ASU research finds that rule on ethics boosts nonprofits' performance

An Arizona State University professor’s research has discovered that holding nonprofit organizations to best practices reduced CEOs’ pay and improved performance.

Ilona Babenka, an associate professor of finance in the W. P. Carey School of Business, looked at compensation data for 14,765 nonprofit organizations in New York state for the years 2009–17.

Babenka and her two co-authors wanted to see what happened after the Nonprofit Revitalization Act of 2013 was passed. Their paper, “Regulating CEO Pay: Evidence From the Nonprofit Revitalization Act,” has been posted on SSRN and will be submitted to a journal.

The researchers found that after the law went into effect, the compensation for CEOs of nonprofits declined, but the executives didn’t work any less. Other performance metrics — such as donations, revenue and volunteers — improved.

The Nonprofit Revitalization Act prohibits CEOs from participating in board or committee meetings in which their salary is discussed or voted on.

Babenka studies executive compensation and said that although many researchers look at the pay for CEOs of for-profit businesses, not as much attention has been paid to nonprofits.

“They’re very important to the economy, and they employ 10% of the workforce,” she said. “They also represent a lot of important sectors like child care, senior care and education.

 “These organizations are at least partly financed by public dollars through tax deductions and tax benefits, which is why it’s interesting to know how much their executives are being paid.”

Babenka said that there is a longstanding debate in finance on whether executives are overpaid or paid fairly, and whether reducing CEO pay would create turnover.

“Fortunately, there was legislation that allows to have a good empirical look at that,” she said.

The Nonprofit Revitalization Act created a natural experiment for the researchers to compare CEO pay before and after it went into effect.

“What we see is that pay dropped by 2% to 3% for CEOs, which is not a negligible amount,” she said, adding that the figure is probably an underestimate because some nonprofit boards already operated using best practices before the act was passed.

“The other key finding is, OK, the pay got reduced, but what happened to the performance metrics of the nonprofit? Do we see executives leaving the firm? Are they putting in the same effort, working the same hours?

“And what about the other metrics, like donor contributions, number of volunteers and revenue? Has that been affected?”

Essentially, no.

“In general, we don’t find any negative consequences, and we find some positive consequences,” Babenka said. “The CEOs worked a slightly longer hours, about 2%, or about one hour a week. It’s not a lot, but at least they don’t work less,” she said.

The research team found that, after the new law went into effect:

  • The new requirements did not lead to more CEO turnover.
  • Contributions and grants increased by nearly 4%. For the average nonprofit in the sample, that represented an increase of $525,000 in contributions per year.
  • The number of nonprofit volunteers increased by approximately 2.4%.
  • Revenue generation increased significantly, by approximately $15,000.

The researchers wrote: “These results suggest that the outside stakeholders generally had a better perception of N.Y. nonprofits following the act’s passage, with volunteers and donors willing to donate more of their time and money.”

All of the data on CEO pay, hours worked, donations, revenue and volunteers are publicly available on tax forms.

The law was not intended to curb CEO pay, but was meant to increase efficiency.

“At the time, New York was worried that they were losing business to other states with more favorable laws,” she said.

“So the law made it easier to register nonprofits in New York, and easier to classify the types. To make it palatable to legislators, it was, ‘And by the way, we’ll also implement good practices.’ ”

Babenka said it’s difficult to judge nonprofit CEOs on performance metrics.

“They can always say, ‘We had lower revenue, but we delivered more bowls of soup,’ ” she said.

“Because they have multiple objectives, it’s harder for their boards to determine whether performance is good or bad. But that is what makes the pay more interesting to study.”

Top image of New York City courtesy of Pixabay

Mary Beth Faller
marybeth.faller@asu.edu