Are nonprofit CEOs overpaid?

Public Interest, Wntr, 2001 by Peter Frumkin

It is not clear how new compensation regulations will prevent violations of the nonprofit nondistribution constraint. Consider the case of large nonprofit organizations. The nonprofit sector has grown over the years to the point where many large nonprofits, such as the Salvation Army, the YMCA, Catholic Charities, and the American Red Cross, have annual budgets of $2 billion or more and employ tens of thousands of people. But since there are few such large nonprofits, the question is what the salaries of their leaders should be. Under the new regulations, an organization like the American Red Cross could argue that, in making compensation decisions, it should compare its executive salaries with those of a $2 billion service corporation, rather than look only to the small pool of other large nonprofit organizations. It might even enlist an independent compensation expert to support this move and to document that the main competition actually comes from the fast growing for-profit blood banks. If the executive the Red Cross wanted to hire were recruited from business, as many of the senior managers in the blood-services division have been, this would appear to be not only a permissible action but a responsible one. In building its case, the Red Cross might well begin its search process by assembling a list of what business managers in large biotech and health corporations earn, which most likely would help justify extraordinarily generous compensation packages.

The problem is that cross-sector comparisons are often subjective. In the case of the Red Cross, the "comparable list" would have to take into account both the salary paid to senior business managers and the stock options that are part of many compensation packages. In many corporations, a senior executive's stock options can often amount to millions of dollars of deferred compensation. For example, Disney CEO Michael Eisner's stock options have in recent years approached $200 million. In many small and mid-sized companies, stock options, though smaller in dollar terms, remain a critical tool for motivating and retaining senior managers. Moreover, researchers have shown that for-profit executive salaries are increasing even though the relation between compensation and performance is not clear.

The problem with cross-sector comparisons is not limited to compensation decisions in large public charities. While small nonprofits do not appear to have corporate equivalents, it could be argued that their organizations are analogous to small businesses. In both cases, the work is entrepreneurial, involves the mobilization of resources, and often demands supervising a small group of workers. Again, however, there is the question of whether profits paid to small business owners can be applied in the nonprofit context.

By allowing for comparisons with the for-profit sector, the new regulations threaten to undermine the fragile identity of public charities as service and mission-driven organizations. If every major hiring decision in the nonprofit sector encourages scrutiny of comparable hires in other organizations, including those in the corporate world, it is unlikely that groups like the Salvation Army and Catholic Charities would be able to recruit and retain their presidents while paying them only $77,754 and $95,227 respectively in 1998. The Salvation Army has long bad a reputation for frugality, and the levels of compensation it pays most of its senior managers can only be described as meager. For some nonprofits, low wages are part of their identity and a critical reason why clients trust and believe in them. Clients and donors are attracted to organizations that spend most of their money on charitable programs rather than on compensation and perks for employees. Yet with one regulatory move, the IRS has hoisted a carrot on a stick, dangled it in front of charity boards, and thereby battered a critical part of nonprofit identity.