In today's booming economy, we are accustomed to seeing reports of huge executive compensation packages. But lately, these stories are increasingly referring to the CEOs of non-profit corporations as competition for talent and new IRS regulations are encouraging non-profit boards to sweeten the salary and benefits pot.
At the same time, the ongoing need to identify new resources is causing many non-profit organizations to compete in the for-profit world. E-commerce ventures, retail stores and product lines are among the many innovative solutions employed by nonprofits in search of cash.
While neither the compensation packages nor the for-profit activity alone are cause for alarm, combined, they have the dangerous potential to cause non-profit organizations to lose focus of their mission and deviate from the purposes for which they were founded.
If an administrator receives personal compensation related in whole or part to for-profit activity, it is appropriate to consider how this incentive alters that individual's behavior and how this, in turn, affects the nonprofit. When the compensation paid to the administrator as a result of engaging in commercial activity is greater than that paid to engage in nonprofit activity, an incentive is created for administrators to spend more time in the former. Over time, this may cause the administrator to move the nonprofit further away from its mission. Alternatively, it may cause the nonprofit to grow at a slower rate while it focuses on growing its commercial activity.
Remuneration packages for nonprofit executives can be complex and involve multiple elements. Consider the following alternative compensation approaches that nonprofits with commercial activities might adopt:
(1) Pay the administrator one salary from nonprofit revenues. This is least likely to cause "mission drift," but it denies the nonprofit a legitimate cost that can be used to offset taxes on commercial activity. Hence, it is not likely to be adopted by a rational governing board.
(2) Pay the administrator salary purely from commercial revenues. This option is unlikely to be adopted for a variety of reasons, the most important of which is that it provides no incentive to tend to the needs of the nonprofit. It may also cause a legal challenge of the status of the nonprofit.
(3) Prorate the salary so that the portion of the time spent on nonprofit activity is charged to the nonprofit and time spent on commercial activity is deducted from commercial revenues. This option is unlikely to cause mission drift and it may limit the willingness of the administrator to engage in for-profit activity.
(4) Pay a separate salary for each type of activity from each pot of funds. This is the easiest of the options and one that may ultimately lead to conflict of interest issues. It is, however, likely to create mission drift, particularly if the compensation is set independently by multiple governing boards.
(5) Base the commercial activity component of salary on the volume of commercial activity that the administrator creates. While this option has the potential to create mission drift, the incentive can be offset if the nonprofit component is also based on the same criterion.
(6) Define compensation for commercial activity to include stock options. This option is likely to have the greatest likelihood of creating mission drift while, at the same time, accelerating growth of the commercial activity.
Which of these options will be selected depends, in part, on the administrative structure under which commercial revenues are collected. But as long as a differential exists between the reward offered for nonprofit as opposed to commercial activities, the incentive persists for mission drift.
It is not hard to imagine the pressures of a competitive marketplace consuming the time and attention of a nonprofit executive whose compensation largely depends on the success of their for-profit venture. And if you were that executive, wouldn't you allocate your staff resources toward people with the skills that would best be able to help you compete? Wouldn't you look to grow your own salary by expanding your commercial venture?
Given the fact that for many organizations, increases in operating expenses is outpacing any growth in available funding, it is likely that we will see an increasing number of non-profit organizations entering into profit-making enterprises. The impact this has on nonprofits and the effectiveness to which they are fulfilling their mission needs to be studied closely.
In the meantime, non-profit boards of directors need to pay careful attention to how they craft executive compensation packages. How you pay your non-profit administrators matters.
Howard Tuckman is the dean of Rutgers Business School in Newark and New Brunswick, New Jersey. He serves as Chair of the Academic Council of the National Center on Nonprofit Enterprise.