Executive compensation

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Abstract

This literature review provides a synthesis of research from salary surveys, academic journals, and trade publications on the topic of compensation in the non-profit sector - in particular, executive compensation. The review follows research with a focus on trends of executive compensation, stakeholder expectations, factors of compensation, increased public scrutiny, organizational culture by industry and governance and the IRS.

There is evidence that excessive executive compensation in the nonprofit sector attracts attention and scrutiny, and even stronger evidence that a nonprofit CEOs compensation package is not closely related to performance. The evidence indicates that there is a need for structure in the nonprofit sector, and if not self-regulated, the nonprofit world as we know it may soon be subject to government regulation.

The literature review concludes by offering advice on determining the appropriateness of a nonprofit executive's pay. It also contains personal views regarding nonprofits that are considering increasing executive compensation.

Introduction

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Research regarding executive compensation can be easily obtained because there has been a great deal of time and study devoted to the topic. However, most research has been conducted concerning for-profit organizations - mainly publically traded companies. There has been little research devoted to nonprofit organizations and their compensation schemes. So, what is reasonable compensation for a non-profit CEO? The topic of compensation for the CEOs of nonprofits has always been one of controversy that receives a great deal of attention. There are many who believe that executive pay must be as competitive in the nonprofit sector as the for-profit sector in order to attract and retain great talent. However, there are many other people who will argue that executive salaries that are extremely high are downright offensive. Nonprofits conduct business in pursuit of a social mission to provide a public benefit. They rely heavily on donations and even public funding, and because executive compensation is public information, when excessive it can undermine public confidence and destroy trust - something else a nonprofit relies upon. The following review will focus on trends of executive compensation, stakeholder expectations, factors of compensation, increased public scrutiny, organizational culture by industry and governance and the IRS.

Trends of Executive Compensation

"The executive compensation structure of nonprofit CEOs has been generally overlooked. What is the incentive structure of these CEOs and how does it impact on executive performance? (Giroux & Wilson)" Understanding an organization's strategy to compensate an executive is necessary to defend its purpose, mission and goals. The best way to manage fair compensation is with a clear policy in place. Evidence shows that some executives are getting "superstar" pay for a "journeyman's" work. In the following Research... take a look at the Survey... There is substantial evidence that illustrates trends of pay increases largely growing. Furthermore, mixed reports make expectations about compensation very complicated. It is expected that pay increases will cease going forward due to shrinking contributions caused by a weak economy.

Examining nonprofit executive compensation is highly important for several reasons. "First, the relationship of the governing board to the CEO is highly political. Second, the governing board can reward CEOs generously or terminate them almost immediately. Third, the role of the CEO and the relationship to the board can result in disastrous consequences under some circumstances, usually because of poor corporate governance practices (Giroux & Wilson)."

Stakeholder Expectations

Some people might express concern that CEOs are paid too much for the work they perform. Careful consideration of stakeholder expectations should be an important factor when making necessary organizational decisions. This will not only help the decision-makers to come to an appropriate decision, but additionally it helps to reinforce the organization's purpose, mission, and values to the people involved in the organization. Stakeholders of nonprofits include, but are not limited to, employees, volunteers, board members, donors and benefactors, the surrounding community, beneficiaries, and in some cases even customers.

Many donors would agree that the CEO leading their favorite nonprofit organization does not deserve a six figure salary. The revelations of extremely high salaries can diminish donor confidence and even more detrimental, it can cause increased public skepticism. This is why it is necessary for board members to pay very close attention when determining a CEOs pay increase, and total overall compensation. Nonprofit boards need to have a rationale to justify their decisions, satisfy any questions from stakeholders, and most important keep their staff happy. Total compensation of the top 5 highest paid officers in any nonprofit is recorded each year when it is filed with the IRS Form 990 - an informational tax form. The Form 990 is a public document that is made available to the public, whenever requested, including the media. It is for this reason that a CEO's pay cannot be regarded as confidential.

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Board members need to be aware of implications of this public information, particularly because the media is only too delighted to report unreasonably large compensation packages of both private foundations' and public charities' executives. Board members should create a compensation philosophy and a set of rules or guidelines to follow when determining executive pay. That way, the executive board can explain to any stakeholder, whether it is an employee or donor, why the rate of pay is what it is.

Factors of Compensation

As with all other human resources initiatives, compensation should be strategic and should include an explicit guideline for base pay, incentives, and increases. Many different factors help determine the rate of pay. A CEO's compensation varies widely and is dependent upon the type of organization, membership type, total number of employees, and total annual budget. To put it simply, more money, more staff, and more responsibilities will result in a larger compensation package. The geographical location is another factor that determines the rate of pay usually based on the cost of living in a region. The findings through research illustrate that nonprofit executive pay structures are complicated and somewhat difficult to categorize.

In these rough economic times, many top executives in the nonprofit world are taking pay cuts in order to increase their bottom-line. But, excessive executive compensation has become an issue in others.

Executive compensation commonly is grouped into three basic categories: (1) salary and benefits that do not depend on the firm's performance; (2) options and other incentive compensation that are based on the performance of the firm's stock price; and (3) bonuses and other incentive compensation that are based on the firm's performance according to specified accounting metrics. The process used to determine and establish executive compensation is so important.

"CEO Compensation Study helps donors, nonprofit leaders and regulators make educated decisions about the appropriateness of a nonprofit executive's pay (Charity Navigator)." Leading a nonprofit requires that an individual must possess both an understanding of the specific issues unique to the mission, and in addition, a business and management expertise.

Attracting that kind of talent requires a certain level of compensation. According to "Nonprofit World", that level of pay averages $160, 000 annually.

Increased Public Scrutiny

Nonprofits are faced with ethical dilemmas that for-profits aren't usually concerned with. the scrutiny being faced by non-profit executives with huge salaries in the U.S.

It relates that back in the mid-1990s, Democratic Representative J. J. Pickle of Texas, chairman of the House committee with jurisdiction over tax-exempts, was so disappointed with big salaries among the charities that he proposed no charitable executive should earn more than the U.S. president. It cites that several non-profit critics proposed that no charity executive must earn more than the Chief Justice of the Supreme Court.

Organizational Culture and Industry

"The total executive compensation package should embody the company's vision, mission, objectives, goals, and strategies. More specifically, the pay delivery system should be aligned with goals and objectives (Griffith)." Nonprofit salary surveys reveal that hospitals and higher education groups pay the highest wages, and at the other end of the spectrum, religion-related nonprofits pay the lowest base salaries. It is very important to understand that in addition to industry, an organizations size also influences compensation packages. "Larger nonprofits generally pay their chief executives significantly more than smaller nonprofit organizations pay (Twombly & Gantz)."

One exception however is found in human service nonprofits where "higher executive compensation is tied to the organization's dependence on direct public support, regardless of organizational size (Twombly & Gantz)."

The compensation a CEO receives also depends in part on the types of programs and services offered by the charity.

Governance and the IRS

the governemtns help, just like the bail out orgs. Obama restrained exec salaries ...The new 990 specifies that the process of determining nonprofit compensation should include the following: (1) review and approval by independent persons; (2) comparability data, and (3) contemporaneous substantiation of the deliberation and decision - in other words, you must record your compensation process when it occurs - no backdating.

IRS continues to prioritize CEO compensation as one of its main areas of focus in uncovering fraudulent nonprofit practices.

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Drawing on its experience in investigating charities, the IRS recently redesigned the Form 990 (the informational tax return that charities must file annually and the document that Charity Navigator utilizes to obtain the necessary data to rate each charity) to provide more transparency regarding executive compensation practices. It is important for each charity to conduct an independent review of its CEO's pay using comparative data.

IRS regulations call for compensation comparables:

For "like" services - jobs similar in responsibilities and duties.

In "like" enterprises - organizations similar in size, revenue, or number of employees and in a similar subsector would pay. Although budget size is often used as an indication of size, a nonprofit with a large budget, five employees, and one project may not be an appropriate comparison with a nonprofit group that has 50 lower-paid employees providing direct services to clients. So it's important to consider many factors. The IRS will also accept for-profit comparisons if appropriate.

In "like" circumstances - accounting for the value of additional benefits like housing or transportation.

(IRS) recently issued detailed guidelines for IRS agents examining executive compensation at forprofit and non-profit corporations, including hospitals. The sections on "non-qualified deferred compensation plans" and "fringe benefits" are most relevant to non-profit hospitals, according to Wayne Henry, a partner in the law firm of Stinson Morrison Hecker LLP in Omaha, NE, who specializes in health care and taxexempt issues. The guidelines follow and amplify issues raised by the agency's recent enforcement initiative to review compensation and benefits at tax-exempt organizations. In addition, Henry notes, the IRS has modified its application for tax-exempt status (Form 1023) for new organizations applying for tax-exempt status beginning May I. The instructions for the new form include a sample "confliet of interest policy," with suggested provisions specifieally for hospitals. "We believe hospitals should be aware of these developments and take appropriate aetion to assure eomplianee with these issues," Henry said.

Here it is important for readers to remember that unlike the for-profit sector, there is a long lag in time from when a charity completes its fiscal year and when it files its Form 990. In fact, many charities file their 990 eight months to a year after their fiscal year ends. So, although our analysis is based on the most current data publicly available, 80% of the data for this study is taken from the charities' 2007 fiscal year ending.

The impact of the recession on the average charity CEO pay will not be seen until future studies.

Recommendations and Personal View

When contributing my hard-earned money to charities and nonprofits, I want my donation to go toward an efficient, effective and mission-driven organization. Donors everywhere will ask themselves, "Why am I contributing to an organization whose CEO is raking in all that cash?" This is exactly why the IRS has stepped in to impose restraints about what is "legally reasonable". When an organization depends on donations and public funding, 'legally reasonable' should be cautiously as good advice. Instead, the best advice is determining what is 'ethical an appropriate'. While there is no clear definition of what is ethical or appropriate, it is always a good idea to lean on the side of caution. It is demonstrated time and time again that some nonprofits prefer to use their money for lavish executive pay instead of fulfilling their mission. With such debate surrounding CEO pay, it should be considered that a well-defined pay structure be considered along with a defined threshold for acceptable pay in any nonprofit organization. Self regulation begins with good governance. President Obama imposed a $500,000 salary cap on executive pay to organizations who receive government bailout money. So who's to say the government won't stop there and impose a salary cap on organizations that get the benefit of tax exemption and tax-deductible contributions? For now, the IRS rules only say that a CEO should receive 'reasonable compensation' - ambiguous, vague, and unclear terminology to say the least. Some charities go as far as having "multiple highly paid family members on staff (Charity Navigator)."

Overpaid CEO's are not only offensive they are destructive. Take for example the most recent headline of a public uproar over the YMCA of Greater Toledo, in Ohio. Robert Alexander, CEO, earns a base salary of $270,357, which makes him the highest paid president and CEO in Ohio as reported by The Blade. His decision to close important community-needed programs and the South Y due to a lack of funding was announced in late July of this year, and soon after triggered a community outcry. Furthermore, his immediate family, including his wife and daughters all work at the YMCA of Greater Toledo in executive-level positions. The Ohio Attorney General is investigating the financial operations of the YMCA. This is not to say that all nonprofits are run so terribly, in fact there are more good entities than bad ones, but once confidence is destroyed, it is hard to regain trust and it affects the entire nonprofit community. It is quite the scandal for a nonprofit to cut programs due to budget restraints, freeze pay for staff association-wide, or even layoff staff members, and at the same time senior executives' large compensation packages remain untouched or even worse they are given increases! It is a sad but true reality. Where is the compassion? An organization, especially faith-based, should live by the mission, and act in the organization's best interest.

A company's board of directors is all too often catering to the CEO, rather than supervising him. For this reason, we shouldn't expect to see a dent in executive compensation anytime soon.

In order to evaluate the appropriateness of executive compensation, an organization should consider about the organization: the size, complexity, geographical location, mission, most importantly the financial condition. Increase should also be determined by the individual qualifications necessary for the job at hand measuring based on compensation at comparable organizations. Think about this: If salaries at a nonprofit are published on the front page news, what would be a result of that?

In San Francisco, a measure introduced to limit pay for leaders of nonprofits that receive significant public funding. An executive could earn "no more than six times the salary and benefits of the lowest-paid full-time employee." This seems reasonable and fair.

The IRS recommends that small nonprofits review salary data for at least three comparable organizations, with the implication that larger organizations should obtain more than three comparables.

That is the thinking and it is appalling

Given the current economic climate

"Almost on a daily basis we learn of charities cutting programs, staff and salaries. So, how could it be that the average nonprofit CEO was awarded a 6% raise?" (Charity Navigator)

The IRS has even redesigned the Form 990, the information tax return charities submit to the IRS annually, in part, to force greater transparency around nonprofit compensation.

Given the level of scrutiny surrounding CEO pay, many would think that the IRS would designate a concrete figure as the threshold of acceptable pay. However, IRS rules simply state that nonprofit CEOs should receive 'reasonable compensation.'

Faith-based nonprofit organizations which belive in fairness and honesty, and are driven by their honest mission will communicate bible scriptures. Hypocrisy. ... Which begs the question "Is the man truly worthy of his hire?"

It is evident that in most cases nonprofit organizations are relying on its organization's size to make compensation decisions. Wouldn't it be ideal, to instead make a pay decision based on the performance of the organization after first defining, quantifying, and measuring any and all social benefits produced? Perhaps, once such measures exist, an organization will be able to structure their CEO compensation so that it provides meaningful incentives and at the same time respects the organization's purpose and mission.

Bibliography

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