Can a violation of investor trust lead to financial contagion in the market for tax-exempt hospital bonds?
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Can a violation of investor trust lead to financial contagion in the market for tax-exempt hospital bonds? Patrick M. Bernet · Thomas E. Getzen
Received: 29 January 2007 / Accepted: 2 November 2007 / Published online: 23 November 2007 © Springer Science+Business Media, LLC 2007
Abstract Not-for-profit hospitals rely heavily on tax-exempt debt. Investor confidence in such instruments was shaken by the 1998 bankruptcy of the Allegheny Health and Education Research Foundation (AHERF), which was the largest U.S. not-for-profit failure up to that date and whose default was accompanied by claims of accounting irregularities. Such shocks can result in contagion whereby all hospitals are viewed as riskier. We test for the significance and duration of resulting contagion using an industry-specific model of interest cost determinants. Empirical tests indicate that contagion does occur, resulting in higher interest on new debt issues from other hospitals. Keywords
Hospital bonds · Contagion · Bankruptcy · Interest costs · Trust
JEL Classifications
G33 · I19
Introduction Tax-exempt municipal debt is an important method of raising capital for most US notfor-profit hospitals. These funds help hospitals build new facilities, replace aging technologies and invest in quality improvement projects. Increases in the cost of such capital jeopardize the ability of healthcare institutions to fulfill their missions. While a hospital’s individual financial and operating performance have strong influence over the risk perceived by investors, adverse events at another hospital may also change the perceived level of risk for all hospitals collectively. The 1998 bankruptcy of the Allegheny Health and Education Research Foundation (AHERF), a large not-for-profit health network, was just one of the recent incidents of corporate fraud and financial deceit, which also include Enron, WorldCom and HealthSouth. News P. M. Bernet (B) Florida Atlantic University, 777 Glades Road, 347 FlemingHall, Boca Raton, FL 33431, USA e-mail: [email protected] T. E. Getzen Temple University, Philadelphia, PA, USA
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coverage, trial summaries and financial analyst opinions focus on the impact on primary parties, such as stockholders, creditors and employees. In this regard, there is little difference between normal business failures and those involving accounting irregularities. In both cases the failed company’s value plummets, vendors are left with unpaid bills, and employees may lose jobs or pensions. When information is publicly available to outside investors, normal business failures can even provide new information to investors, particularly when the collapse is the result of factors common to the entire industry, resulting in contagion. A unique aspect of failures involving accounting fraud is that the information content of the event includes signals that the very information on which investors depend cannot be trusted. In retrospect, investors can see that the failed company was overstating revenues or un
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