High compensation for nonprofit leaders, such as the recently
reported $1 million pay for Michael Govan, Executive Director of the Los
Angeles County Art Museum, often creates a outcry for federal limits on
nonprofit executive compensation.
The concern is understandable, but much that’s been written about this
is off the mark.
Critics objecting to high levels of nonprofit compensation
often hold one or more of the following views:
- Pay
for leaders in nonprofits should be reasonable in terms of competitive levels
for similar nonprofit executives, and the expectations of donors and funders of charitable
organizations. As such, they
should almost always be below those paid in the private sector.
- Pay
for nonprofit leaders should be less than some arbitrary standard, such as the
salary of the President of the United States.
- Nonprofit
leaders should work primarily for the psychic income of fulfilling important
missions; compensation should not be an important factor in recruiting or
retaining leaders.
- The
world is full of competent leaders who would work in nonprofit positions for
compensation that critics deem reasonable.
The article’s main theses are:
- Except
for the first point above, with which I fully agree, most critics of high
nonprofit compensation don’t have a good understanding of the dynamics of
nonprofit leadership or of the pay required to attract and retain top talent.
- Setting
an arbitrary standard to limit nonprofit executive compensation would be a
mistake, with damaging unintended consequences.
- Existing
controls – board oversight, the threat of fines and sanctions, and public
review -- provide sufficient control of nonprofit compensation, even at the
top. But these controls could be
strengthened.
This post will attempt to deal with these issues. It's a long post, so you may want to read it in segments, or you can print a pdf version by going here.
Managing Nonprofits Can Be Highly Complex
Imagine you are the CEO of a YMCA in a major metropolitan
area. You are responsible every
day for hundreds of children in dozens of locations; you need to structure
operations and supervision so that none of them are lost or injured or abducted
or drowned. This is in addition
the normal responsibilities of ensuring financial health, raising funds,
coordinating with city and state authorities, developing and motivating staff,
etc. Few for-profit positions have
a similar level of complexity and risk.
The same can be said of presidents of universities, who must
combine significant fund-raising expertise with sufficient diplomacy to
influence diverse constituencies (faculty, students, alumnae, trustees) to
uphold and improve educational excellence. Ditto for hospital CEO’s, with their financial and
regulatory imperatives and diverse constituencies.
Leaders of these organizations and many other types of
nonprofits are responsible for much more than revenues and profits – they
nurture individual growth and development, heal and comfort the sick, shelter
the homeless, protect the battered, and in hundreds of other ways improve our
communities. Yes, almost all of
them are willing to do this for less pay than their jobs would be worth in the
private sector. But that does not
mean that their pay should be limited to some arbitrary number.
Good Leadership Makes a Difference
One thing I have noticed in my nonprofit work is that there
are usually four to five organizations that are considered the leaders in each
city’s nonprofit sector and that these leaders vary considerably by type of
service provided. In city A the
top charities might include a foundation or museum, in city B it may include
the Girl Scouts or an animal welfare charity, in city C it may include a hospital
or a homeless shelter or a zoo.
Whether a cause or result of their success, these top
charities almost always attract a high level of contributions. Community leaders want to serve on
their boards, where doing so is a badge of honor and acceptance. These charities usually do a good job
of measuring outcomes clearly; they have a strong track record of success; they
are financially stable.
These charities are not the community leaders just because
of what they do – there are always equally worthy charities not in the
leadership group. Sometimes their
leadership results from a significant economic windfall – the Marin Community
Foundation comes to mind. But
almost always, somewhere during the organization’s growth, an inspirational,
highly effective leader brought its performance to a level where it’s
achievement and value became clearly apparent to the most important and
influential individuals in the community.
And their involvement – encouraged by this leader – contributed
exponentially to its success.
Now let’s assume you are a trustee of a nonprofit looking
for a new leader and you want someone with the potential to build the
organization to one of the premier nonprofits in your community. Or to turn around an organization in
trouble. Or to greatly enhance the
organization’s ability to achieve its mission. The pool of potential candidates includes existing executive
directors, nonprofit managers just below the ED level, and for-profit
executives, either active or recently retired. Any of these candidates could be independently
wealthy, willing to work for little or even no compensation.
But why limit your search to those willing to accept below
fair pay? The candidate pool
undoubtedly includes qualified people with children in college or other
financial needs, without independent financial resources, for whom a decent
salary is very important. The best leaders may come from this
pool.
Why capping pay is wrong
For most nonprofits, the type of caps being proposed is
immaterial – few pay their top people close to $400,000 or $500,000. But for the small percentage of
nonprofits who do pay this level of compensation, caps would create serious
problems.
First, any pay limit set by the IRS on Congress other
governing body would be arbitrary.
The most common suggestions are limiting nonprofit executive pay to the
salary of the President of the U.S. (currently $400,000) or the $500,000 base
salary limit being applied by the Treasury Department to organizations
receiving government funding under the TARP program. But neither of these numbers reflect the value of the work
being performed – they are just politically expedient numbers the public can
more readily accept.
Second, any cap would undoubtedly be unfair to nonprofit
executives whose scope of responsibilities genuinely reflect greater value than
the cap itself. Limiting pay for
university investment professionals or basketball coaches or heads of
cardiology in medical schools to $400,000 or $500,000 would result in a
unsustainable gap between what they can make in the private sector and what
nonprofits could pay.
Third, it is likely that a pay cap would lead larger
nonprofits to look for other ways to compensate their top people, through
expanded benefits, or added time off, or job sharing, or special fees, in order
to keep their best talent. The
government might try to preclude this through legislation beyond the pay cap,
but such legislation would be very complex and costly to administer.
Fourth, the pay cap could actually result in higher
compensation for leaders of smaller nonprofits – those below the pay cap. Even $150,000 or $200,000 is higher
compensation than the vast majority of nonprofits should be paying their
executive directors today – most charities are very small. Providing an official ceiling of
$400,000 or $500,000 could put pressure on trustees to raise executive compensation
more quickly than they would do absent the cap.
Finally, in the largest nonprofits, a pay cap could cause
salary compression, with many executives earning close to the cap even though
their responsibilities are substantially less than those of the CEO, creating
serious inequities in the compensation structure.
There is a Solution
You won’t get rid of excessive pay entirely in nonprofits,
no more than in any other sector.
But there are good steps that can be taken to lessen the incidence of
egregious pay.
First, the IRS should use existing sanctions more
forcefully. These sanctions
(commonly called the “intermediate sanctions”) enable the IRS to fine trustees
and tax executives in cases of egregious excess compensation. But these sanctions apparently are rarely
used. They may be saddled by budget constraints, but I think the IRS should be more aggressive
going after apparently excessive compensation.
Further support should come from publications such as the
Chronicle of Philanthropy or the Chronicle of Higher Education, and
organizations such as the Independent Sector or Charity Navigator. Some of these organizations may be reluctant
to bite the hands that feed them, but as the Chronicle of Philanthropy has
shown, pointing out specific cases of potential abuse can create change.
Most important, the Boards of Trustees should do their
homework with a thorough periodic review of top officer compensation. This review should address these
questions:
§
Does the organization have a compensation
policy, and if so what is the intended position of the organization’s
compensation against the peer groups to which it will be compared? If the intended position is above
average (e.g., 75th percentile), is this strategy supported by the
organization’s size and complexity and/or the background, experience, and
performance of the executives being reviewed?
§
Is the peer group against which the organization
being compared truly representative, in terms of size, mission, scope, and
geography?
§
How does the top executive’s market position
compare to that of other executives and employees in the organization? If the CEO is the only executive at the
75th percentile while everyone else is at or below average, is there
a clear justification for the difference?
§
How transparent is the entire compensation
package? Are there special
benefits or perquisites that apply only to the top officer, and if so is there
a justification for this? Will
this justification stand up to public scrutiny?
With strong board oversight, a stronger and more active IRS,
and aggressive publicity about questionable compensation, we can strengthen
nonprofit compensation generally and reduce the incidents of abuse.
Pete Smith is the
President of Smith Consulting. The
former CEO of Watson Wyatt Worldwide, he now provides executive compensation
consulting services to the nonprofit community.
Recent Comments