For-profit and nonprofit charter schools: an agency costs approach.

• Author: Morley, John

NOTE CONTENTS INTRODUCTION I. CHARTER SCHOOL STRUCTURE A. The Charter School Concept B. Distinguishing For-Profit and Nonprofit Charter Schools II. EXPLAINING NONPROFIT DOMINANCE A. Contract Failure Theory B. High Monitoring Costs in Charter Schools 1. Monitoring by Parents 2. Monitoring by Governments 3. Monitoring by Donors C. Enforcement of the Nondistribution Constraint in Charter Schools D. Alternative Explanations for Nonprofit Dominance III. EXPLAINING FOR-PROFIT EXISTENCE IV. ORGANIZATIONAL FORM AND THE GOALS OF CHARTER SCHOOL POLICY A. Resource Attraction B. Localized Governance C. Output-Based Accountability V. REGULATORY IMPLICATIONS CONCLUSION INTRODUCTION

Charter schools are becoming an increasingly important part of America's primary and secondary education system. Since 1991, forty states, the District of Columbia, and Puerto Rico have authorized charter schools, (1) and more than 3000 such schools have opened. (2) Congress has recently devoted considerable time and attention to charter schools, authorizing major grant programs to assist charter schools with startup costs (3) and facility acquisition, (4) and allowing failing conventional public schools to restructure themselves as charter schools under the No Child Left Behind Act. (5)

As charter schools increase in importance, so does the debate about the laws that govern them. In this Note, I examine one aspect of that debate: whether to organize charter schools as nonprofit or for-profit entities. The role of profit has become a contentious issue in charter school policy. For-profit schools have drawn criticism for cutting quality in the interests of shareholders and overlooking the public good aspects of education. They have also drawn praise, however, for the innovation, efficiency, and market-style discipline they promise to bring to education.

I explore charter schools' use of the nonprofit and for-profit forms from the perspective of agency costs theory. Though the debate about charter schools is so broad that strong claims about its content are dangerous, voices well informed by agency costs theory appear to have been largely absent. This Note seeks to fill that gap.

Agency costs theory illuminates the debate about charter school organizational form in a number of ways. First, agency costs theory explains the relative dominance of nonprofits in the charter school market. As Henry Hansmann has argued, the nonprofit form is useful when principals have an unusually difficult time monitoring or enforcing contracts with their agents. By prohibiting nonprofits from distributing earnings to shareholders, state laws allow nonprofits to pledge with a high degree of credibility that they won't cheat their patrons in ways the patrons can't perceive or control. Since nonprofits don't stand to gain anything from cheating, they have little reason to do it. Hansmann's model fits the charter school market, because the various parties that control charter schools' success--parents, government agencies, and donors--all have a great deal of difficulty perceiving and controlling abuse and cheating by charter schools. In other words, monitoring costs are high and the nonprofit form reduces them. A significant minority of for-profit charter schools exists in spite of these high monitoring costs, however, because for-profit schools' superior access to capital markets allows them to operate on a large scale. For-profit schools exist when they can achieve economies of scale that outweigh agency-cost inefficiencies.

Second, agency costs theory suggests that nonprofits may be better than for-profits at furthering some of charter school policy's more complicated goals. Nonprofit schools attract charitable donations and improve local teachers' and parents' control more effectively than for-profits do. This conclusion must not be overstated; for-profit schools may be slightly more responsive to the pressures of output-based accountability than nonprofits are. But there is little doubt that organizational form has important consequences for charter schools' abilities to actualize the goals of charter policy.

Finally, agency costs theory suggests that regulators may need to control for-profit schools more aggressively than nonprofit schools. The rhetoric of the charter school movement has emphasized charter-school-specific forms of accountability, such as parental monitoring and periodic output-based review by government agencies. But agency costs theory suggests that the nonprofit form may be just as important in regulating most charter schools as these more direct forms of accountability are. For-profit schools not subject to the nonprofit form's constraints are therefore likely to expose the gaps and cracks in charter-school-specific regulation. In this Note, I suggest a handful of regulatory changes to meet the challenges for-profit schools pose. These include curtailing "hybrid" for-profit-nonprofit management arrangements, limiting for-profit schools' ability to cut quality in imperceptible ways, and strengthening existing governmental monitoring and information-gathering systems.

I begin in Part I by explaining the charter school concept and the organizational forms charter schools use. These forms tend to be complex and cannot be placed into "nonprofit" and "for-profit" categories as neatly as forms in most industries. In Part II, I explain nonprofit schools' relative dominance. In Part III, I explain why nonprofits' dominance is not total, and why there are still a significant number of for-profit charter schools. I move in Part IV to examining how for-profit and nonprofit schools differ in achieving some of the more complicated goals of charter school policy. In Part V I then propose changes in regulation to meet the challenges posed by for-profit schools.

1. CHARTER SCHOOL STRUCTURE

   "Charter schools" are notoriously hard to define. Charter laws differ widely from state to state, and charter schools exist alongside other school choice regimes, some of which go by different names but are difficult to distinguish from charter schools. (6) The concepts of "for-profit" and "nonprofit" are also complicated in the charter school context. Mostly to avoid restrictions on for-profit entities' abilities to hold charters directly, charter schools have produced unusual fusions of for-profit and nonprofit legal forms that defy easy categorization. To clarify these murky concepts, in Section A I define "charter schools" and distinguish them from conventional public and private schools. In Section B, I draw distinctions among charter schools, and separate these schools into for-profit and nonprofit groups.

   1. The Charter School Concept

      Charter schools combine elements of conventional public and private schools. (7) The key characteristic of a charter school is that it combines public funding with private management. Unlike conventional private schools, charter schools do not charge tuition (8) and receive all of their funding from state and local governments, school districts, and private charitable donations. Unlike conventional public schools, however, charter school teachers and managers usually are not government employees. (9) State laws place few restrictions on who can start a charter school, and the charter school definition the U.S. Department of Education uses for administrative purposes allows parents, teachers, school administrators, and any "members of the local community" to operate a charter school. (10)

      Enrollment in a charter school is also usually optional. (11) Unlike conventional public schools, charter schools rarely have geographic boundaries inside which attendance is compulsory. (12) Students can leave charter schools for other charters, conventional private schools, or conventional public schools. If a school has more students wishing to attend than seats, it must admit students by lottery. (13)

      Prior to opening, a charter school must receive a "charter" from a statutorily authorized agency. (14) Under the federal definition, any "public entity" authorized under state law and approved by the Secretary of Education can authorize a charter school. (15) In most states, charters may be granted by local districts, state departments of education, or universities. The chartering process and the level of scrutiny applied to charter applications vary widely among states.

      A related point is that chartering agencies rarely solicit applications. Unlike most publicly funded, privately operated enterprises, charter schools typically apply for public funding on their own initiative, operate largely according to their own terms, and rarely have to endure a competitive bidding process. (16)

      When cities hire private trash collectors, for example, they usually begin by defining the areas to be served and seeking competitive bids. (17) In most cases, after signing a contract, the city stops collecting the trash and lets the winner of the bidding process take over. In contrast, school-chartering agencies tend to wait passively for charter operators to come to them, and the goals of charter schools may have little or no connection to the strategic plans of the districts in which they operate. Charter applicants usually determine their own "educational objectives" and basic curricula; these objectives and curricula are merely "agreed to" by chartering agencies. (18) And charter authorizers usually grant charters to worthy applicants even when existing conventional public schools have the capacity to educate all students in an area. This often means that conventional schools' costs remain the same even after charter schools appear in their areas and begin drawing away students and the funding attached to them. (19) Sometimes charter schools follow a more traditional privatization model. Under the No Child Left Behind Act, for example, local districts, on their own initiative, can dissolve failing conventional public schools and convert them to or replace...