Project Risk Definition and Measurement in a Not-for-Profit Setting

Abstract

The health care finance literature on capital investment decisions generally applies conventional market risk concepts without distinguishing between proprietary and not-for-profit forms of organization. Since proprietary firms have shareholder wealth maximization as their primary goal, a project's relevant risk is its contribution to the riskiness of the equity investors' well diversified stock portfolios, or its market risk. However, not-for-profit organizations do not have shareholder wealth maximization as their primary goal, and thus market risk concepts are not applicable. Rather, the relevant risk in a not-for-profit setting is a project's corporate risk; that is, the project's contribution to the riskiness of the organization. The difference in risk definition and measurement between proprietary and not-for-profit firms has two implications for managerial decisions: (1) in making capital investment decisions, a manager must define and measure a project's riskiness on the basis of the firm's organizational form; and (2) although diversification for the sole purpose of risk reduction is not a valid rationale for proprietary firms because stockholders can achieve the same result at less cost, risk-reducing diversification does make sense for not-for-profit firms.