In the quest to help healthcare institutions save, manage, and raise money, financing has to be executed. Some of the financing options that the healthcare institutions can implement are debt financing and equity financing. In debt financing, a healthcare institution may borrow money from the financial institutions to fund its projects. In equity financing, the healthcare institution uses its internal funding to facilitate the running of the projects. Capital structures in the healthcare institutions target to support their assets by using either debt or equity or both at the same time (Mason et al., 2015). The capital structures of the healthcare systems are viewed as a strategic element of their financial programs. While the not-for-profit healthcare institutions have maintained almost constant levels of debt over the last ten years, the investor-owned institutions have lowered their relative use of debt financing. Chief financial officers in the hospitals indicated that besides reducing debt due to the less favorable reimbursement incentives, there was a focus on the maintenance of high bond ratings. Debt levels have not been lowered as sharply in the not-for-profit healthcare systems as they have in the investor-owned institutions, in part due to the use of debt to support investments in financial markets (Mason et al., 2015). Because these healthcare systems do not have convenient access to equity, high bond ratings and solid investment earnings are a cornerstone of their capital structure policies of preserving access to debt markets. Therefore, the selection and the decision of the capital structure financing that healthcare uses may be affected by some factors, the main one being how the hospital can access equity and debts. The investor-owned healthcare institutions can flexibly choose between debt and equity while the non-profit healthcare institutions may not be flexible enough in selecting the funding options (Mason et al., 2015). All in all, both equity financing and debt financing have various merits and demerits to the healthcare institutions that adopt them.
Capital Structure Strategies in Health Care Financial System
Presentation Page
Project name: expansion of the waiting room
Organization name: Lee Memorial Hospital
Business address: 2776 Cleveland Avenue
City, st, zip: Fort Myers, Florida, 33901
Telephone number: +1 239-343-2000
Facsimile number: +1 239-343-2000
Website address: http://www.leememorial.org/
Email address: webinfo@leehealth.org
Complaints have severally been addressed to Lee Memorial Hospital regarding the small waiting room that the hospital has. The waiting room has been stated as insufficient in the accommodation of the many visitors who come visiting the hospital on an hourly basis. The visitors to the institution have also stated that the waiting room is poorly ventilated which makes it stuffy. Lee Memorial Hospital has therefore decided to focus on the customers' concerns about the waiting room by expanding it to accommodate more visitors at a time and ventilating it better to ensure that the visitors have clean air as they wait to walk in the wards and visit their patients.
Delegate your assignment to our experts and they will do the rest.
Capital Structure Theory: Definition, Explanation, and Uses
In the financial management of the health care institutions, the capital structure theory refers to a strategic approach to the funding of the corporate activities that sustain the various projects that the healthcare institutions need to undertake (Ukhriyawati, Ratnawati, & Riyadi, 2017). According to the capital structure model, business activities in the hospitals are funded through a combination of liabilities and equities. The capital structure theory explores the link between equity and debt financing and the market values of the healthcare institutions. The link determines how much funding is required for the projects in the hospitals (Ukhriyawati, Ratnawati, & Riyadi, 2017). The link also identifies the most appropriate financing source for the activities of the hospital.
The capital structure theory has multiple approaches. One of the approaches is the traditional model (Graham, Leary, & Roberts, 2015). According to the traditional approach, a healthcare institution such as Lee Memorial Hospital should target to expand its marketable assets value (Graham, Leary, & Roberts, 2015). The result of such a target for the healthcare institutions is to maximize the growth potentials that the healthcare institutions have. The traditional model of the capital structure theory further suggests that the use of debt funding has a clear-cut limit, which is identifiable (Graham, Leary, & Roberts, 2015). If the hospitals go beyond the debt-financing limit, the debt capital develops the company's devaluation and the superfluous financial leverage. The managers of the healthcare institutions are expected to come up with multiple assumptions while using the traditional approach (Graham, Leary, & Roberts, 2015). One of the assumptions that the leaders make is that the interest rate of the debt is constant within a period and the rate rises with the skyrocketing in the financial leverage over time. Therefore, the financial administrators have to ensure that the debt-financing limit is not crossed lest they increase the financial leverage, which would be needless at the end of the day (Graham, Leary, & Roberts, 2015). The other assumption that the managers make is that the return on equity remains constant and only records a gradual increase with the increase in leverage.
The other approach of the capital structure theory is the Modigliani and Miller approach (Brusov, Filatova, Orekhova, & Eskindarov, 2015). Popularly known as MM, the procedure is used as an alternative to the traditional method. Centrally, the MM approach has two propositions. The first proposition of the method is that the capital structure and the value of a company have no direct correlation (Brusov, Filatova, Orekhova, & Eskindarov, 2015). The model argues that the value of the healthcare firm is dependent on the future earnings that it has. The second proposition states that the financial leverage in an organization increases the forecasted future profits but has no effect on the firm's value (Brusov, Filatova, Orekhova, & Eskindarov, 2015). The increase in the forecasted earnings by the financial leverage is offset by an increase in the expected rate of returns. The MM approach assumes that there are no taxes, transaction costs are inexistent, and bankruptcy costs are also not present (Brusov, Filatova, Orekhova, & Eskindarov, 2015). The other assumption that the MM model works under is that the borrowing costs for both investors and the healthcare organizations are equivalent. The MM approach also works on the assumption that market information is symmetrical (Brusov, Filatova, Orekhova, & Eskindarov, 2015). The companies involved and the investors have the same information regarding the company and its market. Lastly, the MM approach has no effect on the company's earnings before taxation and interests as an assumption (Brusov, Filatova, Orekhova, & Eskindarov, 2015).
One of the functions of the capital structure theory is to dictate the type of financing that a healthcare institution should have (Li & Singal, 2019). According to the capital structure model, the organization gets to decide what assumptions work in collaboration with the facts of the hospital. For instance, if a healthcare institution finds out that the borrowing costs for the institution and its investors are almost similar, it may opt to ide with the debt financing to maintain the financial leverage required. The other role of the capital structure theory is to educate the company managers on the most appropriate financing strategy for its projects (Li & Singal, 2019). Many administrators and especially in the healthcare sector may be torn between equity and debt financing when it comes to the evaluation of the best strategy to use. The other use of the capital structure theories is to establish the relationship between an organization's use of debt and equity financing versus the value of the firm (Li & Singal, 2019). The capital structure approaches form an integral part of the company's value calculation and the determination of the amount of financing it needs. The capital structure theories also come up with a platform for the use of both equity financing and debt financing in a company, as well as the other alternative strategies.
The Capital Structures Strategy of Leading Integrated Healthcare System
Modernization of the healthcare sector in the United States of America has governed the choices that the chief financial officers (CFOs) of the healthcare institutions make regarding project financing (Lehoux, Daudelin, Denis, & Miller, 2017). The choices have of course been reliant in factors such as the amount of money that is required to complete the project, the extent of risk that the healthcare institution wishes to undertake and the availability of the sources of funding (Lehoux, Daudelin, Denis, & Miller, 2017). Most of the leading healthcare institutions in the USA have gone the debt financing way to reduce the risks they have to undertake in the projects they wish to undertake.
The leading integrated healthcare system has employed the pecking order theory as part of the capital structure theories in funding (Turner, Broom, Elliott, & Lee, 2015). The Pecking order theory states that the cost of financing rises with asymmetric information. When it comes to financing a business, the Pecking order approach explains that when determining whether to use internal funds, debt, or new equity, the healthcare institutions follow a sort of ranking (Turner, Broom, Elliott, & Lee, 2015). The ranking is as follows. Healthcare Companies will commence by preferring internal financing, then debt, before issuing new Equity, in that order. Stewart C. Myers and Nicolas Majluf developed the pecking order model in 1984 on the basis that companies prioritized their financing sources in order of the easiest to obtain first (Turner, Broom, Elliott, & Lee, 2015). As per the pecking order approach, the leading healthcare system will seek the most comfortable option to obtain funding first before implementing the other methods of financing for the projects. In the case of Lee Memorial Hospital, the easiest way for funding to get is the internal funding since the expansion project it wishes to undertake considered a small project (Turner, Broom, Elliott, & Lee, 2015). The next method of financing that the hospital may seek is the debt financing due to the minimal risks associated with the method of funding and the vastness in its availability (Turner, Broom, Elliott, & Lee, 2015). Lastly, the health care institution would make use of the equity financing method due to the increased risks associated with it and the possibilities of commencing a disagreement among the shareholders of the company.
Some of the CFOs in the leading healthcare institutions required that their projects be self-financing. The reasons that have been given on the avoidance of debt in that perspective are as follows. Firstly, debt reduces the flexibility of the management (Ismath Bacha & Mirakhor, 2018). The healthcare institutions that seek the various amounts of money in the form of debt tend to have fixed cash flow, which restricts the adjustment of the projects in multiple ways (Ismath Bacha & Mirakhor, 2018). For instance, the money borrowed for the expansion of the waiting room at Lee Memorial Hospital cannot be used to design and construct more parking spaces for the visitors who come to the hospital daily to visit their patients. The financial institutions that offer lending services to the healthcare institutions seem to have a say in the operations of the institutions where they issue them with conditions on what they are supposed to do to qualify for the funding (Ismath Bacha & Mirakhor, 2018). Sometimes, resulting to debt financing can disadvantage the management flexibility by depriving the administration of the learning opportunities they would have had, for example, concerning the optimal use of debt financing to fund hospital projects without wasting the money (Ismath Bacha & Mirakhor, 2018). In most of the times the hospitals which use debt financing have to look for an expert in financial matters to oversee the project.
Debt financing has also disadvantaged healthcare institutions by increasing the financial risk when the leverage increases (Ismath Bacha & Mirakhor, 2018). The more money there is to spend on a project, the more risk there is for the money to be misused or used for unintended operations within the hospitals. Lee Memorial Hospital might, therefore, find it difficult to fund its expansion of the waiting room primarily by the use of debt (Ismath Bacha & Mirakhor, 2018). From the financial approaches regarding funding of the hospitals' project, it is clear that the increase in the amount of money borrowed as debt leads to the rise of the interest rates, which comes with substantial growth in the risks associated with the funding (Ismath Bacha & Mirakhor, 2018). Leading healthcare systems have resulted in using a mixture of equity and debt financing for their projects at different proportions to minimize risk as well as own their plans. In that case, Lee Memorial Hospital may opt to use less equity financing and more debt financing to expand the waiting room (Ismath Bacha & Mirakhor, 2018). For instance, the hospital may use 30% of equity financing for the project and 70% of debt funding. The mixing of the funding options distributes the risks to the various aspects of the project and assures it of timely completion.
Conclusion
The issue of capital structure has been continuously deliberated on in the healthcare system. Choosing between debt and equity financing has also been an uphill task for many administrators within the hospital systems, as they have had to acquire more in-depth knowledge of the merits and demerits of both financing methods. Lee Memorial Hospital has found it relevant to have a blend of the two funding options to induce growth by distributing the risks to the various components of the business. Overall, the financing plan at Lee Memorial Hospital has been essential to the understanding of the choices made in the capital structure within the healthcare institutions. On an analytical approach, the debt financing method is a necessary method for the growth of the projects in healthcare systems due to its reduced risks and increased availability. Healthcare systems in the United States of America will, therefore, prefer to use more debt financing than equity financing. However, the use of debt financing entirely might reduce the control over the projects for the hospital project managers and CFOs. Therefore, a blend of both equity and debt financing may be relevant to the healthcare needs of funding.
References
Brusov, P., Filatova, T., Orekhova, N., & Eskindarov, M. (2015). Capital Structure: Modigliani–
Miller Theory. In Modern Corporate Finance, Investments and Taxation (pp. 9-25). Springer, Cham.
Graham, J. R., Leary, M. T., & Roberts, M. R. (2015). A century of capital structure: The
Leveraging of corporate America. Journal of Financial Economics , 118 (3), 658-683.
Ismath Bacha, O., & Mirakhor, A. (2018). Funding development infrastructure without leverage:
A risk ‐ sharing alternative using innovative sukuk structures. The World Economy , 41 (3), 752-762.
Lehoux, P., Daudelin, G., Denis, J. L., & Miller, F. A. (2017). A Concurrent Analysis of Three
Institutions that Transform Health Technology ‐ Based Ventures: Economic Policy, Capital Investment, and Market Approval. Review of Policy Research , 34 (5), 636-659.
Li, Y., & Singal, M. (2019). Capital structure in the hospitality industry: The role of the asset-
Light and fee-oriented strategy. Tourism Management , 70 , 124-133.
Mason, M. C., Floreani, J., Miani, S., Beltrame, F., & Cappelletto, R. (2015). Understanding the
Impact of entrepreneurial orientation on SMEs’ performance. The role of the financing structure. Procedia Economics and finance , 23 , 1649-1661.
Turner, J., Broom, K., Elliott, M., & Lee, J. F. (2015). A comparison of capital structure: The use
Of debt in investor owned and not-for-profit hospitals. Journal of Health Care Finance , 41 (4).
Ukhriyawati, C. F., Ratnawati, T., & Riyadi, S. (2017). The Influence of Asset Structure, Capital
Structure, Risk Management and Good Corporate Governance on Financial Performance and Value of The Firm through Earnings and Free Cash Flow As An Intervening Variable in Banking Companies Listed in Indonesia Stock Exchange. International Journal of Business and Management , 12 (8), 249.
