Hospital board effectiveness: Relationships between board training and hospital financial viability

Hospital Board Effectiveness:Relationships between GoverningBoard Composition and HospitalFinancial ViabilityCarol Molinari, Laura Morlock, Jeffrey Alexander,and C. Alan Lyles

Objective. Two theories - agency and managerialism- are compared with respect totheir usefulness in explaining the role of insiders on the hospital board: whether theirparticipation enhances or impairs board financial decision making.Data Sources/Study Setting. The study used 1985 hospital financial and governingboard data for a representative sample of acute care California hospitals.Study Design. Relationships were examined cross-sectionally between the presence orabsence of insiders on the board and measures of hospital financial viability whilecontrolling for the organizational factors of system affiliation, ownership, size, region,and corporate restructuring.Principal Findings. Multiple regression analysis found significant relationshipsbetween insider (CEO, medical staff) participation and hospital viability.Conclusions. These results support the managerial theory of governance by suggestingthat the CEO and medical staff provide informational advantages to the hospital govern-ing board. However, the cross-sectional design points to the need for future longitudinalstudies in order to sequence these relationships between insider participation andimproved hospital viability.Keywords. Board composition, CEO/medical staff board participation, hospital finan-cial viability/performance, board managerialism/agency theory

The purpose of this study is to examine whether or not insider boardparticipation is associated with hospital financial viability. We utilizetwo economic theories-agency and managerialism-to help addresswhether the expertise and knowledge of insiders enhance or impairhospital financial performance. Multiple financial performance mea-sures are used to assess the dimensions of profitability, liquidity, capitalstructure, capital intensity, and occupancy. We selected these financial

358 HSR: Health Services Research 28:3 (August 1993)

indicators as study outcomes of board effectiveness because major deci-sions of governing boards (i.e., those involving resource acquisitionand allocation) typically have a short-term and long-term financialeffect on the performance of the hospital. Consequently, these mea-sures of financial viability are hypothesized as relevant criteria forassessing the effectiveness of governing board decisions. Such an inves-tigation of relationships between board composition and hospital via-bility is important for two major reasons: (1) hospital boards have beenaltering their composition by increasing the participation of insiderswithout any systematic assessment of these changes; and (2) as thecomposition of the hospital board is clearly within the control of thehospital, significant relationships between board composition and hos-pital viability can lead to board selection strategies capable of enhanc-ing hospital performance.

The first section of this artide presents a rationale for the study ofgovernance and a discussion of alternative theoretical perspectivesleading to the study hypotheses. Next the methodology and sampleselection are described, followed by an examination of study findingsand possible implications.

GOVERNANCE IN THEHOSPITAL INDUSTRY

During the 1980s, prospectively set reimbursements from public andprivate third party insurers (Medicare and major commercial payers)significantly limited hospital patient revenues (Deloitte, Haskins, andSells 1988). In addition, greater competition for patients resulted inincreased financial pressures for many hospitals. Consequently, manyinstitutions have undergone significant organizational changes to helpthem remain viable within an economically constrained environment.For example, horizontal integration strategies to provide access to

Address correspondence and requests for reprints to Carol Molinari, Ph.D., AssistantProfessor, Division of Health Administration, Department of Health Services, 103Medical Center Annex #2, University of Kentucky, Lexington, KY 40536-0080.Laura Morlock, Ph.D. is Professor and Director in the Department of Health Financeand Management, Johns Hopkins School of Public Health, Baltimore, MD; JeffreyAlexander, Ph.D. is Associate Professor in the Department of Health Services Man-agement and Policy, University of Michigan, Ann Arbor; and C. Alan Lyles, Sc.D. isVice President, Office of the Dean, Johns Hopkins School of Medicine, Baltimore,MD 21205. This article, submitted to Helth Services Research on June 9, 1992, wasrevised and accepted for publication on January 6, 1993.

Board Composition and Financial Viability

economies of scale as well as other possible benefits have been vigor-ously adopted. This is evidenced by the 43 percent of hospitals thatparticipate in multihospital arrangements (American Hospital Associa-tion 1988). In addition, by 1985 almost one-third (30 percent) of hospi-tals had diversified into related or unrelated business ventures in orderto bolster revenues (Alexander, Morlock, and Gifford 1988).

As the general organization of the hospital has undergonechanges, so too have the function and form of its governing board.Traditionally, the hospital board served as a "linkage" to the commu-nity (Pfeffer 1972). Its responsibility was to obtain needed resources forhospital operations. However, in the 1970s two court rulings held thehospital board legally accountable for the fiscal management and qual-ity of services delivered. Hence, the function of the hospital boardbegan to reflect greater concern for internal hospital decision making.For example, among hospitals participating in multihospital systemsfrom 1979 to 1982, a significant increase in board participation byCEOs took place (Morlock, Alexander, and Hunter 1985; Alexanderand Morlock 1985). In addition, a 1985 hospital survey indicated thatboards of hospitals that had corporately restructured after 1980 weremore likely to report board participation by insiders (CEO and medicalstaff) as well as board participation by outsiders from the businesscommunity (Alexander, Morlock, and Gifford 1988). With the adventof Medicare prospective payment as well as competitive price settingby commercial insurers, boards were exhorted (Delbecq and Gill 1988)to become more strategic- to look for financial ventures that wouldaugment revenues and bolster shrinking hospital margins. Thus thehospital governing board role was expanding in terms of both opera-tional and strategic decision making.

As the role of the hospital board has grown to include not onlylinkage with the community but also active involvement in internaldecision making and monitoring (Alexander and Zuckerman 1989),the competence and composition of hospital boards have becomeincreasingly important. Consequently, hospital trustees need to beaccurately informed about hospital operations in order to fulfill theirresponsibilities. Because two-thirds of hospitals are under not-for-profit ownership, market-imposed discipline is often limited to the debtmarket, making external pressures less pervasive than among for-profit corporations, which are also affected by controls in the equitymarket. While the governing board may serve as the major monitoringand decision-making body in the hospital industry, the question ofwhether or not boards are carrying out their responsibilities in a man-ner that leads to improved hospital performance remains open for

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empirical examination. Of particular concern is whether insiders pro-vide needed information to the hospital board, or whether theyincrease the board's vulnerability to making opportunistic, ineffectivepolicies.

To explain how directors of governing boards affect corporateperformance, Zahra and Pearce (1989) thoroughly reviewed corporatestudies examining relationships between characteristics of governingboards and financial performance. They developed a topology of per-spectives to help explain what directors should do. From the manage-rialist and agency perspectives, Zahra and Pearce (1989) posit thatboard composition represents variables of interest in explaining bothfinancial outcomes and the decision-making processes associated withthe board's role. Their review of the corporate governance literaturesupports an assessment of the research question: whether board com-position influences hospital viability from both the managerial andagency perspectives. Specifically, this study is an attempt to addresssystematically the issue of whether participation by insiders and out-side business community members on the hospital board is associatedwith hospital financial viability. We hope that such information dosesthe knowledge gap due to the lack of research examining ways in whichboard composition influences hospital performance.

THEORETICAL BACKGROUNDAND HYPOTHESES

To understand the possible effect of insiders (medical staff and CEO)and business outsiders on the financial performance of the hospital, itis useful to examine two theoretical perspectives from the corporategovernance literature-managerialism and agency theory.

In the corporate governance literature there has been a divergencein thinkling about who should sit on the govcrning board. Managerial-ism and agency theory are the two perspectives that offer differentexplanations concerning the role of insiders on governing boards. Tra-ditionally it has been believed that participation by top-level manage-ment enhances board decision making. and effectiveness. Thismanagerialist perspective argues that insider board participation pro-vides "informational advantages" necessary to keep boards informedand capable of making sound decisions. Some theorists, whom Eisen-berg (1976) has labeled "corporate reformers," believe that insiderboard paticipation poses "informational asymmetries" (Moe 1984) thatcan lead to opportunistic board decision making. This potential for


opportunism through insider board participation has been furtherarticulated by agency theorists who argue that when there is a separa-tion between owners (shareholders) and managers, a conflict of inter-ests between management and shareholders exists (Fama and Jensen1983). They posit that governing boards' legal responsibility to safe-guard the interests and wealth of shareholders can be seriouslyimpeded when insiders are active on the governing board. Conse-quently, agency theorists have advocated increased independent boardparticipation by outsiders to protect shareholders' equity and financialinterests. Thus, the major difference between these two positionsinvolves the role of insiders.

Managerialists argue that part-time boards removed from theday-to-day operations of the firm need the knowledge and informationof top-level insiders to guide board members in decision-making andgovernance activities. Thus, insiders' knowledge and experience enablethe board to monitor and govern the firm more effectively (Baysingerand Hoskisson 1990). Alternatively, agency theorists postulate thatinsiders' control of information about their own performance and orga-nizational activities can lead to the manipulation of information inorder to serve the insiders' own personal interests (Alchian andDemsetz 1972; Baysinger and Hoskisson 1990).

Among hospital boards, insiders include top-level managers aswell as medical staff members. The chief executive officer (CEO) istypically placed on the board to provide administrative informationabout the hospital. The medical staff's clinical expertise is also neededto keep the board informed about service and delivery issues. Thus,from a managerial perspective, board participation by both the CEOand members of the medical staff help the governing board accrueinformational advantages. However, there are reasons why theseinsiders may desire to pursue their own more narrow interests ratherthan those of the hospital. First, since the annual turnover rate forhospital CEOs during the mid-1980s was 25 percent nationally and 35percent in the western region of the United States (Sabatino 1987), it isplausible that hospital CEOs may put their own interests in safeguard-ing their positions above the financial interests of their hospitals. Thus,the potential for opportunism by hospital CEOs may take the form ofrisk-averse, fiscally conservative policies. Second, given physicianinterests in state-of-the-art diagnostic and therapeutic technologies, itis plausible that medical staff board participation may result in impru-dent capital investments that impair the fiscal viability of the hospital.

It is argued that due to managerial expertise, participation byoutside business persons will increase the hospital board's ability to

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make sound financial decisions. Independent from the hospital, thesecorporate outsiders are expected to keep their focus on the best interestsof the hospital, thus leading to effective board decision making.

These alternative possibilities suggest the desirability of testingcompeting hypotheses that address whether board participation byinsiders (CEO and medical staff) enhances board effectiveness as mea-sured by hospital financial viability, or whether it poses the potentialfor opportunism thereby impeding hospital financial performance.

BOARD PARTICIPATION BY THEMEDICAL STAFF AND CEO

From a managerialist perspective it is expected that the effectiveness ofthe governing board will fall along a continuum in which boards withvoting participation by the medical staff and the CEO are most effec-tive, boards with participation by only one insider group are less effec-tive, and boards without either are least effective. Therefore, it ishypothesized that:

HI. Compared to hospitals without any insider participanton the governing board, those with active board par-ticipation by both the CEO and the medical staff areexpected to have the best financial performance, fol-lowed by hospitals with only one insider group repre-sented on the board.

BOARD PARTICIPATION BY MEDICAL STAFF,CEO, AND MEMBERS OF THE BUSINESSCOMMUNITY

To assess the agency hypothesis that insider board participationincreases the potential for "informational asymmetries" (Moe 1984)and opportunism, another variable was formulated to examine insiderboard participation in conjunction with the presence of business outsid-ers. Agency theorists claim that these outside board members' indepen-dence enables them to monitor insiders' behavior and thus reduces thepotential for managerial opportunism. While outsiders' diverse back-grounds can impair the board's ability to adapt to changes in a turbu-lent environment (Goodstein and Boeker 1991), the acumen of outsidebusiness professionals is expected to help the hospital board oversee theinformation provided by insiders, thus enhancing the board's decisionmaking. This reasoning leads to the next hypothesis:

H2. Hospitals with insider and business outsider participa-tion on their governing boards will have better finan-


cial performance than hospitals with insiderparticipation and no outside business directors on theirboards.

METHODS

Description of Surveys

Data for this cross-sectional study were obtained from two major datasources: (1) the Eleventh Year (1985) California Health Facilities Com-mission (CHFC) Financial Disdosure data set, and (2) the 1985 Amer-ican Hospital Association (AHA) governance survey. The followingdescribes each of these components and how they were merged to formthe working data file.

The 1985 AHA survey used a written questionnaire addressed tohospital CEOs that covered a broad range of governance topics. Thesurvey achieved a 55 percent response rate. Since the governance sur-vey sample was composed of short-term general hospitals, this categoryof institutions served as the study population. The universe of short-term general hospitals in California in 1985 was 487, all of whichreported financial data to the CHFC. However, 61 hospitals either didnot have financial data that represented a one-year period (due toorganizational changes such as mergers, acquisitions, restructuring,etc.) or were members of the Kaiser system. These were excluded fortwo reasons. First, it was deemed necessary to have financial data fromthe same timne period as the governance survey to ensure comparabilityof data across hospitals; and, second, since Kaiser filed consolidatedfinancial statements for its member hospitals, an examination of hospi-tal level financial data was precluded.

Of these 426 short-term general (non-Kaiser) hospitals with com-parable financial data 190 had matching governance survey data. TheCHFC financial disclosure data were merged with the governancesurvey data to form the working data file.

Response Bias Analysis

Because participation in the AHA governance survey was completelyvoluntary, some response bias was assumed to be likely. An analysis ofdifferences between the sample 190 hospitals and the remaining 236nonsample hospitals found that a significantly lower proportion of for-profit hospitals were represented in the sample than in the nonsamplegroup. However, this ownership difference applied only to indepen-

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dent hospitals. Differences in ownership for system-affiliated hospitalsin the sample were not significantly different from those in the non-sample. In addition, differences in system affiliation and size forsample and nonsample groups were insignificant. Thus sample andnonsample hospital groups are comparable, except with respect to for-profit independent hospitals. Mean comparisons of eight financialratios between the sample and nonsample groups indicated that onlyone ratio- the net income to patient revenues ratio- reached statisticalsignificance. These findings support the contention that poor- or good-performance hospitals do not self-select into the sample.

Measurement

Hypotheses were tested using the individual hospital as the unit ofanalysis. Variables were constructed in order to test associationsbetween insider board participation and selected hospital financial per-formance outcomes. Definitions and descriptive statistics for the inde-pendent (governance and nongovernance) and dependent variables(financial outcomes) are listed in Table 1 and Table 2. The primaryindependent variable is the composition of the hospital board. Dummyvariables were used to assess board participation by the CEO, medicalstaff, and outside members of the business community. Active boardparticipation by members of the medical staff and members of thebusiness community is defined as participation with voting privileges.Boards typically confer voting status on these board members. In con-trast, there is greater variation concerning the status of the CEO on thegoverning board. However, to minimize small number problems thatarose when these three occupational groups were examined separatelyand jointly, it was considered appropriate to define active CEO partici-pation as either voting or nonvoting board status, in contrast to a roleonly as an observer.

While many approaches can be used to assess the financial perfor-mance of a hospital, the utilization of multiple measures to assess thevarious dimensions of financial performance is expected to be mostreliable. For example, while profitability or surplus suggests that ahospital has generated excess revenues, information about how thesurplus was achieved and at what level of risk is also important in themeasurement of hospital viability.

In this study, the method of financial ratio analysis was chosen formeasuring hospital financial performance. The major dimensions forwhich financial ratios were calculated included profitability, liquidity,capital structure, and capital intensity. Hospital occupancy rate was


Table 1: Study Measures and Descriptive StatisticsVariabk Description

Governance VariabksInsider board part *Voting MD/Voting or nonvoting CEC

*Voting MD/Observing CEO*No MD/Voting or nonvoting CEO*No MD/Observing CEO

Outside business Corporate executive'board members 0 - yes

1 - noBanker*0 - yes1 = noLawyer*0 = yes1 = noIndependent businessperson*0 = yes1 - no

Nongovernance Variabks (Controls)Corporate restructuring Restructured

0 = yes1 - no

Size 0 = 200 or fewer beds1 - 201+ beds

Region 0 = rural1 = urban

Ownership/system 'For-profit chain (1)affiliation (HTYPE) 'Not-for-profit chain (2)

'Public chain (3)'Public independent (4)'Not-for-profit independent (5)

'Refers to primary occupation of board member(s).

Frequency Percent

125 68.314 7.730 16.314 7.7

93 48.997 51.1

82 43.2108 56.8

91 47.999 52.1

137 72.153 27.9

77 40.5113 59.5114 60.076 40.030 15.8160 84.235 18.656 29.810 5.332 17.055 29.3

also examined as a viability measure, since it is often used to evaluatethe hospital's credit worthiness (Deloitte, Haskins, and Sells 1988).

Dependent variables included eight measures of hospital financialperformance: hospital operating margin; net income to patient reve-nues; return on total assets; days in accounts receivable; bad debt;long-term debt to total assets; hospital occupancy rate; and net plant,property, and equipment per bed. The square root, natural log, andarcsine transformations were used to normalize skewed distributionsfor five of these measures' ratios in order to test for mean differences.In addition, transformations were also used in the multivariate analy-

365

)


Table 2: Financial Measures and Descriptive StatisticsVariabk Description Mean s. d. N

HOPMAR Hospital operating margin .03 .12 188NATIR Net income after tax to patient revenues .06 .08 187ROTA Return on total assets .07 .11 186LTDAR Long-term debt to total assets .29 .23 177BADDR Bad debt and charity .04 .06 190DARFRAT Days in accounts receivable 75.28 24.68 184OCC Hospital occupancy rate 60.00% 16.14% 190NPPEB Net plant, property, equipment per bed $79,151 $50,444 189

Source: Eleventh Year (1985) Califomnia Health Facilities Commission FinancialDisclosure data set, and 1985 AHA governance survey.

ses to meet homoscedasticity (equal-variance) assumptions. To controlfor alternative explanations of differences in these hospital perfor-mance outcomes, four control variables (corporate restructuring, bedsize, system affiliation/ownership,' and location in a rural or urbanregion) were included in the analysis.

Control Variables

The control variable strategy was based on identifying variables thatmight affect hospital financial performance and on an association withthe board composition variables. As indicated in the hospital govern-ance literature, system affiliation, hospital ownership, and corporaterestructuring influenced hospital board composition. Given the globalnature of the short-term and long-term financial outcomes used in thisstudy to assess hospital viability, these, together with several otherorganizational factors of size and region, were also examined to helpcontrol for alternative explanations of differences identified in thesefinancial outcomes.

(1) System affiliation, defined as two or more hospitals sharing acommon management or ownership (American Hospital Association1988), has become increasingly popular in the industry. As of 1986, 43percent of all hospitals were either owned, managed, or leased by amultihospital system (American Hospital Association 1988). Amongboards of hospitals affiliated with multihospital systems, board partici-pation by the CEO and medical staffwas significandy greater than wasCEO and medical staff participation among boards of independenthospitals (Morlock and Alexander 1986). Theoretically, system-affiliated hospitals enjoy financial advantages derived from centralizedadministration and economies of scale. These potential cost savings


have been found to influence profitability (Renn et al. 1985) andcapital structure (Glandon et al. 1987; Coyne 1982).

(2) The major hospital ownership categories include for-profit, not-for-profit, and public. For-profit ownership involves individuals(shareholders) who invest capital in return for claims on future profits.Thus, for-profit hospitals have a responsibility to shareholders to gen-erate short-term and long-term profits. In contrast, not-for-profit hos-pitals, while they need short-term surpluses to finance their operations(Chang and Tuckman 1990), have a primary responsibility to theircommunities to provide necessary, quality services rather than to gen-erate long-term profits. Consequently, while for-profit and not-for-profit hospitals both attempt to generate short-term profit margins,for-profits' financial responsibility to shareholders is likely to result inhigher long-term profitability than that enjoyed by hospitals in the not-for-profit sector.

The availability and cost of external funds for facility expansionand renovation is also expected to be affected by ownership. Amongfor-profit, publicly traded hospital corporations, access to the equitymarket may provide capital at a lower cost than debt financing. Theirability to generate low-cost equity for capital also can lead to lower debtcosts because capital markets may view for-profits as better financialrisks. Therefore, increased access to debt by for-profit hospitals, coup-led with their lower debt costs, can result in levels of debt that exceedthose of not-for-profits. Without access to the equity market, not-for-profit hospitals depend more heavily on the debt market, which tendsto increase their capital costs. Consequently, for-profit hospitals areexpected to have higher debt financing ratios because of their increasedaccess and lower capital costs.

Because of the commitment by public hospitals to the indigent anduninsured as well as the steep discounts paid to them under California'sMedicaid program (Holohan 1988), public hospitals' increased serviceto these populations is expected to result in the poorest financial perfor-mance when compared to for-profit and not-for-profit hospitals.

(3) To remain viable in the competitive health industry, hospitalsmay focus their attention on long-range strategic planning and diversi-fication (Delbecq and Gill 1988) that involves corporate restructuring.During the first half of the 1980s many not-for-profit hospitals changedtheir corporate structures in order to pursue diversification strategiesto supplement patient revenues without forfeiting their tax-exemptstatus (Gerber 1983; Ernst and Whinney 1982). According to an AHAsurvey (Alexander, Morlock, and Gifford 1988), by 1985 30 percent ofnot-for-profit hospitals had undergone corporate restructuring. Board

367


composition among hospitals that restructured indicates increased par-ticipation by the CEO and medical staff (Alexander, Morlock, andGifford 1988).

The empirical studies assessing the impact of corporate restruc-turing on hospital financial performance have not supported the claimsof improved profitability. A study of not-for-profit California hospitalsundertaking diversification activities during the pre-prospective pay-ment period of 1978 to 1983 found that, while hospital financial perfor-mance was not impaired, it was not improved (Clement 1987). Theeffects of restructuring after enactment of prospective payment underMedicare in the mid-1980s, however, have not been empiricallyassessed.

(4) Based on the premise that fixed overhead costs (billing sys-tems, administrative costs) ought not to increase in proportion to thesize of the hospital, larger hospitals should realize lower overheadbecause they can spread costs across more beds and services. However,evidence is not consistent regarding these economies of scale for hospi-tals larger than 100-125 beds (Deloitte, Haskins, and Sells 1988).

(5) As noted by Cleverley (1988), significant urban/rural differencesexist influencing profitability and capital structure ratios. In 1985, theaverage age of rural hospitals was 8.2 years compared to 7.2 for theindustry (Cleverley 1988). The advanced age of small rural hospitals,in comparison to the rest of the industry, underscores the pressing needfor capital funds to renovate and modernize their physical plants. Inaddition, lower profitability among rural hospitals suggests that thesehospitals are less able to secure critically needed capital funds (Clever-ley 1988). Their lower debt-to-equity ratios also confirm reducedaccess to capital markets by rural hospitals, which exacerbates fiscalproblems associated with aging plants and weak profits.

The hospital governance literature led to expectations that systemaffiliation and corporate restructuring would influence board composi-tion. System affiliation was expected to affect hospital profitability andcapital structure. Although corporate restructuring during the pre-prospective payment period was not found to affect hospital profitabil-ity (Clement 1987), it was considered worthy of examination in thisstudy because, since the introduction of prospective payment, hospitalpatient revenues have been further constrained. These patient reim-bursement restrictions increasingly have led hospitals to generate reve-nues from nonhospital sources (i.e., diversification activities) in orderto bolster their shrinking operating margins derived from inpatientservices. Consequently, it has been hypothesized that corporaterestructuring can have a significant influence on hospital financial


performance, and thus should be included in the analysis. In addition,hospital size and region have also been used as controls for the finan-cial outcomes.

ANALYSIS STRATEGY

The primary objective of this analysis was to assess the relationshipbetween board composition and hospital financial viability. The firststep in the analysis was to examine the bivariate relationships for eachhypothesis to determine whether CEO, medical staff, and businesscommunity participation on boards was significantly associated withthe various outcomes. Since these bivariate analyses involved multiplemeans comparisons, to control for type 1 error the conservative Stu-dent Newman-Keuls (SNK) test was used (Kolckars and Sax 1986).

Many of the outcomes were derived from common financial mea-sures; therefore, correlations among the dependent variables werelikely. If the outcomes are correlated, the examination of individualregression analyses may be misleading. Thus, prior to the examinationof individual financial outcomes through multiple regression analysis,a preliminary multiple analysis of variance (MANOVA) was per-formed in which associations between insider participation and all out-comes were examined simultaneously, while controlling for theorganizational control variables.

Since board composition categories were induded as dummy vari-ables, it seemed most appropriate to test for changes in the level ofexplained variation in the outcomes, as advocated by Pollisar andDiehr (1982). Thus, changes in the explained variation of each out-come (i.e., changes in the R-square) were examined to help interpretwhether or not significant coefficients supported the importance ofeach construct in the model. Additionally, the lack of significanceamong individual dummy variables with significant changes in R-square levels in an outcome may suggest that the number of categoriesin the dummy variable is too large. Such a condition tends to dilute thestatistical significance between categories, although the construct as awhole may explain differences in the selected outcomes.

RESULTS

Each financial outcome was regressed on the set of four control vari-ables and the appropriate governance variables.

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INSIDER BOARD PARTICIPATION BY THEMEDICAL STAFF AND THE CEO

To test the managerialist perspective stipulated in hypothesis 1, com-parisons of means for the selected eight performance measures wereexamined among the four categories describing various combinationsof medical staff and CEO board participation. When compared toother categories of boards, those with active participation by neitherthe medical staff nor the CEO had significantly worse hospital operat-ing margins; return on total assets; bad debt; and net plant, property,and equipment ratios.

For the multivariate analysis of variance (MANOVA), thehypothesis that insiders had no effect was rejected (Hotelling-LawleyTrace F = 2.38 p < .01) when all of the eight performance measureswere simultaneously examined after controlling for corporate restruc-turing, ownership and system affiliation, size, and region. Resultsfrom the separate multiple regressions (Table 3) indicate that for alloutcomes, with the exception of occupancy rate, boards with medicalstaff and CEO participation had significantly better financial out-comes than boards without active participation by both types ofinsiders. When the categories with one type of insider on the boardwere compared to the reference group of no participation by bothinsiders, only the measures of operating margin, return on total assets,and bad debt ratios were significantly better.

In addition to the statistically significant relationships identified,changes in explained variation for operating margin, net income topatient revenues, long-term debt to total assets, bad debt, and days inaccounts receivable indicate significant associations between the boardcomposition variable and performance measures. While statisticallysignificant relationships were found between categories of insider par-ticipation and the long-term outcomes of return on total assets and netplant, property, and equipment ratios, this compositional dummy vari-able did not significantly explain differences in these ratios. In contrast,the board compositional variables explained a significant degree ofvariation in hospital occupancy rates, although there were no signifi-cant differences among the various categories of board participation.The significantly higher profitability and liquidity ratios suggest thatinsider board participation is associated with better hospital financialperformance especially in the short run.

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MEDICAL STAFF, CEO, AND CORPORATEEXECUTIVE BOARD PARTICIPATION

Hypothesis 2 argues that the presence of outside members from thebusiness community is needed to monitor insider participation. As pre-viously noted, agency theory postulates that outsiders enhance the accu-racy of information and balance the viewpoints provided by the insiders(CEO, medical staff), thus improving decision making and the hospital'sviability. The primary occupation of each outside director was utilized asan indicator of his or her area of expertise. To examine whether boardparticipation by members of the business community (i.e., bankers,lawyers, independent businesspersons, and corporate executives) is asso-ciated with hospital financial performance, bivariate analyses were per-formed in which means for the selected outcomes were comparedbetween boards with and without each of these business occupations. Inthe bivariate analysis, the corporate executive occupational group hadthe most significant associations with hospital performance indicators.Consequently, this group of corporate executives, within the larger cate-gory of business community board members, was chosen to test thehypothesis regarding the role of outside directors in monitoring andbalancing the information and perspectives provided to the board byinsiders. Thus, to assess whether boards with both insider and corporateexecutive participation are less vulnerable to agency problems of "infor-mation asymmetries" and opportunism, comparisons were made andexamined between these boards and those with insider and no corporateexecutive participation.

In the multiple regression analysis, the full board with active par-ticipation by the medical staff, CEO, and corporate executives servedas the reference group. When all of the outcomes were examinedsimultaneously using a MANOVA, the hypothesis that the full boardhad no effect was not rejected. Similarly, the individual regressionsshowed that boards with active insider participation but without corpo-rate executive participation were not significantly worse than the refer-ent full boards for any of the eight outcomes (Table 4). However,boards with less than full participation by both the medical staff andthe CEO had significantly worse operating margins; net income topatient revenues; long-term debt to total assets; bad debt; days inaccounts receivable; and net plant, property, and equipment ratios.These findings are supportive of the first hypothesis, that is, of theadvantages of board participation by both insiders as compared to onlyone. The lack of significant differences between boards with activeinsider participation and corporate executives and those with active

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insiders and no corporate executives does not support the agencyhypothesis that outsiders are needed to reduce the likelihood of oppor-tunism and ineffective governance associated with insider board partic-ipation. Furthermore, the significantly poor financial outcomes ofboards with only one insider suggest that active participation by bothinsiders is more likely to provide informational advantages to hospitalboards than to create information asymmetries. The significantly unfa-vorable outcomes for boaris without involvement by both the CEOand the medical staff further support earlier findings from hypothesis 1concerning the informational advantages of having both insiders on theboard.

DISCUSSION

Knowledgeable, expert board members are deemed necessary foreffective governance activities. This empirical examination of relation-ships between board composition and hospital performance provideshelp in understanding whether insider board participation offers infor-mational advantages or disadvantages to the hospital board. Based oncomparisons between boards with active insider board participationand those without, the findings suggest that insider participation by themedical staff and hospital CEO is significantly associated withimproved hospital financial performance. These results provide sup-port for the managerialist view that effective hospital boards shouldinclude insiders (CEO, medical staff). In fact, they are supportive offindings about the positive influence that insiders have had on corpo-rate strategy and performance for California hospitals during the 1980s(Goodstein and Boeker 1991).

In addition, insider board participation may also enhance themedical staff's support and compliance with board policies, thusenhancing hospital performance. These results also suggest that medi-cal staff board participation may serve to co-opt physicians into thedecision-making process (Morlock, Alexander, and Nathanson 1988),and thus to increase their support of governing board activities.

While agency theorists hypothesize that hospital insiders are mosteffective in the presence of corporate executives because corporateexecutives can add expertise and provide oversight to the governingboard, this study found that hospitals with insider participation andwithout corporate executives on their boards did not appear to besignificantly less viable that those with both insiders and corporateexecutives. The lack of empirical support for the idea that insiders


create agency problems for the board by manipulating inside informa-tion in order to further their own interests rather than those of thehospital suggests that the benefits of insiders' knowledge outweigh theopportunism potential.

While these results are limited in their generalizability to the stateof California, the examination of one state with its local and regionalresources and delivery systems helps to minimize extraneous factorsthat can affect hospital performance. As noted by Shortell (1988), theevaluation of hospitals and hospital systems within a defined market orregion may be the most effective strategy for assessing the performanceof the organization.

Although this study provides only preliminary empirical findingsin support of board composition as an important factor influencing theeffectiveness of hospital governing boards, nonetheless, it does supportearlier work (Shortell and LoGerfo 1981) that found that medical staffboard participation had a positive influence on hospital outcomes. Ashospitals struggle to survive in a turbulent environment, these resultsprovide an empirical basis for directing attention toward judiciouscomposition of the hospital governing board as a strategic tool forhospitals to use in gaining a competitive advantage.

The temporal limitations of the cross-sectional design (which pre-cludes identifying antecedent-consequence relationships) point to theneed for future research in these areas: (1) an examination of addi-tional years of hospital financial viability to determine whether thecross-sectional results are sustained, diluted, or enhanced over time;and (2) an assessment of changes in hospital board composition overtime to identify more definitively the contribution to hospital perfor-mance made by governing board composition. Such future studies canlead to clarification about the role and function of the hospital board,and can systematically answer the question of whether changes inboard composition are predictive of changes in hospital financialviability.

ACKNOWLEDGMENTS

The authors would like to acknowledge the contributions of the mem-bers of the administrative staff at the University of Kentucky's HealthAdministration program: Bonnie Gay, Mary Baird, and ReginaLewis, and the helpful comments of the editor and reviewer of HealthServices Research.

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NOTE

1. The system affiliation-ownership variable has five categories depicting theownership for system-affiliated and independent hospitals. The categoriesinclude (1) for-profit chain, (2) not-for-profit chain, (3) public chain, (4)public independent, and (5) not-for-profit independent. Because of the lackofdata on for-profit independent hospitals in this data set, this category hasbeen omitted from the analysis.

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Hospital board effectiveness: Relationships between board training and hospital financial viability

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