
0.05
1.00

estimated coefficients for variables AMt (Pos_AMt + Neg_AMt), RM1t

4

(Pos_RM1t + Neg_RM1t), and RM2t (Pos_RM2t + Neg_RM2t). Further,

because we compute pre-managed ROS by subtracting AMt, RM1t, and
¡0.27
¡0.33

¡0.31
¡0.24

¡0.28

¡0.16
¡0.05
¡0.11

¡0.08
¡0.06
¡0.05
0.06

0.17

0.04
1.00

0.00

RM2t from reported ROS, we examine an additional earnings manage­

N/A
3

ment variable, Total_EMt (AMt + RM1t + RM2t), to study overall earnings

management behavior. For brevity, we omit all included control vari­
¡0.15

¡0.27
¡0.19
¡0.24
¡0.03
¡0.31

¡0.16
¡0.10
¡0.03

¡0.08
¡0.02
¡0.05

ables and fixed effects, and only report the coefficient of interest, NFP.
0.30

0.08
1.00

0.00

0.00
N/A

Consistent with H2a, non-profit managers use significantly fewer

2

income-increasing discretionary accruals and discretionary cost ma­

¡0.17
¡0.14
¡0.25
¡0.12

¡0.17

¡0.11
¡0.04
¡0.06

¡0.07
¡0.05
¡0.04

nipulations than for-profit managers use (columns 1 and 3 coefficients

0.11
0.27

0.03

0.11

0.06
1.00

0.01
N/A

= − 0.169, − 0.018, p-values <0.01) when pre-managed earnings are

1

negative (quintile 1). Turning our attention to H2b, we see that as pre-
managed profits increase across quintiles 3, 4, and 5, non-profit man­
Occupancy Ratet
Market Sharet–1

agers use significantly fewer income-decreasing discretionary accruals

RELIGIOUS
Neg_RM1t
Neg_RM2t
Pos_RM1t
Pos_RM2t
Neg_AMt
Pos_AMt

RURAL
TEACH
NOAt–1

ROAt–1

%DSHt
ALOSt

UCCt
CMIt
Correlations.

Sizet
NFP
Table 5

10
11
12
13
14
15
16
17
18
19
1
2
3
4
5
6
7
8
9

10
J.N. Cannon et al. Advances in Accounting 58 (2022) 100612

Table 6
OLS regressions: hospital ownership and earnings management.
Dep. var. Pos_AMt Pos_RM1t Pos_RM2t Neg_AMt Neg_RM1t Neg_RM2t

(1) (2) (3) (4) (5) (6)

NFP − 0.085*** 0.000 − 0.022*** 0.084*** − 0.001 0.018***

[− 6.80] [− 0.15] [− 8.58] [6.83] [− 0.32] [7.72]
NOAt–1 − 0.009* − 0.003*** − 0.006*** 0.006 0.004*** 0.007***
[− 1.85] [− 3.67] [− 4.74] [1.09] [4.86] [5.76]
Market Sharet–1 0.013 − 0.001 0.001 − 0.005 0.001 − 0.002
[1.31] [− 0.44] [0.40] [− 0.46] [0.40] [− 0.84]
Sizet − 0.003 − 0.008*** − 0.004*** 0.005 0.008*** 0.004***
[− 0.73] [− 9.15] [− 3.78] [0.94] [9.49] [3.35]
ROAt–1 0.025 − 0.004 − 0.004 − 0.030 0.000 0.012**
[0.85] [− 0.88] [− 0.77] [− 0.99] [− 0.08] [2.10]
Occupancy Ratet − 0.018 0.004 − 0.002 0.011 − 0.001 0.005
[− 1.07] [1.50] [− 0.49] [0.68] [− 0.55] [1.19]
ALOSt 0.002 0.000 0.000 − 0.003 0.000 0.000
[0.58] [− 0.39] [− 0.16] [− 0.73] [− 0.73] [− 0.16]
CMIt − 0.038** 0.007*** − 0.007* 0.044*** − 0.008*** 0.006*
[− 2.51] [2.76] [− 1.87] [2.77] [− 3.08] [1.77]
%DSHt 0.044 0.002 0.026*** − 0.037 0.000 − 0.035***
[1.57] [0.43] [4.18] [− 1.35] [0.05] [− 5.83]
TEACH 0.007 0.004*** 0.006*** − 0.009 − 0.003*** − 0.003*
[0.96] [3.40] [3.46] [− 1.13] [− 2.94] [− 1.81]
RURAL 0.012 0.002 0.000 − 0.006 − 0.001 − 0.002
[1.30] [1.55] [0.18] [− 0.63] [− 0.76] [− 1.14]
RELIGIOUS 0.019*** 0.000 0.003** − 0.016*** 0.001 − 0.003**
[4.59] [− 0.22] [2.43] [− 3.63] [1.08] [− 2.15]
UCCt − 0.197* − 0.032* 0.026 0.122 − 0.016 0.058**
[− 1.88] [− 1.67] [0.93] [1.06] [− 0.55] [2.40]
RM1t − 0.062 − 0.046
[− 0.52] [− 0.30]
RM2t 0.113 − 0.015
[1.16] [− 0.15]
Constant 0.387** 0.146*** 0.125*** − 0.574* − 0.132*** − 0.119***
[2.42] [9.35] [6.56] [− 1.85] [− 9.33] [− 5.84]
Observations 4980 4954 4933 4956 4982 5003
Adjusted R2 0.09 0.14 0.17 0.09 0.15 0.16
State Fixed Effects Y Y Y Y Y Y
Year Fixed Effects Y Y Y Y Y Y
Clustered by hospital Y Y Y Y Y Y

Notes: ***, **, and * denote significance at the 1%, 5%, and 10% levels (two-tail), respectively. P-values are based on robust standard errors clustered at the hospital
level. All models include year and state fixed effects. T-statistics are reported in square brackets. Pos_AMt (Neg_AMt) is income-increasing (− decreasing) discretionary
accruals, proxied by the residuals from the discretionary accruals model of Jones (1991). Pos_RM1t (Neg_RM1t) is income-increasing (− decreasing) real earnings
manipulations, proxied by the residuals from the expected patient service cost model (2) multiplied by − 1. Patient service cost includes costs of providing patient
services for inpatient routine services, ancillary services, ambulatory services, and outpatient services, scaled by the beginning-of-year total assets. Pos_RM2t
(Neg_RM2t) is income-increasing (− decreasing) real earnings manipulations, proxied by the estimated residuals from the expected discretionary expenditures model
(3) multiplied by − 1. Discretionary expenditures are the sum of R&D and general and administrative expenses, scaled by the beginning-of-year total assets. NFP is a
dichotomous variable, coded 1 if a hospital is a non-profit hospital, 0 otherwise. All variables are defined in Appendix A

0.400
0.350
0.300
Average pre-managed ROS

0.250
0.200
0.150
0.100
0.050
0.000
(0.050)
(0.100)
(0.150)
(0.200)
1 2 3 4 5
Pre-managed ROS FP Pre-managed ROS NFP

Fig. 2a. Pre-managed ROS in for-profit (FP) and non-profit (NFP) hospitals by quintile of pre-managed return on sales (ROS).

11
J.N. Cannon et al. Advances in Accounting 58 (2022) 100612

0.400
0.350
0.300

Average pre-managed ROS

0.250
0.200
0.150
0.100
0.050
0.000
(0.050)
(0.100)
(0.150)
(0.200)
1 2 3 4 5

ROS FP ROS NFP

Fig. 2b. Reported return on sales (ROS) in for-profit (FP) and non-profit (NFP) hospitals by quintile of pre-managed ROS.

0.400
0.375
0.350
0.325
0.300
0.275
0.250
0.225
0.200
0.175
0.150
0.125
ROS

0.100
0.075
0.050
0.025
0.000
(0.025)
(0.050)
(0.075)
(0.100)
(0.125)
(0.150)
(0.175)
(0.200)
1 2 3 4 5

Pre-managed ROS FP ROS FP Pre-managed ROS NFP ROS NFP

Fig. 2c. Quintiles of mean reported return on sales (ROS) and pre-managed ROS in for-profit (FP) and non-profit (NFP) hospitals.

than do for-profit managers (less “cookie-jar” reserves).19 Importantly,
the differences in earnings management between non-profits and for-
profits are driven primarily by accrual manipulations, and that the
greatest differences occur in the first and fifth quintile (see columns 1
and 4). Consistent with results related to H1a and H1b, with the
exception of the quintile 3 subsample, we observe insignificant co­
efficients on NFP in column (2), suggesting no difference in the use of
service-critical real earnings management between non-profit and for-
profit hospitals.
We further note that the economic magnitude of the differences are
19
The positive NFP coefficients in quintiles 3, 4, and 5 may create an
impression than non-profits manage earnings upward relative to for-profits.
Note that had we coded the test variable using a for-profit indicator, FP, the
resulting negative estimate would be the inverse of NFP (or the difference be­
tween for-profits and non-profits). Therefore, for-profit managers use more
income-decreasing earnings management (i.e. “cookie-jar” reserves). Our in­
terpretations are also consistent with the visuals of earnings management be­
haviors by hospital type and pre-managed ROS quintile presented in Figure 2c.
also significant, ranging from − 17.9% to 25.7% of total assets. In short,
our analyses by quintile suggest that for-profit managers make more use
of discretionary accruals (in particular) and discretionary costs to report
consistent earnings than non-profit managers do.
5.5. Robustness tests
5.5.1. Influential observations
While we winsorize all continuous control variables at 1% and 99%,
there is a possibility that outliers still remain and may influence our OLS
estimations. In untabulated tests, we re-estimate model (4) after
removing observations with studentized residuals below − 3 and above
3. These additional tests do not alter our findings.
5.5.2. States with a disproportionately large number of observations
Because observations from five states (CA, FL, OH, PA, and TX)
represent 34.8% of our sample, we re-estimate model (4) after excluding
those states from the sample. All of our inferences remain unchanged,
suggesting that our results are not driven by any of the larger states

12
J.N. Cannon et al. Advances in Accounting 58 (2022) 100612

Table 7 relative to non-profit hospitals, for-profit hospitals use greater income-

OLS regression: hospital ownership and earnings management within quintiles increasing earnings manipulations when pre-managed earnings are
of pre-managed return on sales. negative, and greater income-decreasing earnings manipulations when
Dep. var. AMt RM1t RM2t Total_EMt(AM1t + RM1t + pre-managed earnings are high.
RM2t) Our study is motivated in part by the lack of large-sample research
(1) (2) (3) (4) directly comparing entities with different ownership structures that
correspond with different managerial incentives to report operating
Quintile 1
NFP − 0.169*** 0.002 − 0.018*** − 0.179*** performance aligned with their organizational mission. Due to its rela­
[− 7.52] [0.64] [− 4.07] [− 8.13] tively homogeneous regulatory environment and the stark ownership
N 1989 1989 1989 1989 differences between for-profit and non-profit institutions, the hospital
Adjusted industry is particularly conducive to accounting research on earnings
0.252 0.015 0.042 0.264
R2
management by ownership type. Examining the hospital industry allows
us to control for regulatory, legal, and competitive factors, while char­
Quintile 2
acteristics causing differences across hospitals such as size, occupancy
NFP − 0.002 0.001 − 0.001 − 0.002
[− 0.33] [0.55] [− 0.37] [− 0.28] ratios, case mix index, and others can be controlled for (Eldenburg et al.,
N 1987 1987 1987 1987 2017). These attributes of the hospital industry permit us to identify
Adjusted
0.139 0.03 0.029 0.175
with greater precision those differences arising from ownership type.
R2 Yet, it is not simply the convenience of the hospital industry that
motivates our study design; the healthcare industry is socially important
Quintile 3 and economically significant. Not only was national healthcare expen­
NFP 0.025*** 0.005** 0.004 0.032***
diture at 17.9% of U.S. GDP in 2016, and projected to increase to 19.7%
[4.14] [2.11] [1.62] [4.76]
N 1987 1987 1987 1987
by 2026 (CMS, 2018), at the federal level, healthcare spending is a
Adjusted significant driver of national debt (CMS, 2018; Sahadi, 2018). An ex­
0.227 0.026 0.045 0.235
R2 amination of earnings management in the hospital industry allows us to
gain a better understanding of earnings quality, an essential attribute of
Quintile 4 earnings for making informed decisions (Dechow, Ge, & Schrand, 2010;
NFP 0.038*** 0.001 0.013*** 0.049*** Francis, Olsson, & Schipper, 2008). Given the size and economic and
[4.77] [0.27] [3.38] [5.50] social relevance of the healthcare industry, it is important that stake­
N 1987 1987 1987 1987
Adjusted
holders understand the variations in reporting behaviors by different
0.164 0.006 0.05 0.194 ownership types of U.S. hospitals.
R2
Our research is not without its limitations. In order to utilize
Quintile 5 consistent CMS reporting format, our sample begins in 2011; thus, we
NFP 0.252*** − 0.002 0.017*** 0.257*** examine management behavior over a relatively short period (six years).
[8.10] [− 0.80] [4.06] [8.38] Moreover, while we control for time-invariant state-level characteristics
N 1986 1986 1986 1986 in our regressions, we do not consider any time-varying changes in
Adjusted
R2
0.221 0.035 0.087 0.24 states' regulatory environments or resources allocated to the oversight
and enforcement of healthcare programs. Flasher and Lamboy-Ruiz
Notes: ***, **, and * denote significance at the 1%, 5%, and 10% levels (two- (2019) document a positive association between resources dedicated
tail), respectively. P-values are based on robust standard errors clustered at the
to Medicaid Fraud Control Units and healthcare providers precluded
hospital level. All models include year and state fixed effects. T-statistics are
from doing business with federal and state governments. In a similar
reported in square brackets. AMt is discretionary accruals, proxied by the re­
manner, future research may examine whether earnings management by
siduals from the discretionary accruals model of Jones (1991). RM1t is real
earnings manipulations, proxied by the residuals from the expected patient U.S. hospitals is curtailed by the levels of resources dedicated at the state
service cost model (2) multiplied by − 1. Patient service cost includes costs of level for investigating and prosecuting healthcare-related fraud.
providing patient services for inpatient routine services, ancillary services, While we offer a comparison of for-profit and non-profit hospital
ambulatory services, and outpatient services, scaled by the beginning-of-year reporting decisions, we do not theorize non-profit hospitals' optimal
total assets. RM2t is real earnings manipulations, proxied by the estimated re­ levels of surplus earnings relative to that of for-profit hospitals. More
siduals from the expected discretionary expenditures model (3) multiplied by theory development and empirical evidence are necessary to help
− 1. Discretionary expenditures are the sum of R&D and general and adminis­ explain whether non-profit hospitals, which appear to engage in less
trative expenses, scaled by the beginning-of-year total assets. NFP is a dichot­ earnings management, are doing so to the benefit of society. We
omous variable, coded 1 if a hospital is a non-profit hospital, 0 otherwise. All
encourage future research to examine the implications of non-profit
control variables, state and year fixed effects are included in OLS models but
hospitals' operating decisions with respect to revenues and costs. In
omitted for brevity.
particular, there has been media scrutiny of non-profit hospitals'
increasing revenues concurrent with decreasing uncompensated care
represented.
costs (Balvin, 2016; Diamond, 2017; Bannow, 2018. Some see such
trends as contrary to non-profit hospitals' missions, while others may
6. Summary and conclusions
explain such trends as the reality of non-profit hospitals having fewer
uninsured patients following the adoption of ACA—naturally reducing
The purpose of our study is to examine how hospital ownership (for-
the demand for charity care—and providing services to their host
profit versus non-profit) influences earnings management by hospital
communities through alternative means, such as programs promoting
administrators. Using a large sample of U.S. hospitals from the 50 states
health and wellness (Ernst & Young, 2017; Pollack, 2018). Whether and
and the District of Columbia from 2011 through 2016, we find that non-
how non-profit hospitals should seek alternative means to contribute to
profit hospitals engage in accrual and discretionary costs-driven real
communities in exchange for their tax-exempt status is an important
earnings manipulations to a lesser degree than for-profit hospitals do.
ethical and empirical question. We leave that question for future
We also show that for-profit hospitals use earnings management tools to
research.
report earnings that are more consistent over time (i.e., that reduce re­
ported earnings dispersion). Specifically, we provide evidence that

13
J.N. Cannon et al. Advances in Accounting 58 (2022) 100612

Data availability Declaration of Competing Interest

All data are publicly available as identified in the text. None.

Appendix A. Variable definitions

Variable Name Definition Source

Dependent Variables
Accrual manipulations proxy, which equals the estimated residual from the discretionary accruals model of Jones (1991)
AMt Not directly reported
in our model (1).
Pos_AMt Positive discretionary accruals (AMt ≥ 0). Not directly reported
Neg_AMt Negative discretionary accruals (AMt < 0). Not directly reported
Estimated residual from the expected patient service cost model (2) multiplied by − 1. Patient service cost includes costs of
RM1t providing patient services for inpatient routine services, ancillary services, ambulatory services, and outpatient services, Not directly reported
scaled by the beginning-of-year total assets.
Pos_RM1t Income-increasing real patient service cost earnings manipulations (RM1t ≥ 0). Not directly reported
Neg_RM1t Income-decreasing real patient service cost earnings manipulations (RM1t < 0). Not directly reported
Estimated residual from the expected discretionary expenditures model (3) multiplied by − 1. Discretionary expenditures
RM2t Not directly reported
are the sum of R&D and general and administrative expenses, scaled by the beginning-of-year total assets.
Pos_RM2t Income-increasing real discretionary expenditures earnings manipulations (RM2t ≥ 0). Not directly reported
Neg_RM2t Income-decreasing real discretionary expenditures earnings manipulations (RM2t < 0). Not directly reported
Total EMt Sum of AM1t, RM1t, and RM2t. Not directly reported

Explanatory Variables
NFP A dichotomous variable set to 1 if the hospital is non-profit, 0 if the hospital is for-profit. MCR S2I, L3, C4
MCR G, L59, C1; G, L1, C1; G, L51,
Lagged net operating assets. Net operating assets are the sum of total fund balance (i.e., stockholders' equity) minus cash
NOAt–1 C1;
and cash equivalents plus total liabilities, scaled by net revenues.
G3, L3, C1
Lagged revenue market share. Revenue market share is the percentage share of a hospital's revenues scaled by the sum of
Market Sharet–1 MCR G3, L3, C1
net revenues from all hospitals within a county in a given year.
Sizet Natural logarithm of total assets. MCR G, L36, C1
ROAt–1 Lagged ROA. ROA is net income scaled by the beginning-of-year total assets. MCR G3, L29, C1
Occupancy Ratet Occupancy rate is calculated as the average daily census divided by the number of hospital beds. MCR S3I, L14, C2; S3I, L14, C3
Average length of stay represents the average number of days that a patient receiving inpatient care occupied a bed in a
ALOSt MCR S3I, L14, C8; S3I, L14, C15
hospital in year t; ALOSt is total number of patient days divided by total number of patients discharged.
Case mix index is a relative value assigned to a diagnosis-related group (DRG/MSDRG) of patients serviced by the hospital
CMIt during a year. CMI is a proxy for the allocation of resources to care for and/or treat the patients in the group. DRG stands CMSa
for “Diagnosis-Related Group.” MSDRG stands for “Medicare Severity-Diagnosis Related Group.”
The disproportionate share patient percentage is equal to the sum of the percentage of Medicare inpatient days attributable
to patients eligible for both Medicare Part A and Supplemental Security Income (SSI), and the percentage of total inpatient
%DSHt CMSb,c
days attributable to patients eligible for Medicaid but not Medicare Part A. DSH Patient Percent = (Medicare SSI Days /
Total Medicare Days) + (Medicaid, Non-Medicare Days / Total Patient Days)
TEACH Coded 1 if a hospital is affiliated with a medical school at a university. MCR S2I, L56, C1
RURAL A dichotomous variable set to 1 if the hospital is located in a rural area, 0 if the hospital is an urban area. MCR S2I, L26, C1
A dichotomous variable set to 1 if the hospital is identified by Medicare as a “Voluntary Non-profit, Church” hospital,
RELIGIOUS MCR S2I, L21, C1
0 otherwise.
Total reported uncompensated medical care (charity care) cost scaled by net revenues. Uncompensated care equals care
UCCt costs for patients that qualify under charity care provisions less payments by such patients plus non-Medicare-related bad MCR S10, L30, C1; G3, L3, C1
debt expense.

Inputs into Accrual and Real Activities Expectation Models (1–3)

Total accruals computed as change in current assets less change in current liabilities adjusted for change in cash, change in
MCR G, L11, C1; G, L45, C1; G, L1,
ACCt short-term debt, and depreciation expense (ΔCA – ΔCL – ΔCASH + ΔSTDEBT – DEPEXP), scaled by beginning-of-year total
C1; A7, L3, C9
assets.
ΔNETREVt,t–1 Change in net revenue, scaled by the beginning-of-year total assets. MCR G3, L3, C1
PPEt Gross property, plant, and equipment scaled by the beginning-of-year total assets. MCR G, L30, C1–4
Total patient medical costs scaled by beginning-of-year total assets. Patient service cost includes costs of providing patient
Patient Service MCR A, L13–32, C3
services for inpatient routine services, ancillary services, ambulatory services, and outpatient services before the allocation
Costt MCR A, L133–137, C3
of non-point-of-service costs.
Discretionary expenditures are the sum of R&D and general and administrative expenses, scaled by the beginning-of-year
DISXt MCR A, L34–130, C3
total assets.
ROSt Return on sales. Net income scaled by net patient revenue. MCR G3, L3, C1
Notes: MCR data are from the 2010 format of MCR Form CMS-2552-10 available from the CMS (https://www.cms.gov/Research-Statistics-Data-and-Systems/Down
loadable-Public-Use-Files/Cost-Reports/). A = Worksheet A “Reclassification And Adjustment Of Trial Balance Of Expenses”; G = Worksheet G “Balance Sheet”; G3 =
Worksheet G-3 “Statement of Revenues And Expenses”; S2I = Worksheet S-2 Part I “Hospital And Hospital Health Care Complex Identification Data”; S3I = Worksheet
S-3 Part I “Hospital And Hospital Health Care Complex Statistical Data”; S10 = Worksheet S-10 “Hospital Uncompensated And Indigent Care Data”; L# = line number
on the related worksheet; C# = column number on the respective worksheet. Not directly reported = amounts were calculated using the reported amounts on the MCR.
a, b, c
= case mix index (CMIt) and %DSHt data were extracted from the CMS at https://www.cms.gov/Medicare/Medicare-Fee-for-Service-Payment/AcuteInpatient
PPS/Acute-Inpatient-Files-for-Download-Items/CMS022630.html and defined at https://www.cms.gov/Medicare/Medicare-Fee-for-Service-Payment/AcuteInpatie
ntPPS/dsh

14
J.N. Cannon et al. Advances in Accounting 58 (2022) 100612

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