Nonprofit Musings

A weak, rehashed proposal on nonprofit executive pay

He's at it again.

Pablo Eisenberg’s commentary in the June 13 issue of the Chronicle of Philanthropy Charities Shouldn't Follow Businesses in Setting Executive Pay once again wraps zealous muckraking around a valid point, at the expense of many dedicated and ethical professionals whose selfless contributions make the nonprofit world such a special place.  This is the third or fourth op-ed Eisenberg has published in recent years advancing essentially the same arguments.  

Yes, there is abusive executive compensation in some charities.  And yes, charities shouldn’t base their compensation levels on private sector pay.  But almost none do this – everyone knows that whether you’re the Executive Director or even an Administrative Assistant, you’re going to earn less in the nonprofit world than in the business world. 

Mr. Eisenberg goes on to repeat his previous proposal that pay of nonprofit executives above $400,000 per year be taxed at 100% to 200% of the amount over $400,000.  This arbitrary limit is wrong on two counts.  First, there are some nonprofit positions –the President of the University of Maryland or the Chief Executive of Kaiser Permanente, for example – where the scope of responsibilities and annual budget and potential liabilities require someone with substantial experience and ability, and where even in the nonprofit world the positions are worth well above $400,000 per year.  In some cases independently wealthy people will take on such assignments for a low wage.  But limiting the field only to such people doesn’t make sense.

Second, Mr. Eisenberg’s proposal doesn’t deal with overpaid charity executives earning less than $400,000.  For many smaller charities, a salary of $250,000 or even $100,000 may be excessive, given their size, funding, scope, and complexity of management.  Determining the right compensation for any position is more complex than Mr. Eisenberg recognizes.

The implication in Mr. Eisenberg’s article is that charities are teeming with overpaid executives not worth their salt.  “Why are so many nonprofit directors’ compensation packages doubled or tripled from their previous salaries when they take on a new job?”  This is an absurd contention; in 40 years of compensation consulting to nonprofits, I have never seen even one such case. 

Finally, a look at the landscape shows that Mr. Eisenberg’s alarm is misplaced.  Charity Navigator’s data base of 5,497 nonprofits – including most of the leading U.S. nonprofits – shows that only 291 (less than one half of one percent) reported total compensation over $400,000 in their most recent IRS 990 form.  One hundred and eight of these executives were in either hospitals or universities, meaning that in general charities, the percentage of executives earning over $400,000 is .033%.  (My thanks to Sandra Miniutti of Charity Navigator for providing this information.)  

My experience shows that today, boards of trustees take their responsibility for setting fair and reasonable executive pay very seriously, and that most of them do a very good job at this.  Watchdogs should continue to look for abuses – Senator Grassley has been most effective in this respect – and the IRS enforcement group should have more funding and a greater presence.  But publishing a broad-based screed on this subject from Mr. Eisenberg every year isn’t helping anyone, and it isn’t providing the Chronicle's readers or charity donors the level of intelligence on this subject they deserve.

New horizons for executive pay in New Jersey

The Chronicle of Philanthropy is reporting today of an uproar over what appears to be incredibly high levels of executive compensation at New Jersey's Horizon Blue Cross Blue Shield.  The article is here: Executive Pay Casts Horizon in a Different Light.  

One can question why the "Blues" are nonprofits in the first place, but that's another issue.  Even given Horizon's extensive operations and competition from for-profit health care organizations, it is difficult to justify the reported $8.7 million paid to Horizon's CEO, William Marino.  Some of this cash was deferred compensation from previous years, which the organization decided to accelerate; Horizon says that Mr. Marino's pay without this acceleration would have been $4.8 million.  It may be that a full analysis would show that this is reasonable compensation given Mr. Marino's responsibilities, experience, and performance, but this still seems like a very high number for a nonprofit, and it's more than a number of other Blue Cross/Blue Shield CEO's earn.

The deferred compensation was part of a long-term incentive plan, but it's payment was accelerated "because of a change in the tax law" according to a Horizon spokesman.  Come again?  Long-term compensation plans are intended to focus performance on greater time horizons and to encourage executive retention.  I suspect that the payments were moved up on the expectation that tax rates for high earners were likely to rise.  So management or the board said to heck with the plan design, let's take the money while it's there.  

As that isn't bad enough, Horizon cites some incredible statistics to support the high compensation levels.  "Total executive at the company last year cost each member $7.68," said company spokesman Thomas Rubino.  What does that number have to do with fat wallets?  It would only cost $3.84 per member -- just another 32 cents a month, or less than a penny a day -- to have a paid Mr. Marino $13 million last year.  

Similarly, Rubino points out that Horizon uses nearly 90% of its revenues to pay for medical care, "more than the state requires."  Why do organizations whose executive compensation is taking heat think that throwing out unrelated statistics is going to calm the waters?  

There are three lessons here.  First, if you are going to change a compensation program in ways that drive pay into the stratosphere, you better have strong valid reasons for doing so.  Second, the Board and its spokespeople should be ready from day one to make these strong reasons clear, in response to any press or government inquiry.  Finally, don't try to cover excesses by introducing unrelated statistics -- the public is much smarter than you think.  

Excessive Compensation -- Is There A Cure?

Despite the recent outcry over executive pay levels, options for curtailing excessive executive compensation appear to be limited.  Even with considerable press scrutiny and the good efforts of pay czar Kenneth Feinberg, little seems to have changed except in the few companies now owned primarily by the U.S. government.

Critics have offered solutions such as requiring shareholder votes on pay levels or stipulating that executive compensation cannot exceed certain predetermined levels or ratios.    While these ideas have some merit, the differing needs of differing industries would make them very difficult to implement. 

An alternative solution is to increase the transparency of each organization’s compensation practices by requiring that in their annual filings (proxy statement or 990 form), each organization provide the following information:     

• The ratio of their Chief Executive’s annual compensation to the average annual compensation of their top five officers (excluding the CEO).
• The ratio of their Chief Executive’s annual compensation to that of the compensation average full-time employee in the entire organization. 
• The ratio of their Chief Executive’s annual  compensation to that of the lowest paid full time employee in the organization.
• The ratio of the top five executives’ (“named executive officers” in public companies) average annual compensation to that of the average full time employee. 
• The ratio of the top five executives’ average annual compensation to that of the lowest paid full time employee in the organization.

For these ratios, only full time employees who worked a full fiscal year for the organization would be included in the calculations.  If the CEO worked for less than one year, his or her ratios would be excluded from the listing.  If one or more of the other top five executives worked less than a year, their data would be replaced by next highest paid full time executive. 

Data would be shown in two ways: 1) total cash compensation (salaries, bonuses of any kind, commissions, overtime, etc.) and 2) total compensation and benefits, including total cash compensation, stock grants and options, plus any benefits and perquisites and allowances, including insurance benefits, retirement benefits, and perquisites such as cars or club memberships. 

How will this help?  Within sectors, it will show the relative greediness of top executives, identifying clearly which executives are taking a bigger piece of the pie.  This won’t stop executives from being overpaid, but the transparency will require some organizations to justify their compensation practices, and undoubtedly result in some different actions by Boards and Compensation Committees.

Critics of this recommendation may point out correctly that compensation dynamics differ greatly from sector to sector.  For example, given the low margins and high percentage of low-income workers in the grocery industry, otherwise reasonable executive compensation at companies like Safeway could produce much higher ratios that in companies with many high paid professionals, such as investment banking.  In nonprofits, a homeless shelter with low executive compensation could have much higher executive compensation ratios than a victims rights organization that employs many attorneys.  Nonetheless, comparisons within industries or service sectors would be enlightening, and could push executive compensation in the outliers towards more reasonable levels.

Pete Smith is President of Smith Compensation Consulting, a firm that specializes in nonprofit executive compensation.  

Managing Compensation in Difficult Times

Almost all nonprofits are approaching compensation decisions cautiously now, given the continuing uncertainty of the economy.  What's right for your organization depends largely on context:  your financial health and the strength of your reserves, how competitive your compensation was when times were good, or how you handled compensation and benefits last year.

Recognizing that there is no one solution that fits every nonprofit, here's a short list of steps that some of the best-managed organizations have been taking during this period:

• Increasing compensation conservatively during the past two years.
• Using the down economy as a rationale for doing some careful pruning of under-performing employees.
• Working from the top of the organization down in implementing salary freezes or reductions, with larger cuts for higher paid employees.
• Working from the bottom up when restoring pay cuts or unfreezing salaries; in other words, taking care of the lower paid employees first.
• Eliminating any fringes or special benefits for top executives.
• Furloughing employees or reducing work hours for everyone rather than eliminating jobs, where possible.
• Communicating compensation and benefit decisions openly and honestly.
• Approaching the future with caution -- conservative salary increases and deferring the implementation of any new or enhanced benefit programs.
• Recognizing that competitive pay for good people is still a necessity.  Well-run nonprofits are not afraid to pay for talent where needed.

When Senator Grassley Calls, Be Prepared!

The controversy over the compensation of Roxanne Spillett at the Boys & Girls Clubs (see Senators Question Executive Salary and Other Perks) emphasizes how important it is for Boards and Compensation Committees in nonprofits with high-paid leaders to be ready should their compensation decisions be challenged.  

Ms. Spillett's 2008 compensation as reported in the most recent 990 form ($360,774 in salary, $150,000 bonus, $385,500 of deferred compensation, and $92,317 of "other" compensation, totaling $988,591) is certainly high enough to raise a controversy.  The organization is large -- over $150 million in annual revenues -- and complex (overseeing more than 4,000 clubs serving over 4 million youth).  Based on these facts, some have argued that her compensation is justifiable.

On the other hand, nearly a million dollars of compensation in almost any nonprofit is pushing the edge of reasonableness.  Paying a $150,000 bonus in a year when the organization had a net operating loss of $13.5 million is surprising.  And providing the CEO with $385,500 of deferred compensation when the next highest paid executive's deferred compensation was $22,500 raises alarms.  Is this an accrual for benefits earned in previous years, or is Ms. Spillett's value so much greater than the other executives in this organization?

There may be good reasons for every single element of Ms. Spillett's compensation.  But the Board of the Boys & Girls Clubs was clearly not prepared to handle the controversy they created by approving this package.  I've worked with Senator Grassley's office on compensation issues before, and he usually doesn't go public with complaints until after he has privately asked the organization to answer some reasonable and specific questions about why the compensation reported in the 990 form is what it is.  In this case, I am not privy to the correspondence between Senator Grassley and the organization, but I suspect that the Board failed to provide transparent, open information about their compensation decisions.  Failure to fully inform tends to get Senator Grassley's ire up, as it should.  

Further, the Board's response to the outcry following Senator Grassley's going public has been mediocre at best.  They have reported that the Mercer consulting firm did a study and found Ms. Spillett's compensation reasonable, and they have argued that they organization is large and complex.  Fair enough.  But why is her compensation reasonable?  What peers did the Mercer organization compare her to?  (This type of information is commonly available even in the required SEC filings for public companies.)  What was the justification for paying a bonus in a year with a huge operating loss? Was the deferred compensation payment for one year of service alone, or a payment that built up over many years of service?

It is not unreasonable to assume that the Boys & Girls Clubs Board considered all these questions when they made their compensation decisions; that they have good answers; and that Ms. Spillett's compensation is reasonable, as defined in the Intermediate Sanctions regulations.  But even if so, the damaging publicity could have been avoided if the Board, which must have been aware of the potential for controversy here, had been prepared.

So what does this mean for your organization?  If you are well under the radar on executive compensation, not to worry. But if your executive compensation is pushing the envelope, it would be well worth the organization's time to have a clear, well thought out, transparent communications plan ready to respond to any Congressional inquiry or negative publicity -- even if your consultant has attested to the reasonableness of the compensation in question.

Lessons on Executive Compensation from the For-Profit Sector

I’m going to venture out of the nonprofit world for a moment to share some lessons from how two major corporations – IBM and Intel – are treating their executive compensation. 

Publicly listed corporations are now required by the Securities and Exchange Commission to file a detailed statement (the “Compensation Disclosure and Analysis” or CD&A) describing their executive compensation.  These disclosures can be very revealing, not only about levels of pay but also about the thinking behind them.

In my view, Intel’s most recent CD&A (available here:  Intel CD&A ) is a model of good compensation governance.  It lays out clearly and openly Intel’s compensation philosophy, processes, programs, and results.  While Intel executives are very well compensated, especially when the company is successful, executives are treated no differently than rank-and-file employees.  There are no special employment conditions or severance arrangements for executives.  Executives receive the same benefit programs as all other full time employees, supporting Intel’s objective of providing an egalitarian culture.  Reading this document, you get the strong feeling that this is the kind of company you would like to work for, or invest in.

By contrast, IBM’s CD&A (available here:  IBM CD&A ) is defensive and arrogant.  Instead of simply spelling out what it does and why, IBM begins its statement by patting itself heavily on the back for “putting tremendous effort and rigor into our own executive compensation process over many years.”  Next, it points out that its “unique integrated business model” demands “a senior leadership team of unusual depth, agility, and experience.”  My, aren’t we proud. . .

After describing how it sets salaries and bonuses, IBM quickly gets to another sore point:  executive perquisites, commonly described as “other compensation” in CD&A’s.  Here, IBM says that “additional programs (beyond those for employees in general) that are restricted to senior executive participation amount to less than 1% of their total compensation on average . . . and are limited to services with a direct bearing on individual productivity or security.”  Come on!  What they’re talking about here are things like corporate aircraft.  Saying that only 1% of total compensation goes to perquisites is the same as saying “we’re making so much money that our corporate jets get lost in the rounding.” 

There’s more of this in the lengthy IBM filing, the message being that although you may not like what we’re doing, it’s serving us well.  Maybe it is.  But the Intel filing is far preferable, the message being that this is how we see the world of compensation and our rationale behind it, and we think this serves all our stakeholders – including all our employees – well.

What can you learn from reading both proxies?  My guess:

• Honesty is the best policy.  Distortion of intent is obvious and counter-productive.
• An egalitarian approach to compensation – treating all employees within the same general compensation philosophy – is better than making the rich richer.  
• Giving stakeholders a say in compensation – Intel is among the first to allow a shareholder vote on executive pay – is better than trying to control everything from within.  

More Commentary on Setting Nonprofit Pay Levels

In his Harvard Business Review blog on nonprofits, Dan Palotta has two interesting new posts dealing with nonprofit compensation, Compensation Should Be Aspirational and Executive Compensation, Charities, and the Curse of Proximity. Both these posts and the related comments are well worth reading.  I am not sure I agree with all of Dan's points -- paying executive compensation based on aspirational goals before achieving such goals can be dangerous -- but they are well worth considering and a healthy balance to the many critics who believe that just because you're saving the world you should be making far less than someone running a modest for-profit business.

A Creative Incentive Plan for Nonprofits

One of my clients -- to whom goes full credit for every good idea in this post, but whose identity I am respectfully keeping confidential -- introduced me recently to an highly effective incentive plan design that other nonprofits may want to consider.

This is a fairly large nonprofit -- expense budget well over $100 million per year.  Their incentive plan covers all the key executives reporting to the Chief Executive Officer, about eight in number.  The target incentive is 3% of base pay -- it does not vary by position or level -- and it is an "all or nothing" incentive: an incentive bonus of 3% of base salary is earned or there is no payment.

For each participating executive, there are three performance criteria, all linked to the strategic plan. The first criteria, given a third of the performance weighting, is based on meeting the overall organization's financial operating budget for the year.  The second and third criteria differ based on each executive's responsibility, but each relates to specific strategic plan goals and each is weighted at one third of the total performance rating.

At the end of the year, performance for each executive is ranked against the criteria using a 5 point scale, in which point 3 is meets expectations, 4 is exceeds expectations, and 5 is far exceeds expectations.  An executive's overall ranking must be 4.0 or above to receive an incentive.  If this threshold is met, an incentive bonus of 3% of base salary is awarded.  If not, nothing is paid.

Why do I like this plan?

• It is a true incentive.  This organization sets stretch performance goals, and pays incentives only when performance is truly above average.  To this point, only 3 in 8 eligible executives received awards last year, and it is unusual for any given executive to receive an award more often than one year out of three.
• The target amount of the incentive -- 3% of base pay -- is not so large that it would encourage setting unrealistically low targets or fudging the numbers to achieve goals.  The awards are meaningful -- $3,000 to $6,000 typically, when earned -- but not life changing.  So top management can assess performance honestly, without the pressure that the potential for very high awards can sometimes bring.
• Management at this organization is always focused on what's right in terms of achieving mission, rather than what will produce year-end incentives.  They value the incentive program, but its mechanics and opportunity are not such that it would ever distract them from acting on the best interests of the institution.

I recognize that some nonprofits pay much larger incentives and that others believe that incentive compensation has no place in the nonprofit community, and that both views have merit.  However, if your organization has been considering incentives, modeling a program on the one described in this post would likely be a good way to start.

Equal Pay's a Long Way Away

Having begun my compensation consulting career in the late 1960's, when some employers were still willing to openly defend their rationale for paying women less than men in equal jobs, I would have expected by now that, all things considered, men and women in positions of equal responsibility were generally paid comparably in this country.

Not so.  In a thoroughly researched and well written article, my friend Deborah Eisenberg -- a Visiting Assistant Professor at the University of Maryland School of Law -- demonstrates that pay discrimination is still very much with us, and greatest at the higher levels of management.  The article is well worth reading, and can be found here:  Shattering The Equal Pay Act's Glass Ceiling.

They're at it again!

In a November 30th article in the Boston Herald, reporter Adam Smith (no relation, fortunately) slams Boston area nonprofit executives for "raking in pay and perks" over the past year.  "As the worst recession in decades stripped thousands of Bay State workers of their jobs," he writes, "a small group of people saw greenbacks continue to fatten their paychecks:  the leaders of the state's top tax-exempt organizations charged with aiding the poor, mentally handicapped, and other disadvantaged residents."

The source of Smith's data is of course the IRS 990 forms, which as I've pointed out in previous posts are measuring compensation paid mostly during pre-recession times.  Particularly galling to Smith are executives who earned more than the President of the U.S., six of whom are featured in his article (two of whom, by the way, took pay cuts last year).  

Why observers continue to think the $400,000 the President earns is a benchmark for anything is beyond me.  The salary in no way reflects the enormous responsibilities of the position.  And these compensation critics never factor in little perks the President gets, like a nice mansion to live in, chauffeured limousines everywhere, private aircraft, a bevy of personal chefs, and a $400,000 retirement benefit for life.  The President's position is not an appropriate market comparison.  Can you imagine a nonprofit CEO candidate saying to a Board Chair "Gee, they're offering me the Presidency, and that pays $400,000 -- what are you offering?"  

I have no idea whether the CEO's Smith attacks are paid reasonably, but neither does he.  It would be nice to believe that reporters approached personal subjects like this ethically, but that of course would be naive.

Smith's full article can be found here:   Charity Heads Home

Are Published Compensation Surveys Accurate?

Experiences with two recent clients have raised some red flags about using typical published surveys to evaluate executive compensation.

Both of these clients had previously hired established, well-known consulting firms to evaluate the compensation levels of their senior executives.  Both consulting firms had carefully matched job descriptions to reputable survey data bases and both had used multiple survey sources to support their findings. 

But actual data from IRS 990 forms showed that in both cases, the consultants’  findings were wrong.  Both consultants significantly underestimated competitive market values, especially for top executives. 

Why?  It turns out that the organizations participating in the broad surveys the consultants used were not representative of the organizations with which my clients are in direct competition.  In one case a survey peer group contained 16 organizations with the same type of services as my client and in the same broad geographic region.  But all but one were in lower cost of living areas with salary levels substantially less than a dozen comparable organizations in my client’s immediate market area.

A consultant’s recommendation for another of my clients, an independent nonprofit hospital, was based largely on a compensation survey in which the vast majority of participants are subsidiaries of organizations like Kaiser Permanente and Catholic Healthcare.  Data on the CEO and CFO and other key positions was representative of these positions operating within a larger system, but significantly under the typical compensation levels for leaders of fully independent organizations.

The standard surveys published by firms such as Hay, Hewitt, Towers Perrin, and my former firm – Watson Wyatt – clearly have value.  But if you are going to use them, you should take the following steps:

1. For top positions, check the survey data against the IRS 990 form data for directly comparable organizations.  The 990 data is a bit out of date – but you can update it by 4 or so per year % (maybe 2% for 2009)  and usually get a dependable reading.
2. Obtain a listing of all the organizations in the published survey peer groups against which your data is being compared, to ensure that the group is representative of your organization in terms of mission, structure, size, and geography. 
3. Develop customized peer groups from the participant listings in the published surveys – most of the largest and best known surveys now allow you to do this.  
4. Make sure you understand any assumptions your consultant is using to adjust data from the published surveys.  Common adjustments include aging data to make it current, increasing or decreasing the market values reported for positions that are presumed to be stronger or weaker than positions in your organization, adjusting for regional salary differentials, and weighting data to give more emphasis to surveys the consultant believes are a best match.  These can all be reasonable and useful adjustments, but you should understand them and the effect they have on the conclusions reached.

 

Nonprofit Salary Budgets for FY 2010

A number of clients have asked me recently what to expect for nonprofit salary increases in the coming year.

The short answer is that while no one knows for sure, there is clearly pressure to reduce salary budgets for FY 2010, with a number of organizations freezing compensation.  At this point, my guess is that average salary increases for nonprofit employees will be between 2.0% and 2.5% in 2010, down from the typical 4.0% to 4.5% over the past ten or fifteen years.  And nonprofit executives may get even less.

A quick survey of my clients shows that first and foremost, what organizations are doing with compensation depends very much on how the recession is specifically affecting them.  In organizations that are cutting back on programs or staffing in material ways, none of the top executives are taking salary increases this year, and others are cutting their pay -- a few by as much as 10 or even 20%.  

In most of these cases, the decision not to take a salary increase (or to reduce pay) is being made by the Executive Director, who then informs the Board that this is what he or she would like to do.  This is partially because these individuals believe this is the right thing, and partially because it is a stronger message optically to announce that the ED requested a pay freeze (or cut) than to announce that the Board decided independently to take this action. 

That said, not all organizations are reducing or freezing pay.  Some are in a growth mode and are going ahead with modest increases.  Some are giving lower increases than they originally planned.  In all of these cases, the organization's funding has not been seriously threatened; there have been no layoffs (except perhaps some pruning of weak performers); revenues are continuing to grow.

The situation with incentives is a bit more complex.  One of my clients has suspended bonuses this year -- none will be paid -- and isn't certain whether there will be any payments next year.  But bonuses in this organization are typically 5% of pay or less -- maybe 10% for the ED -- so while they are not unimportant, they are not a highly significant part of total compensation.  The President of another client voluntarily took a substantial cut in a bonus targeted at about 30% of base pay -- even though the Board had evaluated her performance as exceptional.  And a third client, whose financial situation remains relatively strong, is letting its bonus payouts operate normally, with no reduction.

The bottom line here is that compensation decisions should be in line with both financial results and the messages you are sending to your employees and the community.  It's important that employees be treated fairly and that their compensation is sufficiently competitive in your labor markets to reward and retain them.  At the same time, it is vital that the nonprofit community not waste its challenged resources, and that pay decisions are reasonable in light of economic circumstances.