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University of Arkansas, Fayetteville ScholarWorks@UARK Theses and Dissertations 5-2014 Donor and Grantor Reactions to CEO Compensation in Nonprofit Organizations Stacey Renee Kaden University of Arkansas, Fayetteville Follow this and additional works at: http://scholarworks.uark.edu/etd Part of the Accounting Commons, and the Organizational Behavior and Theory Commons Recommended Citation Kaden, Stacey Renee, "Donor and Grantor Reactions to CEO Compensation in Nonprofit Organizations" (2014). Theses and Dissertations. 2348. http://scholarworks.uark.edu/etd/2348 This Dissertation is brought to you for free and open access by ScholarWorks@UARK. It has been accepted for inclusion in Theses and Dissertations by an authorized administrator of ScholarWorks@UARK. For more information, please contact scholar@uark.edu, ccmiddle@uark.edu. Donor and Grantor Reactions to CEO Compensation in Nonprofit Organizations Donor and Grantor Reactions to CEO Compensation in Nonprofit Organizations A dissertation submitted in partial fulfillment of the requirements for the degree of Doctor of Philosophy in Business Administration by Stacey Kaden Truman State University Bachelor of Science in Accounting, 2003 Truman State University Master of Accountancy, 2004 May 2014 University of Arkansas This dissertation is approved for recommendation to the Graduate Council. Dr. Gary Peters Dissertation Director Dr. Juan Manuel Sanchez Committee Member Dr. Junhee Han Committee Member ABSTRACT Nonprofit organizations often rely on donations and grants to accomplish their mission. This study examines whether nonprofit organizations with high CEO compensation receive less in donor and grantor support compared to nonprofit organizations with lower CEO compensation. I find strong evidence that both donors and grantors give less to organizations that spend a larger percentage of total expenses on total CEO compensation. I also find that the reactions of donors and grantors differ based on the type of CEO compensation. While donors and grantors react to CEO base compensation, grantors also react to other CEO compensation and nontaxable benefits. In additional tests, I find strong evidence that the negative reaction of donors and grantors is stronger when organizations have more sophisticated donors and grantors. I also find that the relation between future contributions and CEO compensation is stronger in organizations that are more reliant on contributions as a source of revenue. I do not find any evidence that the reporting of CEO compensation expense as program related, management, or fundraising has any effect on how donors and grantors respond to the percentage of expenses spent on CEO compensation. I also do not find that the CEO serving on the board of directors changes how donors and grantors respond to CEO compensation. Overall, my results suggest high compensation to CEOs of nonprofit organizations can have adverse consequences to an organization through reduced funding from donors and grantors. ACKNOWLEDGEMENTS I thank Gary Peters, Juan Manuel Sanchez, Linda Myers, and workshop participants at the University of Arkansas for helpful suggestions and comments that have improved the paper. I thank GuideStar for access to GuideStar Premium to assist with my research. I am grateful to my wonderful husband, Ryan. He has supported me every step of this journey – agreeing to move our family, helping at home and with our boys, reading my writing, and encouraging me during the hard times. I thank my two boys, Jaxson and Harrison, for being my motivation through this process. I thank my parents and Ryan’s parents for their support. I thank Arnold Howell for his constant encouragement. I am grateful for my fellow PhD cohorts who have made the experience all the more memorable, especially my officemate, “twin”, and partner in all shenanigans, Lauren Dreher-Cunningham, and my former officemate, Jacob Haislip. I am grateful for the support from my dissertation committee, Gary Peters, Juan Manuel Sanchez, and Junhee Han. I am thankful for Gary’s service as my chair and all of his advice and suggestions. I am forever grateful for the support and mentoring Manuel has provided to me not only with my dissertation but throughout my time in the PhD program. He is an invaluable advisor and friend. I thank Junhee for his patience with us Accounting PhD students that invaded his graduate statistics classes. He is an exceptional teacher. TABLE OF CONTENTS 1. INTRODUCTION .........................................................................................................1 2. LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT .............................8 Prior Literature .........................................................................................................8 CEO Compensation ...............................................................................................12 Types of CEO Compensation ................................................................................13 Donor and Grantor Sophistication .........................................................................14 CEO on the Board ..................................................................................................15 Source of Revenue .................................................................................................16 CEO Salary Allocation ..........................................................................................17 Form 990 ................................................................................................................18 3. SAMPLE AND RESEARCH DESIGN.......................................................................20 Sample and Data Sources.......................................................................................20 CEO Compensation ...............................................................................................22 Types of CEO Compensation ................................................................................24 Donor and Grantor Sophistication .........................................................................25 CEO on the Board ..................................................................................................26 Source of Revenue .................................................................................................27 CEO Salary Allocation ..........................................................................................28 4. RESULTS ....................................................................................................................29 Descriptive Statistics ..............................................................................................29 Schedule J Descriptives .........................................................................................30 Correlations ............................................................................................................31 CEO Compensation ...............................................................................................31 Types of CEO Compensation ................................................................................33 Donor and Grantor Sophistication .........................................................................34 CEO on the Board ..................................................................................................36 Source of Revenue .................................................................................................36 CEO Salary Allocation ..........................................................................................39 Robustness Tests ....................................................................................................40 Additional Tests .....................................................................................................41 5. CONCLUSION ............................................................................................................42 REFERENCES ..................................................................................................................45 APPENDIX A: 2008 Form 990, Schedule J ......................................................................50 Page 1 .....................................................................................................................50 Page 2 .....................................................................................................................51 APPENDIX B: Variable Definitions .................................................................................52 1. INTRODUCTION Executive compensation can be a controversial issue for stakeholders of nonprofit organizations. Many donors and grantors contend that Chief Executive Officer (CEO) compensation is too high at some nonprofit organizations (e.g., Perry 2010, Green 2012, Charity Navigator 2013). This often stems from the belief that the resources spent on high compensation are funneled away from activities directly related to the organization’s mission. Others believe that CEOs should not be highly compensated because they work for a nonprofit organization (e.g., Gose 2012a, Parker 2013). In this study, I examine whether CEO compensation affects the donations and grants a nonprofit receives. If donors and grantors are sensitive to the amount of compensation that nonprofit organizations pay their CEOs, I predict that organizations that spend a higher percentage of their expenses on CEO compensation will receive less in donations and grants compared to nonprofit organizations that spend a lower percentage.1 Additionally, I expect the response to be conditional on the type of CEO compensation so I also examine whether donors and grantors respond to the type and amount of compensation paid to the CEO, such as bonuses or deferred compensation.2 Most donors and grantors contribute funds to nonprofit organizations to provide resources to further the mission of the organization. However, because of agency costs, donors and grantors lack confidence that the organization will use their funds for the purported mission (Jensen and Meckling 1976, Hansmann 1980, Fama and Jensen 1983). Top management can expropriate donations and grants for personal use through excessive salaries and perquisite 1 I examine the reaction of donors and grantors jointly and separately. I use the level of future donation income to examine donor reaction and the level of future grant income to examine grantor reaction. I use the level of total contributions – the combination of donations, grants, and indirect donations – to examine donor and grantor reaction jointly. 2 Specifically, I examine CEO base compensation, incentive compensation, other compensation, deferred compensation, and nontaxable benefits. I define these in Section 2. 1 consumption (Manne 1999, Krishnan et al. 2006). High profile scandals reported in the media provide examples of how this expropriation occurs.3 Consider for example, the two founders of The Young Adult Institute Network, a New York nonprofit organization operated to help the developmentally disabled. They each earned close to one million dollars a year, drove luxury automobiles financed by the organization, and had the organization pay their children’s college tuition and over $50,000 in living expenses for one year for one child (Buettner 2011). This controversy led the governor of New York to limit the amount of state funds that can be used to pay nonprofit salaries (Gose 2012a). This example shows how serious a concern the agency problem can be for donors and grantors and is consistent with prior research arguing that agency problems can be more severe in nonprofit organizations (Fama and Jensen 1983, Manne 1999). The primary source of disclosure about nonprofit organizations is the Internal Revenue Service (IRS) Form 990. The IRS requires most organizations that are exempt from paying federal income tax to file Form 990, an information return, with the IRS every year. Donors and grantors have access to these returns because organizations must make them publicly available and GuideStar, a charity watch organization, makes them available on their website.4 In 2008, the IRS implemented new disclosure rules that increased and improved the reporting of executive compensation information on the Form 990. The change in regulation requires nonprofit organizations to report details about executive compensation not previously available, including a breakdown of total compensation by type for each executive (Panepento and Kean 3 For examples of some high profile scandals involving nonprofit organizations, see Williams et al. (2005) (American University), Perry (2007) (The Smithsonian Institution), Frazier (2009) (United Way of Central Carolinas), and Buettner (2011) (The Young Adult Institute Network), among others. 4 Donors and grantors can view these completed Form 990s for free at www.guidestar.org. 2 2008). I exploit the compensation information reported on the revised Form 990 to test my research questions. It is possible that donors and grantors may not respond to CEO compensation levels. The median donation by an individual per charity is small and these individuals may not feel like the size of their donation warrants extensive research of the nonprofit organization (Mulligan 2007). Additionally, some donors and grantors may feel that high CEO compensation is necessary to attract and retain high quality executives who are able to run large, complex nonprofit organizations (Perry 2010, Parker 2013). Finally, some donors have internal motivations to give such as personal ties or the “warm glow” they feel from giving (Hansmann 1980, Andreoni 1990, Gordon and Khumawala 1999). However, given that prior studies have found that donations are sensitive to the disclosure of material weaknesses and governance quality (Petrovits et al. 2011, Harris et al. 2014), it is reasonable to expect that donors and grantors react to CEO compensation, a topic that receives significantly more media attention. To address my research questions, I construct a sample of 501(c)(3) organizations from 2008 and 2009.5 I choose these years to take advantage of the compensation information now available on the revised Form 990 to test several of my hypotheses. Since I am interested in the level of donations and grants made to an organization the year after the disclosure of CEO compensation details, for an organization to remain in my sample, it must have donation and grant information available for 2009 and 2010. Additionally, future contributions, donations, and grants must be at least one thousand dollars. After eliminating organizations that are not required to disclose detailed compensation plan information and observations with missing data, 5 I focus on 501(c)(3) organizations because these public charities receive tax deductible donations by donors. I construct my sample using information from 2008 through 2010 Form 990s, available on the IRS’s website. 3