STUDY SHOWS NONPROFITS MAY BE PENALIZED UNFAIRLY
Recent laws that can invoke penalties on nonprofit organizations for spending too much on executive salaries may actually impede an organization's ability to perform its mission, according to a study by Sandra Richtermeyer, professor of accounting in the University of Wyoming College of Business.
The 1996 federal law, known as the Taxpayer's Bill of Rights, allows the IRS to penalize board members of nonprofits if they are found to be involved in setting salaries of nonprofit executives too high.
"The new legislation is in response to public perceptions that a high percentage of the funding received by nonprofit organizations is paid to executives, rather than being used to accomplish its mission," she says. "In addition, many critics of nonprofit organizations do not feel that compensation is tied to performance. This study indicate that compensation does appear to be related to financial performance. A lot of the misperception comes from a few highly- publicized examples that gave nonprofits a bad name."
Richtermeyer makes this conclusion after analyzing the financial performance of hundreds of United States tax-exempt organizations with assets of more than $10 million. The statistics were obtained from tax returns filed by the nonprofits with the IRS.
In examining the relationship between executive compensation and accounting performance in nonprofits, Richtermeyer looked at two performance measures-- the percentage of revenue the organization spends on its direct purpose; and revenue growth.
She studied five types of nonprofit organizations and used performance benchmarks established by charity-watchdog organizations, such as the Better Business Bureau and the National Charity Information Bureau. The watchdogs recommend that nonprofits spend at least 50-60 percent of their funds on their direct missions. The results in Richtermeyer's study show average percentages spent on direct missions by organizational type to be human services, 75 percent; health, 73 percent; public and societal benefits, 68 percent; and both arts/cultural and environmental and animal related organizations, 60 percent.
Richtermeyer found a strong negative relationship between compensation and revenue growth across all organizational types, indicating that increases in revenues do not appear to result in increases in compensation. Her study also found a positive relationship between executive compensation and the percentage of revenue spent on direct purpose for all organization types except human services. The results show that nonprofits appear to reward their executives for performing well, and don't seem to increase executive compensation just because more funding is received. The opposite result for human-service organizations indicates that as these organizations receive more funds, executive compensation goes up.
She observed that the new law could have a negative impact on nonprofits' abilities to compete for executive talent with businesses.
"Traditionally, salaries in the nonprofit sector have been lower than those paid by businesses," Richtermeyer says. "Nonprofits are currently operating in a highly competitive environment where it is becoming increasingly difficult to obtain funding from governmental, corporate, and individual sources. In order to effectively perform their missions, nonprofits are becoming acutely aware of the need to adopt business-like practices."
Richtermeyer says a key way of doing this is for nonprofits to pay their executives similar to the way it is done in the business world -- by tying compensation to performance.
"The new legislation may make nonprofits reluctant to do this if they are afraid of being penalized for paying their executives too much," she says. "Furthermore, the legislation does not provide a clear definition of what 'excessive compensation' actually is, and this could make nonprofit leaders even more cautious. Nonprofit organizations provide over one million jobs in the United States and the sector is rapidly growing. Policy makers need to be aware of how the recent legislation will impact this important segment of our economy."
The American Accounting Association recognized Richtermeyer's study as 1998's best dissertation for nonprofit accounting.
Richtermeyer joined the UW faculty in 1997. She earned a B.S. degree (1987) in accounting at UW, an M.S. degree (1990) at the University of Colorado-Denver, and M.B.A. (1992) and Ph.D. (1997) degrees at the University of Colorado-Boulder.
For more information, call Richtermeyer at (307)-766-2348, e-mail [email protected]
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