Management compensation disclosures in private colleges' and universities' forms 990: reporting strategies and donor reaction

Journal of the Academy of Business and Economics, Jan, 2004 by R. Steven Flynn

ABSTRACT

The Internet presence of private colleges' and universities' Forms 990 and their disclosure of top management's compensation amounts have led to fears of declines in donor contributions to these institutions. This paper explores donor reaction to two possible reporting strategies to counter negative perceptions: a high measure of management's financial efficiency, and a high level of management's non-financial success. The study finds that while each measurement type may succeed in countering some negative donor reaction, high non-financial success levels may offset greater amounts, a potentially important discovery since many institutions fail to highlight significant non-financial achievements in Form 990.

1. INTRODUCTION

The reporting of top management compensation amounts in nonprofit organizations' Form 990, the comprehensive yearly informational return filed with the Internal Revenue Service (IRS) and now available on the Internet, has raised concerns that such disclosures may lead to declines in donor contributions (Evangelical Council for Financial Accountability, 1999). This fear may be especially great among private colleges and universities, since their presidential compensation amounts have recently come under the scrutiny of the popular media (See for example Lockman (2002)). Recognizing that all nonprofit organizations, including colleges and universities, may now need to justify their management compensation amounts (Evangelical Council for Financial Accountability, 1999), this paper explores, in an experimental setting, the potential success of two Form 990 reporting strategies in countering negative donor reaction: a high measure of management's financial efficiency; and a high level of non-financial success achieved under management's leadership. The paper's results, although couched in the context of private educational institutions, should interest all nonprofit organizations competing for donations in an increasingly skeptical donor environment.

2. LITERATURE REVIEW

Form 990 is the informational return that most tax-exempt organizations (501(c)(3) organizations) file with the IRS to provide evidence that they have not violated their tax-exempt status. The return, a voluminous report often spanning as many as 30 pages or more, consists of nine parts and one set of schedules. Part I, the Revenue, Expenses, and Changes in Net Assets or Fund Balances statement, reports the organization's revenue sources and total expenses. This section of the report classifies total expenses in one of three categories: program services (amounts spent on activities related to the organization's mission); management and general (amounts devoted to administrative functions); and fundraising. The individual expense composition of these three totals is disclosed in Part II, the Statement of Functional Expenses. Part III, the Statement of Program Service Accomplishments, presents non-financial measures of an organization's success in achieving its mission. Currently, most organizations, including colleges and universities, do not utilize this statement to highlight significant non-financial success, a deficiency that may be due to the IRS's lack of specifications as to the exact measures to report (The Urban Institute, 2004; Moore & Williams, 1998). Part IV, the Balance Sheets, presents an organization's beginning and ending year financial position, while Part V, the List of Officers, Directors, Trustees, and Key Employees, reports top management's compensation amounts, data typically absent from most annual reports. The remaining sections of the return disclose miscellaneous information ranging from an analysis of income producing activities to compensation amounts of the five highest paid independent contractors.

Because of the wealth of data it contains, Form 990 can serve as an invaluable informational source for donors contemplating contributions to nonprofit organizations. When evaluating such entities, donors and public service agencies rank the ratio of total program service expenses to total organizational expenses, the program expenditure percentage, high in importance (Baber et al., 2002; Baber et al., 2001). This ratio, which can be directly calculated from data appearing in the Revenue, Expenses, and Changes in Net Assets or Fund Balances statement, provides an indication of the financial efficiency of the organization. Research findings suggest that donors increase their levels of contributions as program expenditure percentages rise (Baber et al., 2002; Khumawala and Gordon, 1997). Nonprofit experts also contend that non-financial achievement disclosures are equally important in gauging the success of an organization (The Urban Institute, 2004; Evangelical Council for Financial Accountability, 1999). These measures, if reported, may be disclosed in Form 990's Statement of Program Service Accomplishments. As with financial metrics, empirical research also suggest that donors may value non-financial measures of an organization's success (Khumawala and Gordon, 1997).