Accessing capital: learning to live in the real world.

The "unreal" world of payment and capital financing of the last 40 years is rapidly coming to a close, and all guarantees of stability are in doubt. Although this seems like a bleak and heartless challenge to the accepted mission of U.S. hospitals, it represents just a taste of the discipline of the capital markets that has always been known and feared by the rest of corporate America. The principles that govern this new world order are simple. 1. All sources of capital demand returns comparable to those of equal risk investments. 2. Returns may vary in form, timing, and source as long as they are sufficient. 3. Dividends-whether cash or in kind-can only be paid out of economic profit. Translated to our healthcare environment, this means that (1) our money is not free or low cost, no matter what the source; (2) our investments must promise clear and immediate returns or viable future options to convince the capital markets to finance us; and (3) the social dividends so central to our identity are in jeopardy if we are not successful (Silvers 2001). The well-worn slogan "no margin, no mission" must be amended to read "no margin, no money, no business, no mission." BACKGROUND The first time I attempted to understand how healthcare capital investment really works was in my second year as a professor teaching in a healthcare executive program at the Harvard Business School in 1972. I ventured to New York to interview the chief financial officer (CFO) of one of the largest hospitals in the city with the intention of gathering teaching material. As a professor of corporate finance, I thought I knew something about the subject and figured that I could whip up a case that explored the financial decision-making process around some interesting investment proposal. I assumed that the process would be similar to that of the businesses I had known: identify potential positive return projects, evaluate them against financial and strategic criteria, determine the financing need implied in the aggregate by the acceptable criteria, and then compare that need against internal and external financing available under current conditions. While short-term capital restrictions might argue for deferral of good projects, turning down those that promised additional shareholder value just because they required external financing made no economic sense. However, when I asked how the capital budgeting process worked, the CFO looked puzzled and replied that, once they had added up all the project requests, they talked to their investment banking firm to see what they could raise in a capital financing program. I responded that I understood the financing process but wanted to know how they made capital budgeting decisions. It quickly became clear that the hospital had no real process. It accepted all projects that the markets would allow based on its general financial condition and current cash flow and debt coverage. At that time, with almost all of its payment based on cost, reimbursement of depreciation and interest was sufficient to cover almost any debt level. Raising funds was not a challenge. In essence, the discipline of the capital markets was completely submerged by the benign payment that guaranteed returns and eliminated financial risk. FINANCIAL RISK Even in recent years, in response to my question as to how to define financial risk, most CFOs respond that it comes from changes in government payment rather than service market conditions. Of course, the government does pose an environmental risk, but it is only one source. Loss of patient volume, substitution of services, or obsolescence of facilities-the sorts of risk factors that one would hear mentioned by CFOs in the general corporate sector-are growing or even dominant sources of risk to healthcare institutions. The two feature articles in this issue of Frontiers reflect these changes from the days when payment was fair (i. …