Financing Nonprofit Organizations [1 ed.] 0367211041, 9780367211042

Citation preview

Financing Nonprofit Organizations

The financial issues of nonprofit organizations (NPOs) have increased their importance in recent years, especially after the last global economic downturn. In this way, NPOs have been threatened by a reduction of income, while their work and expenses have not decreased. In this book, the editors bring together several topics that the academic literature has previously addressed, connecting them to each other and evaluating how all these issues are interrelated. Financing Nonprofit Organizations analyzes the state of art of all these financial topics and the consequences of the last economic crisis. It dives into the interrelations of these concepts to suggest lines of future research and to reflect on the future of the different sources of funding of the NPOs. It will be of interest to students, practitioners, and researchers interested in initiating and updating their knowledge in the growing field of the financial aspects of NPOs. Inigo Garcia-Rodriguez is Assistant Professor of Finance at the University of Burgos, Spain. M. Elena Romero-Merino is Associate Professor of Finance at the University of Burgos, Spain.

Routledge Studies in the Management of Voluntary and Non-Profit Organizations Series Editor: Stephen P. Osborne University of Edinburgh, UK

Voluntary and non-profit organizations are playing an increasingly sig­ nificant role, worldwide, in the provision and management of public ser­ vices. Drawing together significant and ground breaking research, this series will be essential reading for students of public policy and manage­ ment as well as the thinking manager. Topics covered include the man­ agement of innovation and change, financial management, performance evaluation and management and organizational development and project management. Financing Nonprofit Organizations Inigo Garcia-Rodriguez and M. Elena Romero-Merino Also available from Routledge: Financial Management in the Voluntary Sector New Challenges Paul Palmer and Adrian Randall Strategic Management for Nonprofit Organizations Roger Courtney Regulating Charities: The Inside Story Edited by Myles McGregor-Lowndes and Bob Wyatt Philanthropy in Practice Pragmatism and the Impact of Philanthropic Action Ekkehard Thümler Transfromational Leadership and Not for Profits and Social Enterprises Edited by Ken Wiltshire, Asatha Malhorta, and Micheal Axelsen For more information about this series, please visit: www.routledge.com

Financing Nonprofit Organizations Edited by Inigo Garcia-Rodriguez and M. Elena Romero-Merino

First published 2020 by Routledge 52 Vanderbilt Avenue, New York, NY 10017 and by Routledge 2 Park Square, Milton Park, Abingdon, Oxon, OX14 4RN Routledge is an imprint of the Taylor & Francis Group, an informa business © 2020 Taylor & Francis The right of Inigo Garcia-Rodriguez and M. Elena RomeroMerino to be identified as the authors of the editorial material, and of the authors for their individual chapters, has been asserted in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. Library of Congress Cataloging-in-Publication Data Names: Garcia-Rodriguez, Inigo, 1987– editor. | Romero-Merino, M. Elena, 1978– editor. Title: Financing nonprofit organizations / edited by Inigo Garcia-Rodriguez and M. Elena Romero-Merino. Description: New York, NY : Routledge, 2020. | Series: Routledge studies in the management of voluntary and non-profit organizations | Includes bibliographical references and index. Identifiers: LCCN 2019049342 | ISBN 9780367211042 (hbk) | ISBN 9780429265419 (ebk) Subjects: LCSH: Nonprofit organizations—Finance. | Nonprofit organizations—Management. Classification: LCC HG4027.65 .F544 2020 | DDC 658.15/224—dc23 LC record available at https://lccn.loc.gov/2019049342 ISBN: 978-0-367-21104-2 (hbk) ISBN: 978-0-429-26541-9 (ebk) Typeset in Sabon by Apex CoVantage, LLC

Contents

Acknowledgements 1

A Journey Through the Finance of Nonprofit Organizations: An Introduction

vii

1

INIGO GARCIA-RODRIGUEZ AND M. ELENA ROMERO-MERINO

PART I

Determinants of Public and Private Income 2

Why Do Donors Donate?

9 11

IGNACIO BRETOS, MILLÁN DÍAZ-FONCEA, AND CARMEN MARCUELLO

3

Efficiency in Nonprofit Organizations

23

VÍCTOR MARTÍN-PÉREZ AND NATALIA MARTÍN-CRUZ

4

Governance and Its Effect on Philanthropic Income

40

MARC JEGERS

5

Accountability, Transparency, and Voluntary Disclosure in Nonprofit Organizations

49

MARÍA DEL MAR GÁLVEZ-RODRÍGUEZ, MANUEL LÓPEZ-GODOY, AND MARÍA DEL CARMEN CABA-PÉREZ

6

Nonprofit Organization Reputation and Its Role in Success: Antecedents and Effects ESTHER DE QUEVEDO-PUENTE AND CLARA PÉREZ-CORNEJO

62

vi

Contents

7

Crowding-Out or Crowding-In: The Dynamics of Different Revenue Streams

83

ARJEN DE WIT, RENÉ BEKKERS, AND PAMALA WIEPKING

PART II

Revenues, Funding, and Financial Health

97

8

99

Revenue Diversification, Growth, and Stability GRACE L. CHIKOTO-SCHULTZ AND NARTTANA SAKOLVITTAYANON

9

Nonprofit Profits: Slack, Surplus, and Reserves

114

THAD D. CALABRESE AND TODD L. ELY

10 Treasury, Cash, and Liquidity Management in Nonprofit Organizations

129

JOHN ZIETLOW

11 Capital Structure and Financial Health

145

MARCUS LAM, ELIZABETH SEARING, CHRISTOPHER PRENTICE, AND NATHAN GRASSE

PART III

New Ways of Financing and an Approach to the Business Practices

159

12 Business Practices in Nonprofit Funding

161

GABRIELA VACEKOVÁ, MÁRIA MURRAY SVIDROŇOVÁ, MICHAL PLAČEK, AND JURAJ NEMEC

13 Crowdfunding as a New Model of Nonprofit Funding

173

DITA HOMMEROVÁ

Contributor Bios Index

188 191

Acknowledgements

The editors would like to thank all the generous contributors to this book. We are honored that so many of our colleagues agreed to col­ laborate altruistically with this project despite their many professional commitments. We would also like to thank the support provided by the Routledge editorial team. A special mention to Brianna Ascher and Mary Del Plato for guiding us in this novel experience and to David Varley for giving us the opportunity to think about this book. Additionally, we would like to acknowledge the support provided by our institution, the University of Burgos, the academic support always provided by Prof. Pablo de Andrés, and the financial support obtained from the Spanish Ministry of Economy and Competitiveness (Project ECO2017-85356-P). Finally, we are personally grateful to our respective families for their patience and comprehension throughout all time we have spent ensuring this draft becomes reality. The editors apologize for any errors or omissions that may appear anywhere in the text. Ignacio Bretos, Millán Díaz-Foncea, and Carmen Marcuello thank the Government of Aragon and the ERDF 2014-2020 project “Building Europe from Aragon” for the support received, which has allowed this chapter to be prepared. Víctor Martín-Pérez, Natalia Martín-Cruz, Esther de Quevedo-Puente, and Clara Pérez-Cornejo want to acknowledge the financial support of the project ECO2016-78128-P, funded by MINECO. John Zietlow gratefully acknowledges library research assistance for his chapter provided by Donna Young and Austin Pelate at Southwest Baptist University. Marcus Lam, Elizabeth Searing, Christopher Prentice, and Nathan Grasse would like to thank Sarah Macartney for line-editing and Phillip Tran for exceptional research assistance. Gabriela Vaceková, Mária Murray Svidroňová, Michal Plaček, and Juraj Nemec thank received funding from the Czech Grant Agency (GA19-06020S).

viii

Acknowledgements

Dita Hommerová thanks funding from scientific project no. TL02000055, “Effective marketing as a tool of the competitiveness and sustainable development of non-profit organizations provid­ ing social services” (Technology Agency of the Czech Republic, Eta programme).

1

A Journey Through the

Finance of Nonprofit

Organizations

An Introduction Inigo Garcia-Rodriguez and M. Elena Romero-Merino

The finance of nonprofit organizations (hereinafter NPOs), defined as the efficient generation and management of cash flow (Pajas & Vilain, 2004), has been a topic often relegated to second place by academics and is usually confused with the act of fundraising. Most research regarding NPOs financing is focused on private individual donations as they are considered the most natural and characteristic source of funding for these entities. The consideration of these private donations as essential for the NPOs derives from theories regarding the origin of the so-called third or social sector. For example, according to market failure/government fail­ ure theories, the nonprofit sector arises when citizens decide to finance those demands from public goods that are met neither by the state nor by the market (Salamon & Anheier, 1998). As it requires the participation of a large number of contributors to be able to finance the achievement of NPOs’ objectives effectively, this method of financing is considered a paradigmatic example of collaborative financing effort. In a sense, NPOs financing can be seen as evidence that the ‘new’ crowdfunding strate­ gies applied nowadays have been used in the nonprofit sector for several decades without the intervention of specialized platforms through the Internet. Therefore, whereas taxes were related to the public sector, and the sale of goods and services to the lucrative private sector, NPOs were always linked to private individual donations (Weisbrod, 1998). Considering private contributions as the main source of NPO financ­ ing may not be problematic in a growing economy, when it is easy to cover the basic financial needs of organizations. However, it becomes a drawback in times of economic recession, when NPOs are threatened by a reduction of income whereas their work, and therefore their expenses, do not decrease. Thus, in recent years, other sources of financing (both external and internal) have gradually been considered more relevant. In addition, beyond raising money to support NPOs’ activities, there has been increasing focus on the way in which these financial resources are managed (e.g., reserves policy and treasury and cash management). Nowadays, although private donations have increased in absolute terms,

2

Garcia-Rodriguez and Romero-Merino

they represent a smaller part of the resources that organizations manage in relative terms (Young, 2017), which indicates that NPOs are using a mixture of different sources to finance their day-to-day operations. The structure of this book follows a similar scheme to that described above. Part I (Chapters 2 to 7) begins with a review of the literature regarding reasons and drivers of donations, especially private individual contributions as well as corporate sponsorship and public subsidies, and the examination of the interrelationships among them. Part II (Chapters 8 to 11) describes how to manage these donations efficiently, the effects of revenue diversification, and their influence on the financial health of NPOs. Finally, Part III (Chapters 12 and 13) outlines the most innovative sources of financing related to new technologies and how this method of managing resources is bringing NPOs closer to the business practices. Traditional literature on NPO financing is focused primarily on asking why donors donate (i.e., determinants of donations) (Bekkers & Wiepking, 2011; Van Slyke & Brooks, 2005; Vesterlund, 2006), how to increase their donations (i.e., research on fundraising) (Haibach & Kreuzer, 2004; Steinberg, 1986), or the price of these donations (i.e., NPOs’ effi­ ciency) (Callen, 1994; Weisbrod & Dominguez, 1986). This research was initially focused on charitable private giving, but it soon evolved to be also relevant in explaining other common sources of NPO funding such as private corporate contributions and public subsidies. In Part I of this book, we consider all these topics by opening with the general question of why donors donate and concluding with the interrelationships that may exist between the private and public sources of financing. Specifically, in Chapter 2, Bretos, Díaz-Foncea, and Marcuello outline the main socio-economic motivations of individual private donors and the importance of the organizational factors that influence the way in which donors make their decision; however, the size, age, or legal form of an NPO have been traditionally considered as drivers of private dona­ tions (Marcuello & Salas, 2001). In Chapters 3 to 6, we have focused on the analysis of NPO efficiency, governance, transparency, and reputation as they all can be managed by the organization. In Chapter 3, Martín-Pérez and Martín-Cruz describe the problem of measuring efficiency in the nonprofit sector and, consequently, the price of donations. As the authors point out, improving governance and pro­ viding accessible accounting information would be the necessary con­ dition to introduce competition in the market for donations, but the sufficient condition requires a proper assessment of efficiency to calculate at what price the NPO aims are achieved. For this reason, we considered it necessary to include a review chapter on the evaluation of efficiency in the nonprofit sector. Regarding NPOs’ governance, transparency, and reputation, the litera­ ture confirms that an effective design of the governance mechanisms and an improvement in organizational transparency foster donors’ confidence

The Finance of Nonprofit Organizations

3

and organizations’ reputation and, therefore, lead to an increase in the volume of financial contributions. Based on this, we address the three interrelated topics throughout Chapters 4 to 6. In Chapter 4, Jegers explains how NPOs’ governance includes all the mechanisms designed to preserve stakeholders’ interests. According to the author, effective governance can generate the perception that the organization is pursu­ ing the ‘right’ objectives, and hence, incite donors to be more generous in their contributions. In Chapter 5, Gálvez-Rodríguez, López-Godoy, and Caba-Pérez describe how an increase in an NPO’s accountability and transparency is welcomed by donors as they not only recognize the professionalism of the organization, but they also understand that the NPO complies with its responsibilities. Furthermore, in Chapter 6, de Quevedo-Puente and Pérez-Cornejo emphasize the role of an NPO’s reputation as it is directly related to the previously described tools (gov­ ernance and transparency) and it seems obvious to assume that it will help to attract money either from public or private contributors. Part I of the book concludes by focusing on the consequences of the interrelationships between the different sources of resources. On the one hand, we address the influence of private corporate sponsorships on reputation and other types of contributions (either charitable indi­ vidual donations or public aids). Apart from individual private dona­ tions, which may be periodic or one-time, there is another private source of financial resources—those derived from both for-profit and nonprofit organizations. Large corporations (corporate sponsorships) are a com­ mon source of financial resources because they entail tax benefits for contributors and substantial amounts of money for nonprofits. However, there is also some reluctance by NPOs and society in general to accept donations from these entities, especially when they are from companies whose objectives are far (or even opposite) from those of the NPO to which they are donating (e.g., it would be questionable that a company that experiments on animals sponsors a project for an organization whose objective is to avoid the degradation of the natural environment, such as the WWF). In this way, as de Quevedo-Puente and Pérez-Cornejo show in Chapter 6, NPOs have to deal with the potential risk of dam­ aging their reputation (and reducing their supporters) due to negative behaviors of their for-profit partners. On the other hand, in Chapter 7, de Wit, Bekkers, and Wiepking address the interrelationship between public and private sources of NPOs financing. Although neither private individual donations nor public grants are required to be repaid, the first usually have specific conditions attached; that is, they require compliance with specific reporting requirements and are usually linked to a specific project. These grants allow nonprofits to finance large and long-term projects with a high social impact that could not be developed based exclusively on small individual contributions. However, public fund­ ing is radically rejected by some organizations that associate it with a

4

Garcia-Rodriguez and Romero-Merino

weakening of their independence (e.g., Greenpeace), whereas, in other cases, it constitutes the main source of the NPO’s financial support (e.g., The Public Finance Initiative of UNICEF). This twofold perception of public funding is described by de Wit et al., who argue that the impact of public aid on private donations (crowding-out or crowding-in) can be positive or negative depending on the NPO’s contextual factors. If Part I of this book focuses on how to raise more money, Part II pays special attention to the way in which this money is managed and how it maintains the financial health of the NPO. Along this line, in Chapter 8, Chikoto-Schultz and Sakolvittayanon explain how the use of several sources of financing, the so-called revenue diversification, can assume a key financial strategy for achieving financial stability and surviving in times of economic recession. However, as the authors indicate, this financing can also increase the risk and administrative costs of the NPO. In terms of the way in which NPOs manage their financial resources, we have included two chapters about slack resources and cash manage­ ment. In Chapter 9, Calabrese and Ely describe how reserves can help to maintain organizational spending during difficult economic times although, at the same time, they are highly criticized by external stake­ holders when they are considered excessive. In Chapter 10, Zietlow high­ lights the importance of liquidity management, especially when NPOs experience a cash flow crisis due to a shortfall of cash inflows relative to cash outflows. The author reviews previous academic literature on the topic and suggests some ways in which NPOs may measure and manage liquidity to better achieve their missions. Finally, we introduce the importance of capital structure in NPOs. When these organizations design their funding structure to meet their expenses, it is important to consider the cost and features of each source. In addition to evaluating the possible effects that one type of donation can have on others (as we have seen in Part I), the NPO needs to decide between the use of internal or external funds. There is a clear differ­ ence between having to repay the amount of money the organization has borrowed (external resources) or, on the contrary, allocating such money to net assets (internal resources). As Lam, Searing, Prentice, and Grasse explain in Chapter 11, the cost of external financing is higher (repayment of principal and interest), but internal financing should be considered neither free nor unlimited. That is, NPOs incur costs (e.g., fundraising events, staff dedicated to obtaining these resources, cost of goods sold or services provided, etc.) to obtain internal funding and, in many cases, such expenses increase proportionally more than the funding obtained (their efficiency decrease), which could be seen by donors as an improper use of their resources. Part III is devoted to illustrating how the sector is seeking new sources of funding and introducing new practices derived from the business sector. In addition to using public and private donations as a method of

The Finance of Nonprofit Organizations

5

financing, NPOs can carry out commercial activities in service of their social missions. They can therefore sell goods (in many cases products made by the beneficiaries of the entity or related to any of its missions, such as from fair trade) or they can charge fees for some of their ser­ vices (e.g., membership fees, admission tickets for museums, orchestras, or theaters). This source of income can be significant, but it is not use­ ful for every nonprofit. The use of this option is considered by some as an excessively risky approach to marketing, which would make NPOs very similar to companies and, therefore, could cause them to lose other sources of financing such as that derived from individual donations. The recent phenomenon of adopting business practices in the nonprofit sector is analyzed by Vaceková, Svidroňová, Plaček, and Nemec in Chapter 12. Moreover, the evolution of technology is also adding new possibilities that NPOs are taking advantage of. We have paid special attention to the use of crowdfunding campaigns (see Hommerová in Chapter 13) as it is one of the latest and most powerful methods to finance nonprofit projects and also because it can be considered a modern adaptation of the original NPO financing through the collaboration of a high volume of charitable private donations. As a whole, we can observe how there is some kind of interrelationship between all the different topics we have dealt with throughout the book. For example, in Chapter 6, de Quevedo-Puente and Pérez-Cornejo suggest that accountability and governance mechanisms may improve reputation, and this could have an effect on the donations received by the NPO. In the same way, revenue diversification may have an impact on the margin and reserves and on other financial measures (e.g., capital structure or financial health) that also impact private donations or organizational efficiency (see Calabrese and Ely in Chapter 9 and Lam et al. in Chapter 11). In addition, governance mechanisms seem to have an effect on private donations (see Jegers in Chapter 4), but Calabrese and Ely also suggest that they may influence the accumulation of reserves. Finally, as Jegers points out, we cannot ignore the problem of reverse causality, which could be applied in most of the aforementioned relationships. Therefore, all these examples demonstrate how we are dealing with complex relationships that need clearer and more comprehensive theoretical support. In this way, beyond testing direct relationships, scholars may consider more complex connec­ tions through moderating and mediating effects. We can also note the importance of technology in this sector. As long as the use of these new technologies continues to increase in society, NPOs should continue using them in several ways. First, information technology (IT) allows NPOs to reach more people. The Internet allows NPOs to share their activities with the entire society, not only with their current donors, so organizations can take advantage of it and increase the visibility of their activities. Second, IT enables NPOs to involve the different stakeholders in the achievement of their organizational goals.

6

Garcia-Rodriguez and Romero-Merino

As stakeholders may be more informed, NPOs have to explore how they could participate in a more active way (i.e., social networks may allow NPOs to establish dialogue and obtain other opinions regarding their activity). Similarly, if stakeholders observe how the NPOs listen to them, their engagement will likely increase. Third, IT facilitates an increase in the accountability of NPOs. As different authors have noted (see Chapters 2, 6, 5, 4, and 13), the problems of information asym­ metries between the organization and its stakeholders may be reduced by using the Internet. It allows NPOs to be scrutinized by their stakehold­ ers, and, if their analyses are positive, the organizational reputation may increase (and hence, donations). Finally, IT continues to progress and NPOs should take advantage of new financing tools. For example, some NPOs are beginning to use blockchain and digital currencies, allowing donors to follow the path of their contributions; potential informational problems may therefore be substantially reduced. Most chapters also note the lack of sources of information and of empirical evidence. Apart from notable exceptions, scholars need to com­ pile information from different sources, reducing the number of variables or sample sizes. This problem is also evidenced in the study of short-term relationships, rather than longitudinal periods that can provide more conclusive findings. Moreover, most of the empirical research focuses on the United States (which has the most complete sources of data) and large NPOs; few studies analyze international samples. Obviously, the non­ existence of homogeneous data complicates these international analyses, which could help, as previously mentioned, to obtain more convincing results. Therefore, we consider international research through the col­ laboration of academics from different countries especially important. In line with the above, the influence of the environment appears to be an important line of research. We highlight the importance of consider­ ing country-specific factors (institutional, economic social, and cultural variable, as Garcia-Rodriguez and Jegers (2017) suggest), the different subsectors within the nonprofit sphere, or the global macroeconomic situation in future research on NPO financing. As de Wit et al. suggest in Chapter 7, all these variables may help to explain the mixed evidence. Moreover, the idiosyncratic characteristics of each NPO (e.g., size, age, legal form) also seem to have an influence on the different relationships that have been reviewed. Thus, each NPO should consider its own mis­ sion, vision, and values; its financial situation; and the context in which it works, and, based on this, explore the introduction of different fund­ ing sources. Nonetheless, although NPOs try to manage their context, there will always be some factors beyond their control that could impact their reputation, credibility, and, ultimately, their funding. This is the case with the inadequate behavior of other NPOs and the appearance of financial scandals. Despite the fact that the NPOs affected by these scandals could be considered ‘bad apples,’ they threaten the credibility

The Finance of Nonprofit Organizations

7

of the whole sector, decreasing the support from society and, therefore, their funding (Greenlee, 2000; Greenlee, Fischer, Gordon, & Keating, 2007; Prakash & Gugerty, 2010; Slatten, Guidry, & Austin, 2011). These reasons, among others, explain the promulgation of self-regulatory codes that promote the efficient functioning of the entire nonprofit sector. Finally, we are in line with recent literature (Andrés-Alonso, GarciaRodriguez, & Romero-Merino, 2015; Mitchell & Calabrese, 2019) that questions traditional financial assumptions in the nonprofit sector. As noted above, the need to take the NPOs’ contextualization into account prevents authors from drawing solid conclusions. Thus, a one-size-fits-all model does not seem to be the approach to address the financial issues of the nonprofit sector. There are not definite answers with which to respond to questions such as what proportion of each revenue source is the most advisable, or how much debt NPOs should have in their bal­ ances. Therefore, NPOs should analyze their setting and, as Chapter 2 indicates, always keep their mission, vision, and values in mind as these are the principles that should guide their activity and also their financial decisions. In addition, it is highly important for NPOs to enhance their relationships with their contributors by being accountable and trying to involve them in the functioning of the organization. This strategy, which could perfectly rely on the use of new technologies, could help NPOs build long-term and stable relationships; that is, valuable alliances that allow them to maintain the support of contributors and, therefore, to continue with their activities in order to achieve their mission.

References Andrés-Alonso, P., Garcia-Rodriguez, I., & Romero-Merino, M. E. (2015). The dangers of assessing the financial vulnerability of nonprofits using traditional measures: The case of the nongovernmental development organizations in the United Kingdom. Nonprofit Management and Leadership, 25(4), 371–382. Bekkers, R., & Wiepking, P. (2011). A literature review of empirical studies of philanthropy: Eight mechanisms that drive charitable giving. Nonprofit and Voluntary Sector Quarterly, 40(5), 924–973. Callen, J. L. (1994). Money donations, volunteering and organizational effi­ ciency. The Journal of Productivity Analysis, 5, 215–228. Garcia-Rodriguez, I., & Jegers, M. (2017). Capital structure of nongovernmental development organizations: First cross-country evidence. Nonprofit Manage­ ment and Leadership, 28(2), 175–194. Greenlee, J. S. (2000). Nonprofit accountability in the information age. New Directions for Philanthropic Fundraising, 27, 33–50. Greenlee, J. S., Fischer, M., Gordon, T., & Keating, E. (2007). An investigation of fraud in nonprofit organizations: Occurrences and deterrents. Nonprofit and Voluntary Sector Quarterly, 36(4), 676–694. Haibach, M., & Kreuzer, T. (2004). Fundraising. In A. Zimmer & E. Priller (Eds.), Future of civil society: Making central European nonprofit organizations work (pp. 367–379). Wiesbaden, Germany: VS Verlag fur Sozialwissenschaften.

8

Garcia-Rodriguez and Romero-Merino

Marcuello, C., & Salas, V. (2001). Nonprofit organizations, monopolistic com­ petition, and private donations: Evidence from Spain. Public Finance Review, 29(3), 183–207. Mitchell, G. E., & Calabrese, T. D. (2019). Proverbs of nonprofit financial man­ agement. The American Review of Public Administration, 49(6), 649–661. Pajas, P., & Vilain, M. (2004). Finance of nonprofit organizations. In A. Zim­ mer & E. Priller (Eds.), Future of civil society: Making central European non­ profit organizations work (pp. 341–366). Wiesbaden, Germany: VS Verlag fur Sozialwissenschaften. Prakash, A., & Gugerty, M. K. (2010). Trust but verify? Voluntary regulation programs in the nonprofit sector. Regulation & Governance, 4(1), 22–47. Salamon, L. M., & Anheier, H. K. (1998). Social origins of civil society: Explain­ ing the nonprofit sector cross-nationally. Voluntas: International Journal of Voluntary and Nonprofit Organizations, 9(3), 213–248. Slatten, L. A. D., Guidry, B. N., & Austin, W. (2011). Accreditation and certi­ fication in the non-profit sector: Organizational and economic implications. Organization Management Journal, 8(2), 112–127. Steinberg, R. (1986). Should donors care about fundraising? In S. Rose-Ackerman (Ed.), The economics of nonprofit institutions (pp. 346–364). New York, NY: Oxford University Press. Van Slyke, D. M., & Brooks, A. C. (2005). Why do people give? New evidence and strategies for nonprofit managers. The American Review of Public Admin­ istration, 35(3), 199–222. Vesterlund, L. (2006). Why do people give? In W. Powell & R. S. Steinberg (Eds.), The nonprofit sector: A research handbook (2nd ed., pp. 568–587). New Haven, CT: Yale University. Weisbrod, B. A. (1998). Guest editor’s introduction: The nonprofit mission and its financing. Journal of Policy Analysis and Management, 17(2), 165–174. Weisbrod, B. A., & Dominguez, N. D. (1986). Demand for collective goods in private nonprofit markets: Can fundraising expenditures help overcome freerider behavior? Journal of Public Economics, 30(1), 83–96. Young, D. R. (2017). Financing nonprofits and other social enterprises: A benefits approach. Cheltenham, England: Edward Elgar.

Part I

Determinants of Public and Private Income

2

Why Do Donors Donate? Ignacio Bretos, Millán Díaz-Foncea, and Carmen Marcuello

Introduction The World Giving Index 2017 report published by the Charities Aid Foundation (CAF) (2017) provides a unified index of financial donations, volunteerism, and aid to foreigners worldwide.1 According to the report Oceania (57%) is at the top of the list followed by America (35%), Asia (34%), Africa (32%), and Europe (32%). At the same time in Europe, the European Fundraising Association (2018, p. 7) states that European countries with the highest share of individual donors are the United King­ dom (64%), Netherlands (64%), Ireland (60%), Norway (55%), Sweden (55%), and Germany (55%), and those with the lowest share are Spain (33%), Italy (30%), and Slovenia (32%). However, notwithstanding the relevance of the previous data, there are scarce official public statistics on financial donations to nonprofit organizations (NPOs); the information comes mainly from studies carried out by private entities and is charac­ terized by a high dispersion and fragmentation of sources, methodolo­ gies, and results. Nevertheless, the academic literature has contributed significantly to the analysis of the phenomena of donations to NPOs from the point of view of different disciplines and, especially, from the economic perspec­ tive. Some of the early works that address this issue include Buchanan (1968), where donor behavior is considered as a purchase of public goods; Feldstein (1975a, 1975b), which analyzes the effect of tax incentives on donations; and Steinberg (1987), which provides a study on the relation­ ship between public expenditure and donor behavior. Other influential theoretical works were compiled by Andreoni (1989, 1990) introducing the concepts of ‘pure altruism’ and ‘warm glow.’ We also have found that academic circles traditionally discuss four models related to philan­ thropy, nonprofit sector, and welfare state that tend to coexist in Europe (MacDonald & Tayart de Borms, 2008: 1) the Anglo-Saxon model where the NPOs have a greater role than the state in the provision of public goods and represent a counterweight to the public authorities; 2) the Latin/Mediterranean model where the NPOs have an important role in

12

Bretos, Díaz-Foncea, and Marcuello

providing education and social services and embed to a large extent reli­ gious values; 3) the model prevailing in Central Europe where the state contracts with NPOs ensuring a model of ‘social corporatism’; and 4) the Scandinavian model which combines a strong universal welfare state together with an outstanding advocacy of the NPOs. In this chapter, we bring together different theories that explain moti­ vations of donors to provide financial support to the NPOs. The chapter also introduces some of the organizational variables that explain why some entities obtain more resources than others. For this purpose, in the following section we carry out a literature review of the most relevant publications in terms of donor motivations; theories on donor behavior; as well as the role of socio-economic factors, welfare state models, and information technologies. In addition, we review the main academic con­ tributions on corporate donors. The next section presents an analysis of the characteristics of NPOs on which the receipt of donations depends. Finally, in the last section we present the main conclusions of the chapter.

Which Motivations Do Donors Have? Which Theories Explain Such Motivations? According to a general approach to the concept of donation, the term ‘donation to an NPO’ can be considered as quite broad and encompass both contributions of time and money. Nonetheless, the term ‘donation’ is usually associated directly with monetary contributions, while ‘dona­ tion of time’ is related to the concept of volunteerism. In both cases, we understand donation (money or time) as a contribution to an NPO with­ out an explicit compensation. In other words, although direct donations can be equally made to family and friends, strangers in the street, and community, we only consider donations made to formally constituted organizations that provide services to other individuals or indirectly to the donor. Likewise, the relationship between the two types of donations (time and money) is evident. It can be observed that financial donors usually volunteer as well. However, the relation between contributions of time and money has been hardly studied due to the lack of avail­ able information (Callen, 1994). In this chapter we will focus on money donations. Another important issue that has to be clarified is the separation between a purchase and consumption of goods and services ‘acquired’ through the act of donating. In case of monetary donations, we find that a donor is making a purchase of a good or a service, to be consumed or used by a third person (beyond one’s own family), that is, there is a sepa­ ration between the fact of buying and the fact of consuming. Regarding the motivations that induce donors to make monetary con­ tributions to NPOs, we find that they are numerous, diverse, and clearly affected by the socio-economic characteristics of donors. As claimed by

Why Do Donors Donate?

13

the academic literature, the most relevant and traditionally considered motivations include altruism, religious motives, seeking after social rec­ ognition, complying with the social norms of the donor’s environment, level of public goods provision, and presence of fiscal incentives (Okten & Weisbrod, 2000; Rose-Ackerman, 1996, 1997; Young, 1989). Hence, the studies on donor behavior have mainly addressed so far the effects of different factors on the utility function of donors. In this context, the pre­ sent analysis discusses three main factors: effect of government spending on the level of private donations; impact of tax incentives on monetary donations; and effect of pure and impure altruism based on whether a donation is included in a donor’s utility function or not. In the first case, the definition of donation as a purchase of a public good (Buchanan and Steinberg) implies that a donor has an ability to observe an amount of the available public goods and make a contribu­ tion based on that observation. It is important to remind that in this case NPOs are mainly characterized as producers of public goods. In other terms, the authors consider that NPOs are producers of collective goods that provide benefits distributed among individuals in the society, such as education, health, social services, culture, etc. Thus, according to the initial assumption donors act as demanders of public goods, whenever the final recipient of these goods is a third person or the donor himself, directly or indirectly. This means that, when modelling the behavior of private donors, it is represented by a demand function rather than sup­ ply. That is, it is described by a utility function allowing to derive the demand function for public goods of an average donor. A donation of one person will also be affected by donations of other people, provision of public goods made by a government, and by a set of NPOs. Therefore, the total utility of a donor depends on consumption of private goods and on total amount of public goods. The latter is determined by private con­ tributions of the donor, total contributions made by other donors, and contributions of the public sector (either as a direct provision or through subsidies to NPOs) (De Wit & Bekkers, 2016; De Wit, Bekkers, & Broese van Groenou, 2017). In the second case, which is the effect of altruism, Andreoni’s initial works (1989, 1990) introduce the idea of differentiating pure altruism from impure altruism. Pure altruism (previous authors are Becker, 1974; Roberts, 1984) refers to a donor making a donation without waiting for or receiving a tangible or intangible compensation. Impure altruism refers to a donor expecting to receive some kind of personal, tangible, or intangible benefit. In case of impure altruism, donors make their deci­ sions on the basis of prestige, respect, personal utility, and possible future or indirect consumption that the donor receives as a reward. Kingma and McClelland (1995) add that: 1) the donor receives satisfaction (utility) from the fact that other people improve their well-being (donations to the development cooperation NGOs, children, disabled people, cancer

14

Bretos, Díaz-Foncea, and Marcuello

patients); 2) the donor perceives that through his donation he receives the capacity or power to influence the decisions of the NPO; or 3) the donor anticipates that he may be a future beneficiary of the NPO to whom he makes the donation and therefore acts with an interest. In the third case, demand functions include fiscal effects as a price of donation (Feldstein, 1975a, 1975b; Harbaugh, Mayr, & Burghart, 2007). In this situation, tax incentives represent an opportunity cost (price) that a donor perceives. Such cost is calculated in relation to each person’s tax situation. This gives grounds for the existence of different models of tax incentives in several countries that aim to encourage private donations from both individuals and companies. In this case, the mentioned works analyze the decision-making process of an individual donor by differenti­ ating two moments: the decision to donate or not, and the decision with respect to how much to donate. This distinction is important because the factors that influence the decision to give do not necessarily have to be the same as those which determine the amount of the donation (Sargeant, 1999). On the other hand, as we mentioned at the beginning of this section, the socio-economic factors are fundamental in explaining the donor behavior. It is also noted that individual socio-economic factors and household characteristics are included in the analysis. In addition, some studies analyze a joint decision of household members, not just individu­ als, to donate (Burgoyne, Young, & Walker, 2005; Garcia & Marcuello, 2001). Bekkers and Wiepking (2011) and Wiepking and Bekkers (2012) conducted a comprehensive study of the impact of age, sex, education, family composition, income, socialization, and religion on donor deci­ sions. The authors examine in detail the main socio-economic factors analyzed in the academic literature, highlighting (Bekkers & Wiepking, 2011, p. 339) a positive effect of affiliation with a religion (especially Judaism and Protestantism); stronger religious involvement; a higher age; a higher level of edu­ cation; income and wealth; home ownership; a better subjective financial position; being married; having children; having a paid job; higher cognitive ability; having prosocial personality characteristics such as empathy; growing up with parents with higher education, income, religiosity and volunteering activity. The evidence on town size, gender, family status, race, and political preferences is mixed. The authors suggest that more research is needed to understand the relationships between these factors. The authors also stress “we have a lot of descriptive knowledge about who gives what but we have very little knowledge about why some people give more than others” (Bekkers & Wiepking, 2011, p. 356). In addition to incorporating the pre­ vious socio-economic factors, the most recent works focus on developing

Why Do Donors Donate?

15

a theoretical relationship between behavioral intention and behavior of donors in the context of such concepts as satisfaction, trust, commitment to explain donation, and difference between giving intention and giving behavior (Shang, Sargeant, & Carpenter, 2019). Another issue that has been analyzed by different studies is the impact of the welfare state model of each country on the level of donations. This question is related to the crowding-out effect proposed by Steinberg but goes further due to: 1) the role of the nonprofit sector and of the funding it receives from the public sector; 2) different policies with respect to both the provision of public goods and fiscal incentives; and 3) the cultural environment related to philanthropy (Kerlin, 2013; Pennerstorfer & Neumayr, 2017; Salamon & Sokolowski, 2004). Thus, for example, the Anglo-Saxon countries are considered to have the longest philanthropic tradition, followed by the corporatist welfare states while social democ­ racies and Mediterranean countries tend to have a lower philanthropic performance. However, Pennerstorfer and Neumayr (2017, p. 550) pro­ pose that “the principal conclusion that can be drawn from this study is that the welfare state structures private giving.” In this sense, they add an important question: This is a hint that differences in giving behavior across nations are even more complex to explain than the crowding-out theory would suggest. Keeping that in mind, claims for the retrenchment of the welfare state and for more reliance on private funding and private provision of welfare services might not work in all countries the same way, but rather lead to quite different effects, depending on philanthropic traditions and values, but also on existing institutional arrangements. Moreover, referring to the found crosswise crowdingin, a call for increased private funding of welfare services could result in reduced resources and thus less activities in non-core welfare fields. (p. 555) Previous studies on motivations, behavior, and decision models are still relevant. However, information technologies have introduced profound changes in donor behavior, both in terms of access to information and ease with which donations can be made (Ben-Ner, 2018). Likewise, these changes have facilitated a creation of new channels for donating, such as crowdfunding, Facebook, and all kinds of digital platforms (SalidoAndrés, Rey-García, Álvarez-González, & Vázquez-Casielles, 2019). According to the 2018 Global Trends in Giving Report (Nonprofit Tech for Good, 2019, p. 23), 29% of donors worldwide say that social media is the tool that most inspires them to give, however, email is a close second at 27%. In third place is an organization’s website at 18%. Together, digital

16

Bretos, Díaz-Foncea, and Marcuello communications inspire 74% of donors to give. Organizations must invest in technology to stay relevant.

The impact of information technologies on donations to NPOs needs to be further explored as a field of study. Finally, we would like to point out briefly another related topic which also has to be developed: corporate donations—corporate philanthropy. As stated by Noble, Cantrell, Kyriazis, and Algie (2008, p. 315), although corporate support for many nonprofit organisations (NPOs) represents only a relatively small component of their overall income its importance is growing. As a consequence, the need to understand corporate giving behavior in a way that supports the development of strategically targeted and successful marketing campaigns is of growing importance to marketing managers in many NPOs around the globe. On the other hand, Amato and Amato (2007, p. 229) point out, “Corpo­ rate giving as a percentage of profit declined over the past 15 years despite recent research suggesting that firms have financial and strategic motives for socially responsible behavior.” In a similar way, again, it is neces­ sary to clarify what understanding lies behind a corporate donation. We define corporate donations as voluntary donations of corporate resources to an NPO. This donation can be made through direct contributions or through corporate foundations. Another important issue to address is the motivation of corporate donations. Gautier and Pache (2015, p. 347)2 identify three motivations giving rise to three general models: 1) corpo­ rate philanthropy as a voluntary expression of the firm’s commitment to the common good; 2) long-term, community-oriented investment through which firms ensure their competitiveness while fostering their business environment; 3) marketing approach to corporate philanthropy, where giving is used as a commercial tool. Regarding the drivers of corporate giving, the authors describe different levels of decision-making and there­ fore different types of factors that affect each of them. Motivations of individual managers, company as a whole (ownership structure, board membership), and of the sector in which a company operates (industry structure) must be taken into account. In this sense, Amato and Amato (2007) observe that “small firms give because they are frequently locally owned and thus close to the consuming public, while large firms give because of the greater visibility that comes from size.” The researchers also affirm with respect to the effect of industry on company’s donations, that “the industry giving culture may create an environment that requires firms to meet or exceed competitor philanthropy in order to maintain customer and community goodwill” (Amato & Amato, 2007, p. 238). Finally, we would like to highlight the work of Catalão-Lopes, Pina, and

Why Do Donors Donate?

17

Branca (2016) where they examine a corporate giving decision under changing macroeconomic conditions. This study shows that there is a dynamic relationship between economic cycle, revenues, and corporate giving. This relationship takes place in such a way that “in the short run the slack resources theory dominates, but the good management theory plays a role in the long run” (Catalão-Lopes et al., 2016, p. 2305).

Which Organizational Features Determine That Some NPOs Receive More Donations Than Others? This question is of great importance since some studies and NPO man­ agers traced a link between more donations received and greater effi­ ciency. In this manner, the traditional market postulates and functioning mechanisms of a capitalist company are used to evaluate the efficiency of the NPOs according to the income received or taking into account only certain economic and financial indicators that do not necessarily reflect the activity of the NPO. In case of NPOs, access to funding is a strategic issue for their survival as their services are often not designed to bring income (development cooperation, services to marginalized groups or those at risk of social exclusion, health, education, social services, culture, etc.). In addition, funding must be consistent with the mission and values of an organization. As a result, we find NPOs with different funding models and strategies, ranging from those that mainly provide public goods and have a greater access to the public funding to those that defend human rights and environment, whose funding strategies are based on independence from governments and other large donors in order to maintain their freedom in taking decisions and avoid an inter­ ference on the part of certain contributors. On the other hand, the size of NPOs is a key factor in the ability to access the donor ‘market.’ That is, some organizations such as, for example, associations of relatives of people who are deaf-blind will always be small entities with no capacity to ‘compete’ for private funding like other large organizations such as Red Cross, Caritas, etc. To sum up, private donations received by NPOs will be conditioned by numerous factors beyond the classic ones used by the market. The 2008 crisis additionally led to a decrease in services provided by public administrations and at the same time to an increase in needs of many social groups. This situation resulted in the increased number of NPOs providing services no longer offered by government and also devel­ oping new services for the emerging necessities of different social groups (housing, employment, help to refugees, etc.). An important decrease in governmental funding of the NPOs caused an increased competition for private funding.3 On the other hand, donors received a greater access to information while NPOs also got direct access to donors by means of information technologies. According to Similon (2015) this phenomenon

18

Bretos, Díaz-Foncea, and Marcuello

added to the emergence of special labels and umbrella organizations aimed at creating self-regulatory models and facilitating transparency, accountability, and coordination of fundraising activities.4 The objective of these regulatory mechanisms is to ensure certain requirements neces­ sary for NPOs to be met so that donors have confidence in their donations being used efficiently. This efficiency has several elements: investment of funds into the activities described above, results obtained by an NPO, and reasonable amount of costs. The first two issues are crucial for the NPO’s relationship with donors while the third element arises because of the competition for funds. The need to look for private funding has increased the expenditures neces­ sary to achieve it: advertising, staffing, and fundraising activities, differ­ ent from the NPO’s main activities. Thus, the expenditure in fundraising activities is one of the variables for analyzing the fundraising efficiency of organizations in order to ensure that these expenses are not excessive (Bowman, 2006; Marcuello & Salas, 2001; Posnett & Sandler, 1989; Weisbrod & Dominguez, 1986). Finally, as we mentioned at the beginning of the chapter, while the phenomenon of private donations is important, there are hardly any offi­ cial public statistics in this field, and it is required to turn to very diverse and fragmented sources. The information available on which sectors of activity and NPOs receive most of donations is very limited. Among dif­ ferent reports, Giving United States of America (U.S.A) (2018), Giving in Europe (European Research Network on Philanthropy, 2017), and CAF United Kingdom (U.K.) Giving Survey (2019) stand out. Such reports coincide in data which points to the religious groups as the largest recipi­ ents of the donations (31% U.S., 19% U.K., 40% Netherlands, 14% France, 21% Switzerland, 27% Norway, 13% Austria), while the rest of the sectors vary according to each country and mainly include publicsociety benefit, health, education, international aid, and others.

Conclusions Private donations to NPOs are an international phenomenon. How­ ever, the available information and homogeneous statistics that enable a global vision and its evolution are very scarce and fragmented. The academic literature has analyzed this topic from the point of view of different disciplines such as economics, sociology, psychology, and law and includes an important number of studies. Main contributors attempt to characterize the individual donor using different socio-economic vari­ ables, like their motivations and behavior, taking into account level of altruism, effect of tax deductions, level of provision of public goods, wel­ fare state model, and impact of information technologies on the emerging models of private contributions to NPOs. On the other hand, corporate donors contribute financially to NPOs as well, even though to a smaller

Why Do Donors Donate?

19

extent than individual donors. In case of corporations, the motivation to donate varies from commercial motives to increase the company’s profit to striving to contribute to the common good. The NPOs as recipients of donations are facing a constantly growing pressure to find sources of funding for their activities. This is caused by the increased needs of social groups, as well as by the decrease in govern­ mental funding and rise in the number of NPOs. The latter develop dif­ ferent financing strategies as another element of the organization’s global strategy at the service of the social objectives of the entity. This is a highly relevant topic because the assessment of NPOs based on economic and financial indicators only, will not adequately reflect efficiency in achiev­ ing their objectives. In the recent years, self-regulating systems have been created within the sector, as well as umbrella organizations and watchdog organizations that attempt to facilitate the process of choice for donors when it comes to deciding on whom to donate. In this sense, it should be mentioned that government continues to be one of the main agents to supervise and control the NPOs’ activities through funding policies. Such policies establish, in turn, very exhaustive controlling mechanisms that guarantee the achievement of the objectives and the proper use of the NPO’s funding. This capacity of the public sector can be hardly acquired by the market or private entities. Finally, it should be noted that government policies regarding the financing of NPOs are essential to ensure the existence of NPOs as well as their plurality and heterogeneity. The donor market will be subject to the preferences of people who do not have access to complete informa­ tion for decision-making. This creates a problem of asymmetric informa­ tion that results in larger NPOs obtaining more funding at the expense of smaller NPOs. As a consequence, small NPOs are unable to allocate resources to the fundraising because their budgets are primarily spent on the organization’s objectives. The situation becomes even more difficult because of the fact that the goods and services offered by most NPOs are public goods and are sometimes offered to the user free of charge or at a price below the cost of production so funding will always be a critical issue. Furthermore, the redistributive capacity of the public sector which provides public funding to promote NPOs in all sectors and reach a greater share of population can hardly be transferred to the donor mar­ ket. In this sense, the study of Weisbrod (1986) reinforces the idea that the joint production of public services by government and NPOs enables higher levels of public goods provision.

Notes 1. Another private statistic is the 2018 Global Trends in Giving Report (Nonprofit Tech for Good, 2019). 2. See also Committee Encouraging Corporate Philanthropy. (Ed.). (2012). Giving in numbers 2012 edition. New York, NY.

20

Bretos, Díaz-Foncea, and Marcuello

3. See also Maier, Meyer, and Steinbereithner (2016), and Chapter 12 of this book about NPOs becoming business-like. 4. According to Coffman (2017), another type of organization that has emerged is the watchdog rankings that has received numerous criticisms.

References Amato, L. H., & Amato, C. H. (2007). The effects of firm size and industry on corporate giving. Journal of Business Ethics, 72(3), 229–241. Andreoni, J. (1989). Giving with impure altruism: Applications to charity and Ricardian equivalence. Journal of Political Economy, 97(6), 1447–1458. Andreoni, J. (1990). Impure altruism and donations to public goods: A theory of warm-glow giving. The Economic Journal, 100(401), 464–477. Becker, G. S. (1974). A theory of social interactions. Journal of Political Econ­ omy, 82(6), 1063–1093. Bekkers, R., & Wiepking, P. (2011). Who gives? A literature review of predic­ tors of charitable giving. Part one: Religion, education, age and socialization. Journal of Voluntary Sector Review, 2(3), 337–365. Ben-Ner, A. (2018). Reflections on the future evolution of social, nonprofit and cooperative enterprise. Annals of Public and Cooperative Economics, 89(1), 109–124. Bowman, W. (2006). Should donors care about overhead costs? Do they care? Nonprofit and Voluntary Sector Quarterly, 35(2), 288–310. Buchanan, J. M. (1968). Demand and supply of public goods. Chicago, IL: Rand McNally. Burgoyne, C. B., Young, B., & Walker, C. M. (2005). Deciding to give to charity: A focus group study in the context of the household economy. Journal of Community & Applied Social Psychology, 15(5), 383–405. Callen, J. L. (1994). Money donations, volunteering and organizational effi­ ciency. Journal of Productivity Analysis, 5(3), 215–228. Catalão-Lopes, M., Pina, J. P., & Branca, A. S. (2016). Social responsibility, cor­ porate giving and the tide. Management Decision, 54(9), 2294–2309. Charities Aid Foundation. (2017). World giving index 2017. Retrieved from www.cafonline.org/docs/default-source/about-us-publications/cafworld givingindex2017_2167a_web_210917.pdf Charities Aid Foundation UK Giving Survey. (2019). CAF UK giving 2019. An overview of charitable giving in the UK. Retrieved from www.cafonline. org/docs/default-source/about-us-publications/caf-uk-giving-2019-report-an­ overview-of-charitable-giving-in-the-uk.pdf Coffman, L. C. (2017). Fundraising intermediaries inhibit quality-driven charita­ ble donations. Economic Inquiry, 55(1), 409–424. De Wit, A., & Bekkers, R. (2016). Government support and charitable donations: A meta-analysis of the crowding-out hypothesis. Journal of Public Administra­ tion Research and Theory, 27(2), 301–319. De Wit, A., Bekkers, R., & Broese van Groenou, M. (2017). Heterogeneity in crowding-out: When are charitable donations responsive to government sup­ port? European Sociological Review, 33(1), 59–71. European Fundraising Association. (2018). Fundraising in Europe, a brief explo­ ration of the European charity fundraising environment, based on a survey of

Why Do Donors Donate?

21

EFA’s members;15 national fundraising association representatives. Retrieved from https://efa-net.eu/wp-content/uploads/2018/10/EFA_Fundraising_in_ Europe_Report_Dec_17.pdf European Research Network on Philanthropy. (2017). Giving in Europe the state of research on giving in 20 European countries. Retrieved from https:// ernop.eu/wp-content/uploads/2017/04/Giving-in-Europe-Executive-Summary­ FinalDEF-1.pdf Feldstein, M. (1975a). The income tax and charitable contributions: Part I— Aggregate and distributional effects. National Tax Journal, 28(1), 81–100. Feldstein, M. (1975b). The income tax and charitable contributions: Part II—The impact on religious, educational and other organizations. National Tax Jour­ nal, 28(2), 209–226. Garcia, I., & Marcuello, C. (2001). A household model of charitable contribu­ tions and tax incentives. Annals of Public and Cooperative Economics, 72(2), 159–181. Gautier, A., & Pache, A. C. (2015). Research on corporate philanthropy: A review and assessment. Journal of Business Ethics, 126(3), 343–369. Giving USA: The annual report on philanthropy for the year 2017. (2018). Chicago: Giving USA Foundation. Retrieved from https://lclsonline.org/wp­ content/uploads/2018/12/Giving-USA-2018-Annual-Report.pdf Harbaugh, W. T., Mayr, U., & Burghart, D. R. (2007). Neural responses to taxation and voluntary giving reveal motives for charitable donations. Science, 316(5831), 1622–1625. Kerlin, J. A. (2013). Defining social enterprise across different contexts: A con­ ceptual framework based on institutional factors. Nonprofit and Voluntary Sector Quarterly, 42(1), 84–108. Kingma, B. R., & McClelland, R. (1995). Public radio stations are really, really not public goods: Charitable contributions and impure altruism. Annals of Public and Cooperative Economics, 66(1), 65–76. MacDonald, N., & Tayart de Borms, L. (2008). Philanthropy in Europe: A rich past, a promising future. London, England: Alliance Publishing Trust. Maier, F., Meyer, M., & Steinbereithner, M. (2016). Nonprofit organizations becoming business-like: A systematic review. Nonprofit and Voluntary Sector Quarterly, 45(1), 64–86. Marcuello, C., & Salas, V. (2001). Nonprofit organizations, monopolistic com­ petition, and private donations: Evidence from Spain. Public Finance Review, 29(3), 183–207. Noble, G., Cantrell, J., Kyriazis, E., & Algie, J. (2008). Motivations and forms of corporate giving behaviour: Insights from Australia. International Journal of Nonprofit and Voluntary Sector Marketing, 13(4), 315–325. Nonprofit Tech for Good. (2019). 2018 global trends in giving report. Retrieved from https://givingreport.ngo/wp-content/uploads/2018-GivingReport-English. pdf Okten, C., & Weisbrod, B. A. (2000). Determinants of donations in private non­ profit markets. Journal of Public Economics, 75(2), 255–272. Pennerstorfer, A., & Neumayr, M. (2017). Examining the association of wel­ fare state expenditure, non-profit regimes and charitable giving. Voluntas: International Journal of Voluntary and Nonprofit Organizations, 28(2), 532–555.

22

Bretos, Díaz-Foncea, and Marcuello

Posnett, J., & Sandler, T. (1989). Demand for charity donations in private non­ profit markets: The case of the UK. Journal of Public Economics, 40(2), 187–200. Roberts, R. D. (1984). A positive model of private charity and public transfers. Journal of Political Economy, 92(1), 136–148. Rose-Ackerman, S. (1996). Altruism, nonprofits, and economic theory. Journal of Economic Literature, 34(2), 701–728. Rose-Ackerman, S. (1997). Altruism, ideological entrepreneurs and the non-profit firm. Voluntas: International Journal of Voluntary and Nonprofit Organiza­ tions, 8(2), 120–134. Salamon, L. M., & Sokolowski, W. S. (2004). Global civil society: Dimensions of the nonprofit sector (Vol. 2). Baltimore, MD: Kumarian Press. Salido-Andrés, N., Rey-García, M., Álvarez-González, L. I., & Vázquez-Casielles, R. (2019). Determinants of success of donation-based crowdfunding through digital platforms: The influence of offline factors. CIRIEC-España, Revista de Economía Pública, Social y Cooperativa, 95, 119–141. Sargeant, A. (1999). Charitable giving: Towards a model of donor behaviour. Journal of Marketing Management, 15(4), 215–238. Shang, J., Sargeant, A., & Carpenter, K. (2019). Giving intention versus giv­ ing behavior: How differently do satisfaction, trust, and commitment relate to them? Nonprofit and Voluntary Sector Quarterly, 48(5), 1023–1044. Similon, A. (2015). Self-regulation systems for NPO coordination: Strengths and weaknesses of label and umbrella mechanisms. Annals of Public and Coopera­ tive Economics, 86(1), 89–104. Steinberg, R. (1987). Voluntary donations and public expenditures in a federalist system. The American Economic Review, 77(1), 24–36. Weisbrod, B. A. (1986). Toward a theory of the voluntary nonprofit sector in a three-sector economy. In S. Rose-Ackerman (Ed.), The economics of nonprofit institutions (pp. 21–44). New York, NY: Oxford University Press. Weisbrod, B. A., & Dominguez, N. D. (1986). Demand for collective goods in private nonprofit markets: Can fundraising expenditures help overcome freerider behavior? Journal of Public Economics, 30(1), 83–96. Wiepking, P., & Bekkers, R. (2012). Who gives? A literature review of predictors of charitable giving. Part two: Gender, family composition and income. Volun­ tary Sector Review, 3(2), 217–245. Young, D. J. (1989). A ‘fair share’ model of public good provision. Journal of Economic Behavior and Organization, 11(1), 137–147.

3

Efficiency in Nonprofit Organizations Víctor Martín-Pérez and Natalia Martín-Cruz

Introduction In a world of scarce resources, the nonprofit sector must not only be effective (achieving its intended objectives) but also efficient; in other words, it must control the level of resources it uses to accomplish a cer­ tain goal (Banerjee, 2009; Duflo & Kremer, 2003). Being more efficient means being able to carry out more actions with the same amount of resources, not only enabling the effect of the resources to be multiplied, but also reducing the pressure on donor agencies and institutions. The measure of efficiency is widely accepted as the relationship between the level of objectives achieved and the volume of resources used (Martín, Hernangómez, & Martín, 2007). However, this measure poses one initial problem which is, given a certain relationship between objectives and resources, to know whether it is efficient; in other words, to establish an adequate standard. A second problem concerns the multiple dimensions that the objective may involve (outputs) and the different resources used to obtain them (inputs), thus making it necessary to assess all the dimen­ sions simultaneously and to assign weights to the organizational factors (Hernangómez, Martín, & Martín, 2009). In the case of NPOs, in order to gauge their efficiency, the initial objective needs to be determined; that is, exactly what you are trying to achieve. One response would be to improve the quality of life and to gen­ erate well-being in people, especially with regard to meeting the require­ ments of those who are most in need, by offering services that provide a social benefit and, in many cases, by acting as substitutes or supplements to the public sector and the market. Evaluating the efficiency of NPOs is therefore a complex task, given that it is a more difficult objective to measure in comparison to com­ panies, as it involves multiple dimensions (quality, adaptation to the needs met, viability, relevance, sustainability, impact, among others), and because the production function is difficult to determine. In addition, NPOs themselves tend to question whether it is really worth devoting

24

Martín-Pérez and Martín-Cruz

funds to evaluation, to the detriment of other actions aimed at achieving their mission. Even large donors adopt a somewhat undecided attitude towards whether assessing the efficiency of the organizations they fund can actu­ ally help to improve the future granting of donations. In many cases, they prefer to focus on a prior analysis of the actions to be financed and pay only secondary attention to whether the results that motivated the initial donation have actually been achieved (Porter & Kramer, 1999). Even so, it seems clear that if there were accurate efficiency indicators for NPOs then donors would value more those organizations which display a greater capacity to generate well-being or welfare to a greater number of people: that is, they would choose the organization which proves most efficient in achieving its objectives.

The Problem of Measuring Efficiency in NPOs As with any organization whose objectives are difficult to quantify and who only tend to look at how resources are used, without taking into account compliance or non-compliance with objectives, little is known about the efficiency with which NPOs go about their activities. This may give the impression that efficiency is not seen as an issue which merits attention in the nonprofit sector. This lack of knowledge substantially reduces the possibilities of NPOs being able to learn from their own experiences, and indeed those of others, in order to improve in the future. In addition, it may give rise to a certain lack of concern for the long-term results of the actions undertaken, fostering a climate of permissiveness towards manifestly improvable yields and preventing an objective analy­ sis that can reveal which mistakes are being made and how they may be corrected in the future. All of this may lead to an inability to realis­ tically evaluate what contribution the third sector makes to the objec­ tives initially established, using the resources available. NPOs should not compete like companies. Rather, their ‘business’ is to create social value (Porter & Kramer, 1999). However, because they use altruistically granted resources, they have a greater responsibility towards them and must ensure their best possible use, which will mean savings for donors or being able to engage in a greater number of actions. Measuring efficiency is a complicated task because of the complexity of establishing precise measures and due to entities’ own doubts about whether it is really worth devoting funds to evaluation, to the detriment of possible additional strategies. In practice, efficiency evaluation is usu­ ally only partial and is conducted in a biased manner, often merely involv­ ing ascertaining whether funds were used as proposed, and employing indicators which show what proportion project expenditures represent over total income or what percentage administrative expenses represent over total expenses. Yet such an evaluation usually fails to measure the

Efficiency in Nonprofit Organizations

25

social impact of the actions financed, actions which often transcend the short term. In addition, evaluations are usually carried out by the very organizations who receive the funds, such that they cannot be expected to be either objective or reliable, because they will seek to present results which allow them to maintain donor support. Although efficiency evaluation may prove costly and complex, it is a task that cannot be ignored, given that in a world of scarce resources it is both necessary and desirable to make the best possible use of them, a reality which the third sector is not currently in a position to ensure. Any control over efficiency obtained by NPOs would introduce competition among them, because donors would have a point of reference with which to establish comparisons when deciding which entity to contribute to. This would result in greater pressure to achieve constant improvement and would prove extremely positive due to the greater impact it would have for society. For donors, it would place fewer demands on them and would instill greater confidence vis-à-vis the correct use thereof—which could also curb any doubts they might have and help to boost contribu­ tions. For beneficiaries, it would enable a greater number of actions to be carried out to improve their living conditions. If such a change of direction is not undertaken, NPOs will continue to act in a context where they cannot fail, which will damage entities that are more efficient and more concerned with improvement, given the difficulty of being able to distinguish amongst them. Accounting Measures of Efficiency in Nonprofit Organizations The third sector cannot use the measures of partial efficiency that firms use, such as profitability or indicators which reflect the ability to com­ pensate shareholders, given that they do not make much sense in view of these organizations’ particular characteristics. It is necessary to establish a homogeneous and comparable indicator which provides donors with useful information to evaluate NPOs’ operations (Trussel & Parsons, 2007): in other words, once the donor has decided to contribute to a cer­ tain cause, an indicator that will help them to determine which organiza­ tion will make the best use of its resources and, therefore, which of them they will donate to. Global efficiency has become the most widely used indicator to meas­ ure overall performance within the third sector, although the issue remains far from clear (Herman & Renz, 1999; Jackson & Holland, 1998; Kanter & Summers, 1987; Murray & Tassie, 1994) and is one on which academics and professionals fail to agree. It is this lack of agreement which has meant that researchers face serious difficulties when developing normative conclusions related to which nonprofit activities and attributes yield higher (or lower) levels of efficiency. For professionals, the difficulties stem from the inability to

26

Martín-Pérez and Martín-Cruz

assess efficiency effectively, particularly when seeking to pinpoint tried and trusted measures that allow for comparisons between organizations (Ritchie & Kolodinsky, 2003). Therefore, more research into the effi­ ciency of NPOs is necessary (Forbes, 1998; Herman & Renz, 1999; Hoefer, 2000; Rojas, 2000; Stone, Bigelow, & Crittenden, 1999; Tuckman & Chang, 1998). In the context of the third sector, efficiency is defined by Parsons (2003) as the degree to which an NPO dedicates the available resources to its mission: that is, it shows the average percentage of each donation that actually reaches the organization’s beneficiaries. The measures used in the literature to gauge efficiency have been based on the analysis of ratios, prominent amongst which are the following: • Price is defined as the cost, for a donor, of purchasing a dollar of output for an organization’s beneficiaries. Without accounting for tax deduction, price is measured as the inverse of the percentage of expenditure on projects (Callen, 1994; Posnett & Sandler, 1989; Tinkelman, 1998; Weisbrod & Dominguez, 1986). • Program ratio, represented as the percentage of project expenditures to total expenditures, is used to measure efficiency instead of price (Baber, Roberts, & Visvanathan, 2001; Kitching, Roberts, & Smith, 2012). Baber et al. (2001) argue that this measure may indicate the NPO’s fundraising strategy. • Allocative efficiency, a very similar and also widely used measure (Andrés, Azofra, & Romero, 2010; Andrés, Martín, & Romero, 2006; Callen & Falk, 1993; Hernangómez et al., 2009), calculates the percentage of project expenditures to the organization’s total revenue. • Technical efficiency or administrative expense ratio (Andrés et al., 2006, 2010; Callen & Falk, 1993; Greenlee & Brown, 1999; Hernangómez et al., 2009) is defined as the percentage of adminis­ trative expenses over total expenditures. Some authors (Greenlee & Brown, 1999) use a similar measure which involves excluding fund­ raising costs from total costs. When observed carefully, these forms of measuring efficiency are closely related, provided that the total income and expenses of the year are equal, given that price is the inverse of the ratio of projects, with technical efficiency being complementary to project ratio. Due to their simplicity, ability to obtain information, and possibilities for homoge­ nous comparisons between entities, the latter two indicators (technical and allocative efficiency) are widely used by donors (Hyndman, 1991; Khumawala & Gordon, 1997) when deciding which organizations to donate to and, should the amount be high enough for them to be able to exert an influence, also establish limits as to what the funds should be

Efficiency in Nonprofit Organizations

27

used for. The entities themselves also employ the two indicators men­ tioned to convey to society as a whole an image of transparency and of fulfilling their mission, which might ultimately translate into raising a greater amount of funds. Based on these indicators, the donor’s main concern is the percentage of expenditures dedicated to projects, as this will determine what part of the donation is actually applied to beneficiaries. In fact, when provid­ ing financing for a specific project, most institutional donors establish in advance the maximum percentage that can be represented by expenses not directly attributable to the project: that is, they establish the ratio of administrative expenses the entity must adhere to in order to obtain funds and thus ensure efficient use of resources. However, these indicators provide a partial and biased evaluation of efficiency because they are confined to checking whether funds were used as intended and what proportion the project expenses and administra­ tive expenses represent. However, they fail to measure the impact of the actions financed or the results achieved, such that they cannot really be conceptualized as efficiency measures because they are not comparing objectives accomplished with resources used. Non-Accounting Measures of Efficiency in Nonprofit Organizations Data Envelopment Analysis (DEA) is a particularly suitable method for the public and nonprofit sector, given that it adapts to the unique char­ acteristics displayed by the organizations operating in them—difficulty in knowing the prices1 of the product/service they generate, a hard to define production function, or working with multiple inputs and outputs—and because it helps to establish an objective measure of efficiency in groups of organizations that have no aggregate indicators to accommodate the multiple simultaneous objectives they pursue. DEA is a non-parametric mathematical programming method, origi­ nally proposed by Charnes, Cooper, and Rhodes (1978), to measure the relative efficiency of homogeneous units (DMU decision-making units) by constructing an efficient frontier. The method identifies the efficient units2 and builds a boundary formed by the linear combina­ tions between these units. The efficiency of the rest of the units is meas­ ured according to their distance from the efficient frontier which is calculated. The formalization of the analysis is carried out as a mathematical optimization model, the estimated variables of which are the efficiency indices, defined as the quotient between the weighted sums of the out­ puts and the weighted sums of the inputs. It is a non-parametric tech­ nique because it does not specify a concrete functional form between the maximum of achievable outputs and the required inputs. Applying this

28

Martín-Pérez and Martín-Cruz

technique allows the measure of efficiency for each entity to be obtained, values for which can vary between 0 and 1 (where 1 corresponds to the location on the efficient frontier), and determines the weights in an endogenous way corresponding to the values of the greatest possible effi­ ciency. This methodology thus provides a global measure, determined in an objective and numerical way, of the value of efficiency that does not require a standard reference value to be established in advance (Charnes, Cooper, Lewin, & Seiford, 1994; Farrell, 1957; Farrell & Fieldhouse, 1962), given that the frontier is obtained from the set of organizations considered, thus overcoming the problem of comparisons made using accounting measures. DEA can be employed applying input orientation or output orienta­ tion. The choice of analysis orientation (input or output) depends on the nature of the problem and is related to entities’ control over the variables: if the units considered are restricted in terms of input management, they opt for an output orientation, and vice versa. In output orientation, a unit is efficient if no other unit can produce a higher level of outputs with the same level of inputs. In input orientation, a unit is efficient if there is no other unit which, when decreasing the amount of inputs (maintaining the proportion), obtains the same quantity of outputs. In both cases, it is necessary to establish what products result from the organization’s activ­ ity, as well as the main factors used to achieve them. There are different versions of DEA depending on the assumptions concerning the production technology and the restrictions incorporated. The mathematical formulation of the basic model, assuming constant returns to scale, for the output and input orientation, is presented in Table 3.1, where ϕ0 and φ0 represent the efficiency indicators for each orientation, yrj and xij represent the quantities of output r and input i of DMU j, ur0 and vi0 represent the weights of output r and input i. Finally, Table 3.1 CCR Model Output Orientation m

Min c0 = L vik xik i =1

t

s.t.f urk yrk = 1 r =1

t

m

-L urk yrj + L vik xij � 0 ( j = 1,...., n ) r =1

i =1

Input Orientation t

Max r0 = L urk yrk r =1

m

s.t.L vik xik = 1 i =1

t

Lu r =1

m

y - L vik xij : 0 ( j = 1,...., n )

rk rj

i =1

urk � 5

( r = 1,..., t )

urk � 5

( r = 1,..., t )

vik ; 5

( i = 1,...., m )

vik � 5

( i = 1,...., m )

Source: Basso and Funari (2004)

Efficiency in Nonprofit Organizations

29

ε represents a small enough positive value below which the weights can­ not fall (Basso & Funari, 2004). Within this methodology, we can apply two approaches to determine an organization’s degree of efficiency: technical efficiency, which reflects an organization’s ability to obtain the maximum level of production with given resources, and allocative3 efficiency, which corresponds to the abil­ ity to use the resources according to the optimal proportions in view of their prices. In turn, each of them can be determined by applying them to the inputs used, or to the outputs generated. Although it is possible to include multiple outputs and inputs in the anal­ ysis, as the number of variables included in the calculation increases, DEA’s ability to discriminate4 decreases. It is also necessary to remember the non­ existence of tests to determine the statistical significance of the variables included and to evaluate the goodness of fit. In light of these considera­ tions, as a general recommendation, the sum of inputs and outputs should not exceed one third of the sample size (Banker, Charnes, & Cooper, 1984; Banker, Charnes, Cooper, Swarts, & Thomas, 1989; McMillan & Datta, 1998). Moreover, when evaluating efficiency in relative terms, and because this technique is sensitive to extreme values, the units included in the anal­ ysis must be homogeneous: that is, the same production technology must be applied and must operate under an identical institutional framework.

Applying DEA in the Nonprofit Sector Applying DEA to calculate efficiency is nothing new in the third sector. This technique has proven particularly suitable, given both its adaptation to the sector’s unique characteristics—difficulty in knowing the prices of the product/service generated, the production function to which they adjust or working with multiple inputs and outputs, and because it estab­ lishes an objective measure of efficiency in groups of organizations that lack any aggregate indicators which accommodate the multiple simulta­ neous objectives such organizations pursue. Within the nonprofit sector, numerous studies have applied this method, key amongst which are the health sector and education, although it is only now beginning to be used in the development cooperation sector. Given the difficulty in directly measuring some of the services provided by the nonprofit sector, due to the number of parameters involved in such services and the different objectives pursued, intermediate indica­ tors have been used to evaluate these outputs. In the health sector, meas­ ures include: • Number of patient days (Al-Shammari, 1999; Hu & Huang, 2004; Valdmanis, 1990, 1992). • Number of inpatients (Banker, Conrad, & Strauss, 1986; Grosskopf & Valdmanis, 1987; Gruca & Nath, 2001; Lo, Shih, & Chen, 1996; Valdmanis, 1992; Watcharasriroj & Tang, 2004).

30

Martín-Pérez and Martín-Cruz

• Number of patients (Hu & Huang, 2004; Rosenman, Siddharthan, & Ahern, 1997). • Number of discharges (Byrnes & Valdmanis, 1994; Watcharasri­ roj & Tang, 2004; White & Ozcan, 1996). • Number of surgical operations (Al-Shammari, 1999; Grosskopf & Valdmanis, 1987; Hu & Huang, 2004; Lo et al., 1996; Valdmanis, 1990, 1992). • Number of outpatient visits (Grosskopf & Valdmanis, 1987; Gruca & Nath, 2001; Hu & Huang, 2004; Lo et al., 1996; Valdma­ nis, 1990, 1992; White & Ozcan, 1996). • Number of emergency room visits (Grosskopf & Valdmanis, 1987; Hu & Huang, 2004; Valdmanis, 1990, 1992). As regards the education sector, the most widely used measures to characterize outputs have been: • Number of students (Carrington, Coelli, & Rao, 2005; Coelli, 1996; Hernangómez, Borge, Urueña, Martín, & Benito, 2007; Urueña & Martín, 2012). • Number of undergraduate students (Ahn, Charnes, & Cooper, 1988; Avkiran, 2001; Beasley, 1995; Madden, Savage, & Kemp, 1997; McMillan & Datta, 1998; Post & Spronk, 1999; Rhodes & Southwick, 1993). • Number or percentage of graduate students (Ahn et al., 1988; Atha­ nassopoulos & Shale, 1997; Avkiran, 2001; Beasley, 1995; Car­ rington et al., 2005; Hanke & Leopoldseder, 1998; Madden et al., 1997; McMillan & Datta, 1998; Post & Spronk, 1999; Rhodes & Southwick, 1993; Stern, Mehrez, & Barboy, 1994). • Achievement scores on test grade levels (Kirjavainen & Loikkanen, 1998; Lovell, Walters, & Wood, 1994). • Student retention rates (Avkiran, 2001; Breu & Raab, 1994). • Published papers in international refereed journals (Carrington et al., 2005; Hanke & Leopoldseder, 1998; Hernangómez et al., 2007; Joh­ nes & Johnes, 1993, 1995; Korhone, Tainio, & Wallenius, 2001; Madden et al., 1997; Stern et al., 1994; Urueña & Martín, 2012). • Research funds (Avkiran, 2001; Beasley, 1995; Carrington et al., 2005; McMillan & Datta, 1998; Post & Spronk, 1999; Rhodes & Southwick, 1993; Stern et al., 1994). • Number of research projects (Ahn et al., 1988; Hanke & Leopold­ seder, 1998). As regards the inputs used, the different empirical works reviewed have shown a wide variety of variables used as representative elements of the factors which organizations, in both health and education, need in order

Efficiency in Nonprofit Organizations

31

to carry out their activities and to generate their services. Some examples from the health sector include: • Number of physicians (Al-Shammari, 1999; Grosskopf & Valdma­ nis, 1987; Hu & Huang, 2004; Kooreman, 1994; Lo et al., 1996; Valdmanis, 1990, 1992; Watcharasriroj & Tang, 2004). • Number of nurses (Byrnes & Valdmanis, 1994; Gruca & Nath, 2001; Hu & Huang, 2004; Kooreman, 1994; Lo et al., 1996; Valdmanis, 1992; Watcharasriroj & Tang, 2004). • Number of beds (Al-Shammari, 1999; Byrnes & Valdmanis, 1994; Gruca & Nath, 2001; Hu & Huang, 2004; Lo et al., 1996; Valdma­ nis, 1992; Watcharasriroj & Tang, 2004; White & Ozcan, 1996). • Paramedical personnel (Al-Shammari, 1999; Grosskopf & Valdma­ nis, 1987; Valdmanis, 1990, 1992; White & Ozcan, 1996). • Non-medical personnel (Kooreman, 1994; Gruca & Nath, 2001; Hu & Huang, 2004). • Administrative staff (Byrnes & Valdmanis, 1994; Gruca & Nath, 2001). • Ancillary staff (Byrnes & Valdmanis, 1994; Gruca & Nath, 2001). • Purchased services and supplies (Banker et al., 1986; Gruca & Nath, 2001). • Total assets (Grosskopf & Valdmanis, 1987; Rosenman et al., 1997; Valdmanis, 1990, 1992). In the education sector, the variables most widely used as inputs in DEA have been: • Academic staff or faculty/student ratio (Athanassopoulos & Shale, 1997; Avkiran, 2001; Bessent, Bessent, Charnes, Cooper, & Thoro­ good, 1983; Hernangómez et al., 2007; Johnes & Johnes, 1993, 1995; Madden et al., 1997; McMillan & Datta, 1998; Rhodes & Southwick, 1993; Urueña & Martín, 2012). • Full-time equivalent student enrolment (Athanassopoulos & Shale, 1997; Hanke & Leopoldseder, 1998; Johnes & Johnes, 1993). • Operating costs (Carrington et al., 2005; Stern et al., 1994). • Total staff costs (Hanke & Leopoldseder, 1998; Stern et al., 1994). • General expenditures (Ahn et al., 1988; Beasley, 1995; Coelli, 1996; Hanke & Leopoldseder, 1998; McMillan & Datta, 1998; Post & Spronk, 1999). • Amount of equipment expenditure (Ahn et al., 1988; Beasley, 1995; Hernangómez et al., 2007; Post & Spronk, 1999; Urueña & Martín, 2012). • Instructional expenditures (Ahn et al., 1988; Bessent et al., 1983; Breu & Raab, 1994).

32

Martín-Pérez and Martín-Cruz

• Total administrative costs (Casu & Thanassoulis, 2006; Coelli, 1996; Hernangómez et al., 2007; Urueña & Martín, 2012). • Expenditure on library and computing services (Athanassopoulos & Shale, 1997; Hernangómez et al., 2007; Rhodes & Southwick, 1993; Urueña & Martín, 2012). Application of DEA is far less widespread in the field of develop­ ment cooperation, with most of the studies that have used this technique employing it to gauge the efficiency of nongovernmental development organizations (NGDOs), the efficiency of the two stages of the oper­ ational process implemented by NGDOs (activities geared towards fundraising and applying the resources obtained in order to carry out projects), and the efficiency achieved when executing international development cooperation projects. The following have been used as outputs: • Project expenditures (Golden, Brockett, Betak, Smith, & Cooper, 2012; Marcuello, 1999). • Total funds raised (Golden et al., 2012; García & Marcuello, 2007). • Number of projects (Hernangómez, Martín, & Martín, 2006; Her­ nangómez et al., 2009; Martín et al., 2007; Martín, Martín, & Her­ nangómez, 2005). As regards inputs: • Operating costs (Golden et al., 2012; Marcuello, 1999). • Donations and grants (Golden et al., 2012; Marcuello, 1999). • Number of volunteers (García & Marcuello, 2007; Marcuello, 1999). • Administrative expenses (García & Marcuello, 2007). • Income (García & Marcuello, 2007; Hernangómez et al., 2006, 2009; Martín et al., 2005, 2007). • Number of employees (García & Marcuello, 2007; Hernangómez et al., 2006, 2009; Martín et al., 2005, 2007). • Age of the organization (Hernangómez et al., 2006, 2009; Martín et al., 2005, 2007). From the empirical works mentioned that have applied DEA in the nonprofit sector, mainly in the case of hospitals, health centers, universi­ ties, primary and secondary schools, and NGDOs, the diversity of meas­ ures employed to characterize the inputs used by these organizations as well as the outputs they generate is evident and reflects the complexity of their production function and the multiplicity of objectives they seek to achieve.

Efficiency in Nonprofit Organizations

33

Conclusions Efficiency is a fundamental concept in the business world. Yet in NPOs, which are mainly financed through donations, it should be even more important, particularly when public funds are involved. As has been seen, measuring efficiency in NPOs is more complex than in companies as it is not possible to resort to measures related to profitability or profit. Having measures that actually capture NPOs’ mission and quantify their objectives, without being confined to merely verifying compliance with certain accounting items and attaining certain ratios that reflect expendi­ ture distribution—such as accounting measures based on the analysis of ratios—emerges as one of the major challenges these organizations face when responding to the growing demands for efficiency from different areas. This points to the need to define the critical inputs and outputs required to carry out such a measurement. The literature has suggested that for NPOs to improve their govern­ ance and management practices, and in order to introduce competition in donation markets, they must provide high-quality, transparent, and widely accessible accounting information (Thornton & Belski, 2010). Nevertheless, this would be the necessary condition. The sufficient condi­ tion requires that, in addition to providing better accounting informa­ tion and evidencing the effectiveness of their actions, efficiency must also be assessed in order to determine at what price the objectives are being achieved. This is an aspect which the third sector is far from guaranteeing at present. In a context of multiple inputs and outputs, DEA is an appropriate method to calculate efficiency, both globally for NPOs and at a particu­ lar level for the different projects/products/services involved. By apply­ ing this method, inefficient units can be identified, as can the reasons that generate their inefficiency, which inputs are being used in excess, and to what degree their consumption must be reduced in order to make the organization or project/product/service efficient. DEA also identifies the efficient organizations and projects/products/services with which the inefficient units must be compared in order to determine how much and in which aspects they need to improve so as to make them fully efficient. This measure allows a ranking of organizations to be established which other approaches fail to provide. Such a hierarchy would prove extremely useful as it identifies the best practices associated with high lev­ els of efficiency, pinpoints which organizational designs and management systems produce the best results, as well as which production objectives and factor consumption objectives inefficient units must reach to be cata­ loged as efficient. Finally, it helps public authorities to establish policies and regulations that have shown their usefulness and, ultimately, redi­ rects donations towards those entities which make the best use of them.

34

Martín-Pérez and Martín-Cruz

Consequently, use of the efficiency measure provided by DEA on an ex-post basis would make it possible to specifically assess the results achieved by each organization and to propose future corrective actions. It would also serve as an ex-ante selection criterion for donors when making their contribution to those NPOs which make fullest use of the resources donated. In this way, assessing and making public the results obtained in terms of efficiency would increase competition among organizations when attracting resources, forcing them to follow a process of continuous improvement and greater transparency in their operation that would help to dispel any doubts which may arise amongst donors. This would ulti­ mately increase the income obtained through donations. Despite the above, we do not wish to convey the idea that the respon­ sibility of NPOs is limited to achieving a certain level of performance to present to donors, given that there is a risk of incurring what Kramer (1981) calls ‘goal deflection’ or ‘displacement of the ends by the means’ because, as Frumkin and Clark (2000) suggest, efficiency must be a means towards the end of better fulfilling the mission in hand.

Notes 1. In the nonprofit sector, the prices of inputs and outputs are very difficult to establish in advance and, sometimes, even a posteriori, which forces us to discard parametric techniques such as stochastic frontiers, which are widely accepted in business. 2. Pareto efficiency criterion is used: a unit is efficient if no other unit obtains higher levels of one output without producing less of another output and without increasing the use of any inputs. Or, if no unit produces the same amount of outputs using less of some input without increasing the use of oth­ ers (Charnes et al., 1978). 3. It is necessary to show that the allocative and technical efficiency calculated with DEA are totally different from the accounting measures which, with the same denomination, we previously defined as two ratios; the percentage that expenses represent in projects on total income, and the percentage that admin­ istration expenses represent over total expenses. 4. A greater number of variables in relation to the number of observations in the sample increases the probability that the units will be efficient in any of the variables.

References Ahn, T., Charnes, A., & Cooper, W. W. (1988). Some statistical and DEA evalua­ tions of relative efficiencies of public and private institutions of higher learning. Socio-Economic Planning Sciences, 22(6), 259–269. Al-Shammari, M. (1999). A multi-criteria data envelopment analysis model for measuring the productive efficiency of hospitals. International Journal of Operations and Production Management, 19(9), 879–890.

Efficiency in Nonprofit Organizations

35

Andrés, P., Azofra, V., & Romero, E. (2010). Beyond the disciplinary role of governance: How boards add value to Spanish foundations. British Journal of Management, 21(1), 100–114. Andrés, P., Martín, N., & Romero, E. (2006). The governance of nonprofit organizations: Empirical evidence from nongovernmental development organ­ izations in Spain. Nonprofit and Voluntary Sector Quarterly, 35(4), 588–604. Athanassopoulos, A. D., & Shale, E. (1997). Assessing the comparative efficiency of higher education institutions in the UK by means of data envelopment anal­ ysis. Education Economics, 5(2), 117–134. Avkiran, N. (2001). Investigating technical and scale efficiencies of Australian Universities through data envelopment analysis. Socio-Economic Planning Sci­ ences, 35(1), 57–80. Baber, W. R., Roberts, A. A., & Visvanathan, G. (2001). Charitable organiza­ tions’ strategies and program-spending ratios. Accounting Horizons, 15(4), 329–343. Banerjee, A. V. (2009). Big answers for big questions: The presumption of growth policy. In J. Cohen & W. Easterly (Eds.), What works in development? Think­ ing big and thinking small (pp. 207–221). Washington, DC: Brookings Institu­ tion Press. Banker, R. D., Charnes, A., & Cooper, W. W. (1984). Some models for estimat­ ing technical and scale efficiencies in data envelopment analysis. Management Science, 30(9), 1078–1092. Banker, R. D., Charnes, A., Cooper, W. W., Swarts, J., & Thomas, D. A. (1989). An introduction to data envelopment analysis with some of their models and its uses. Research in Governmental and Nonprofit Accounting, 5, 125–163. Banker, R. D., Conrad, R. F., & Strauss, R. P. (1986). A comparative application of data envelopment analysis and translog methods: An illustrative study of hospital production. Management Science, 32(1), 30–44. Basso, A., & Funari, S. (2004). A quantitative approach to evaluate the relative efficiency of museums. Journal of Cultural Economics, 28(3), 195–216. Beasley, J. E. (1995). Determining teaching and research efficiencies. Journal of the Operational Research Society, 46(4), 441–452. Bessent, A. M., Bessent, E. W., Charnes, A., Cooper, W. W., & Thorogood, N. C. (1983). Evaluation of educational program proposals by means of DEA. Educational and Administrative Quarterly, 19(2), 82–107. Breu, T. M., & Raab, R. L. (1994). Efficiency and perceived quality of the nation’s top 25 national universities and national liberal art colleges: An application of data envelopment analysis to higher education. Socio-Economic Planning Sci­ ences, 28(1), 33–45. Byrnes, P., & Valdmanis, V. (1994). Analyzing technical and allocative efficiency of hospitals. In A. Charnes, W. W. Cooper, A. Y. Levin, & L. M. Seiford (Eds.), Data envelopment analysis. Theory, methodology and applications (pp. 129– 144). Boston, MA: Kluwer Academic. Callen, J. L. (1994). Money donations, volunteering and organizational effi­ ciency. The Journal of Productivity Analysis, 5(3), 215–228. Callen, J. L., & Falk, H. (1993). Agency and efficiency in nonprofit organiza­ tions: The case of ‘specific health focus’ charities. Accounting Review, 68(1), 48–65.

36

Martín-Pérez and Martín-Cruz

Carrington, R., Coelli, T., & Rao, P. (2005). The performance of Australian uni­ versities: Conceptual issues and preliminary results. Economic Papers, 24(2), 145–163. Casu, B., & Thanassoulis, E. (2006). Evaluating cost efficiency in central admin­ istrative services in UK universities. OMEGA: International Journal of Man­ agement Science, 34(5), 417–426. Charnes, A., Cooper, W. W., Lewin, A., & Seiford, L. (1994). Data envelopment analysis. Theory, methodology and applications. Boston, MA: Kluwer Aca­ demic Publishers. Charnes, A., Cooper, W. W., & Rhodes, E. (1978). Measuring the efficiency of decisions making units. European Journal of Operational Research, 2(6), 429–444. Coelli, T. (1996). Assessing the performance of Australian universities using data envelopment analysis. Armidale, Australia: Mimeo Centre for Efficiency and Productivity Analysis, University of New England. Duflo, E., & Kremer, M. (2003, July). Use of randomization in the evaluation of development effectiveness. Paper presented at World Bank Operations Evaluation Department (OED) Conference on Evaluation and Development Effectiveness, Washington, DC. Retrieved from http://people.bu.edu/jgerring/ Conference/MethodsGovernance/documents/DufloKremerprogrameval.pdf Farrell, M. J. (1957). The measurement of productive efficiency. Journal of the Royal Statistical Society, 120(3), 253–290. Farrell, M. J., & Fieldhouse, M. (1962). Estimating efficient production func­ tions under increasing returns to scale. Journal of the Royal Statistical Society, 125(2), 252–267. Forbes, D. P. (1998). Measuring the unmeasurable: Empirical studies of nonprofit organization effectiveness from 1977 to 1997. Nonprofit and Voluntary Sector Quarterly, 27(2), 183–202. Frumkin, P., & Clark, A. A. (2000). When missions, markets, and politics collide: Values and strategy in the nonprofit human services. Nonprofit and Voluntary Sector Quarterly, 29(1), 141–163. García, L., & Marcuello, C. (2007). Eficiencia y captación de fondos en las organizaciones no gubernamentales para el desarrollo [Efficiency and fundrais­ ing in nongovernmental development organizations]. CIRIEC-España, Revista de Economía Pública, Social y Cooperativa, 58, 221–249. Golden, L., Brockett, P., Betak, J., Smith, K., & Cooper, W. (2012). Efficiency metrics for non-profit marketing/fundraising and service provision—A DEA analysis. Journal of Management and Marketing Research, 9(1), 1–25. Greenlee, J. S., & Brown, K. L. (1999). The impact of accounting information on contributions to charitable organizations. Research in Accounting Regulation, 13, 111–125. Grosskopf, S., & Valdmanis, V. (1987). Measuring hospital performance: A non­ parametric approach. Journal of Health Economics, 6(1), 89–107. Gruca, T. S., & Nath, D. (2001). The technical efficiency of hospitals under a single payer system: The case of Ontario community hospitals. Health Care Management Science, 4(2), 91–101. Hanke, M., & Leopoldseder, T. (1998). Comparing the efficiency of Austrian universities. A data envelopment analysis application. Tertiary Education and Management, 4(3), 191–197.

Efficiency in Nonprofit Organizations

37

Herman, R. D., & Renz, D. O. (1999). Theses on nonprofit organizational effec­ tiveness. Nonprofit and Voluntary Sector Quarterly, 28(2), 107–125. Hernangómez, J., Borge, L., Urueña, B., Martín, N., & Benito, J. (2007). Las Universidades de Castilla y León ante el reto del Espacio Europeo de Edu­ cación Superior: Un análisis de su competitividad y eficiencia [The universities of Castilla y León facing the challenge of the European higher education area: An analysis of their competitiveness and efficiency]. Revista de Investigación Económica y Social de Castilla y León, 10, 13–154. Hernangómez, J., Martín, N., & Martín, V. (2006). La relevancia del objetivo en la medida de la eficiencia. Un análisis para las ONGD españolas desde la Teoría del Comportamiento [Aim relevance in assessing efficiency. Analysing Spanish NGDOs applying behavioral theory]. Boletín Económico del ICE, 2884, 17–30. Hernangómez, J., Martín, V., & Martín, N. (2009). Implicaciones de la organi­ zación interna sobre la eficiencia. La aplicación de la teoría de la agencia y la metodología DEA a las ONGD españolas [Implications of internal organiza­ tion on efficiency. The use of agency theory and DEA methodology to Spanish NGDOs]. Cuadernos de Economía y Dirección de la Empresa, 40, 17–49. Hoefer, R. (2000). Accountability in action? Program evaluation in nonprofit human service agencies. Nonprofit Management and Leadership, 11(2), 167–177. Hu, J. L., & Huang, Y. F. (2004). Technical efficiencies in large hospitals: A man­ agerial perspective. International Journal of Management, 21(4), 506–513. Hyndman, N. (1991). Contributions to charities—A comparison of their infor­ mation needs and the perceptions of such by the providers of information. Financial Accountability and Management, 7(2), 69–82. Jackson, D. K., & Holland, T. P. (1998). Measuring the effectiveness of nonprofit boards. Nonprofit and Voluntary Sector Quarterly, 27(2), 159–182. Johnes, J., & Johnes, G. (1993). Measuring the research performance of UK eco­ nomics departments: An application of data envelopment analysis. Oxford Economic Papers, 45(2), 332–347. Johnes, J., & Johnes, G. (1995). Research funding and performance in U.K. uni­ versity departments of economics: A frontier analysis. Economics of Education Review, 14(3), 301–314. Kanter, R. M., & Summers, D. V. (1987). Doing well while doing good: Dilem­ mas of performance measurement in nonprofit organizations and the need for a multiple constituency approach. In W. W. Powell (Ed.), The nonprofit sector: A research handbook (pp. 154–165). New Haven, CT: Yale University Press. Khumawala, S. B., & Gordon, T. P. (1997). Bridging the credibility of GAAP: Individual donors and the new accounting standards for nonprofit organiza­ tions. Accounting Horizons, 11(3), 45–68. Kirjavainen, T., & Loikkanen, H. A. (1998). Efficiency differences of Finnish sen­ ior secondary schools: An application of DEA and Tobit analysis. Economics of Education Review, 17(4), 377–394. Kitching, K. A., Roberts, A. A., & Smith, P. C. (2012). Nonprofit resource alloca­ tion decisions: A study of marginal versus average spending. Journal of Gov­ ernmental and Nonprofit Accounting, 1(1), 1–19. Kooreman, P. (1994). Nursing home care in the Netherlands: A non-parametric efficiency analysis. Journal of Health Economics, 13(3), 301–316.

38

Martín-Pérez and Martín-Cruz

Korhonen, P., Tainio, R., & Wallenius, J. (2001). Value efficiency analysis of aca­ demic research. European Journal of Operational Research, 130(1), 121–132. Kramer, R. (1981). Voluntary agencies in the welfare sector. Berkeley, CA: Uni­ versity of California Press. Lo, J. C., Shih, K. S., & Chen, K. L. (1996). Technical efficiency of the gen­ eral hospitals in Taiwan: An application of DEA. Academia Economic Papers, 24(3), 375–396. Lovell, C. A. K., Walters, L. C., & Wood, L. L. (1994). Stratified models of educa­ tion production using modified DEA and regression analysis. In A. Charnes, W. W. Cooper, A. Y. Lewin, & L. M. Seiford (Eds.), Data envelopment analysis. Theory, methodology and applications (pp. 329–351). Boston, MA: Kluwer Academic Publishers. Madden, G., Savage, S., & Kemp, S. (1997). Measuring public sector efficiency: A study of economics departments at Australian universities. Education Eco­ nomics, 5(2), 153–168. Marcuello, C. (1999). Análisis de la conducta y eficiencia de las organizaciones no gubernamentales para el desarrollo españolas [Analysis of the conduct and efficiency of Spanish nongovernmental development organizations]. Infor­ mación Comercial Española, 778, 181–196. Martín, N., Hernangómez, J., & Martín, V. (2007). El deleite de la eficiencia [The delight of efficiency]. Universia Business Review, 14, 56–67. Martín, V., Martín, N., & Hernangómez, J. (2005). La valoración de los resul­ tados de las entidades sin fines de lucro: Una aplicación en el análisis de la eficiencia de la arquitectura organizativa de las ONGD Españolas [Perfor­ mance appraisal of nonprofit organizations: Analysing the efficiency of Spanish NGDO organizational architecture]. Revista AECA, 71, 34–40. McMillan, M. L., & Datta, D. (1998). The relative efficiencies of Canadian uni­ versities: A DEA perspective. Canadian Public Policy, 24(4), 485–511. Murray, V., & Tassie, B. (1994). Evaluating the effectiveness of nonprofit organi­ zations. In R. D. Herman (Ed.), Jossey-Bass handbook of nonprofit leadership and management (pp. 303–324). San Francisco, CA: Jossey-Bass. Parsons, L. M. (2003). Is accounting information from nonprofit organizations useful to donors? A review of charitable giving and value-relevance. Journal of Accounting Literature, 22, 104–129. Porter, M. E., & Kramer, M. R. (1999). Philanthropy’s new agenda: Creating value. Harvard Business Review, 77(6), 121–130. Posnett, J., & Sandler, T. (1989). Demand for charity donations in private non­ profit markets. The case of the U.K. Journal of Public Economics, 40, 187–200. Post, T., & Spronk, J. (1999). Performance benchmarking using interactive data envelopment analysis. European Journal of Operational Research, 115(3), 472–487. Rhodes, E. L., & Southwick, L., Jr. (1993). Variations in public and private university efficiency. In E. L. Rhodes & R. L. Schultz (Eds.), Applications of management science. Public policy applications of management science (pp. 145–170). Greenwich, CT: JAI Press. Ritchie, W. J., & Kolodinsky, R. W. (2003). Nonprofit organization financial performance measurement. An evaluation of new and existing financial per­ formance measures. Nonprofit Management and Leadership, 13(4), 367–381.

Efficiency in Nonprofit Organizations

39

Rojas, R. R. (2000). A review of models for measuring organizational effective­ ness among for-profit and nonprofit organizations. Nonprofit Management and Leadership, 11(1), 97–104. Rosenman, R., Siddharthan, K., & Ahern, M. (1997). Output efficiency of health maintenance organisations in Florida. Health Economics, 6(3), 295–302. Stern, Z. S., Mehrez, A., & Barboy, A. (1994). Academic departments efficiency via DEA. Computers and Operations Research, 21(5), 543–556. Stone, M. M., Bigelow, B., & Crittenden, W. (1999). Research on strategic management in nonprofit organizations. Administration and Society, 31(3), 378–423. Thornton, J. P., & Belski, W. H. (2010). Financial reporting quality and price competition among nonprofits. Applied Economics, 42(21), 2699–2713. Tinkelman, D. (1998). Differences in sensitivity of financial statement users to joint cost allocations: The case of nonprofit organizations. Journal of Account­ ing, Auditing and Finance, 13(4), 377–393. Trussel, J. M., & Parsons, L. M. (2007). Financial reporting factors affecting donations to charitable organisations. Advances in Accounting, 23, 263–285. Tuckman, H. P., & Chang, C. F. (1998). How pervasive are abuses in fundraising among nonprofits? Nonprofit Management and Leadership, 9(2), 211–221. Urueña, B., & Martín, N. (2012). La evaluación de la eficiencia en las universi­ dades: Un análisis de inputs y outputs por áreas de conocimiento [The evalua­ tion of efficiency in universities: An analysis of inputs and outputs by areas of knowledge]. Regional and Sectorial Economic Studies, 12(3), 209–225. Valdmanis, V. (1990). Ownership and technical efficiency of hospitals. Medical Care, 28(6), 552–561. Valdmanis, V. (1992). Sensitivity analysis for DEA models. An empirical example using public vs. NFP hospitals. Journal of Public Economics, 48(2), 185–205. Watcharasriroj, B., & Tang, J. C. (2004). The effects of size and information technology on hospital efficiency. Journal of High Technology Management Research, 15(1), 1–16. Weisbrod, B. A., & Dominguez, N. D. (1986). Demand for collective goods in private nonprofit markets: Can fundraising expenditures help overcome freerider behavior? Journal of Public Economics, 30(1), 83–96. White, K. R., & Ozcan, Y. A. (1996). Church ownership and hospital efficiency. Journal of Healthcare Management, 41(3), 297–310.

4

Governance and Its Effect on Philanthropic Income Marc Jegers

Introduction to the Relevant Concepts and Mechanisms Generally speaking, governance can be defined as the set of measures and organizational arrangements designed to safeguard stakeholders’ interests. In the present chapter, we specifically look at the impact of governance on philanthropic funding, the underlying assumption (to be interpreted in a ‘ceteris paribus’ way) being that effective governance in line with the funders’ interests generates the funders’ perception that the organization is pursuing the ‘right’ objectives, inciting them to be more generous. Fully mapping stakeholders of nonprofit organizations (NPOs) reveals the distinction between internal and external stakeholders to be relevant (Van Puyvelde, Caers, Du Bois, & Jegers, 2012). Internal stakehold­ ers comprise (voluntary) board members, managers, and employees, whereas at least three types of external stakeholders can be distinguished: funders, beneficiaries, and suppliers. Pursuing the objectives of each of them mostly implies compromising between them, introducing some implicit or explicit hierarchy of stakeholders and their objectives, even although one group of stakeholders might internalize the objectives of another group, such as, e.g., funders pushing the organization to prior­ itize beneficiaries’ interests. As said, we focus in the present chapter on the organization’s funders, of which we consider three groups: private donors, corporate donors, and, to a limited extent, public donors, excluding the ‘earned income’ generated by sales of goods or services. Absent a comprehensive theoreti­ cal framework, in what follows the empirical literature on the relation­ ship between governance and funding will be reviewed at a conceptual level (as comparing numerical effect values would be comparing the incomparable, given the diversity of samples, periods, and estimation techniques encountered in the different papers), and some theoretical speculations will be proposed. It will become clear that the bulk of the available empirical work does not articulate the logical chain described above between governance and funding, but limits itself to look at the

Governance and Philanthropic Income

41

direct relationship between both, leaving a wide avenue for further research. Further, some papers look at overall revenues without mak­ ing a distinction between the different sources of funds. Finally, gov­ ernance is frequently (but certainly not exclusively) operationalized by looking at some board characteristics, although the concept and reach of governance goes beyond the functioning of the board, as exemplified by the ‘Governance Self-Assessment Checklist,’ validated for NPOs by Gill, Flynn, and Reissing (2005), containing 12 categories, just one of which is board effectiveness. Obviously, looking at the board is not a problem as such, although merely integrating the research conclusions from studies made in different countries may not always be warranted, as board membership of (big) donors is more common in some countries (such as the United States, to which, for that matter, most of the studies reported below pertain) than in other ones (such as in Continental Euro­ pean countries). Zimmerman and Stevens (2008, p. 194), for example, establish that in their sample of 448 South Carolinian organizations 69% of the boards ‘contribute to fundraising.’ A less outspoken result is found by Hager, Rooney, and Pollak (2002), also for the U.S.,1 reporting that scored on a scale between 1 (not involved) and 5 (extremely involved) the average involvement of board members in fundraising is about 3.

The Empirical Literature on Governance-Income Relations The Board Board Size Board size is a popular parameter in board related governance research and is also found in researchers probing into the link between govern­ ance and funding. Based on the available empirical results (all of them pertaining to the U.S.), this link is positive, in different forms: board size and donations (Aggarwal, Evans, & Nanda, 2012;2 Harris, Petrovits, & Yetman, 2015),3 change in board size and change in donations (Aggarwal et al., 2012), and size and change in direct contributions (defined as pri­ vate donations less funds raised by other organizations; Callen, Klein, & Tinkelman, 2010).4 In the light of previous governance research, it is sur­ prising that the relationships estimated are all linear, whereas one might expect some countervailing effects to appear once some threshold board size is reached. As in the research referred to organizational size is controlled for, it is hard to find a theoretical reason why board size exceeding the level one can expect given the organization’s size should spur donors’ trust, unless one assumes that more eyes are better than less to detect mis­ appropriation of resources, even though this runs counter to the idea

42

Jegers

of non-linearity, well-established in the governance literature. Probably some trade-off between the benefits of more control and the disadvan­ tages of diluted attention is at work here. Board Composition As far as could be ascertained, only Callen et al. (2010) delve into the relationship between board composition and donations. In their sample, direct contributions (defined above) are positively related to the share of the board occupied by staff members, the more so when the organiza­ tion is unstable. Maybe surprising, there is no effect of major donors being board members (but see below). Obviously, one might expect that rational donors expect boards to fulfill their governance duties in a trust­ worthy way, and that their perception of this is affected by the expertise collected in the board. Looking at it from this point of view, one could argue that staff, because of its day-to-day involvement in the organiza­ tion’s operations, is more apt to propose sensible strategies, especially in turbulent circumstances. Fundraising Committee Composition Callen et al. (2010) also establish that major donors being members of the fundraising committee has a positive effect on direct contributions growth. The fact that the effect is on growth of contributions and not on levels of contributions is maybe surprising, as if major donors being in the fundraising committee bolsters perceived trust through time, making more people donate and/or people donate more. Remuneration In the sense that the board decides upon the way management is remu­ nerated (and probably also indirectly on how the other members of staff are paid), it has a powerful weapon to steer organizational behavior, potentially signaling to external stakeholders (such as donors) the inten­ sity with which it attempts to have stakeholders’ objectives pursued. Looking at the, admittedly scant, available data, one indeed sees a rela­ tionship between (top management) wages and donations. Harris et al. (2015) find that the presence of compensation policies “such as review and approval by independent persons, use of comparability data, and contemporaneous substantiation of the deliberation and conclusion” (Harris et al., 2015, p. 589) goes together with more donations. Galle and Walker (2016)5 document a 10% decrease in donations for organi­ zations of which managerial wages are widely publicized. Balsam and Harris (2014)6 find a comparable result: higher managerial remunera­ tions mentioned in press releases have a downward effect on donations.

Governance and Philanthropic Income

43

In another study, the same authors (Balsam & Harris, 2018, p. 1710)7 also find that donors “react to bonus pay by reducing future donations.” Accountability A lot has been written on nonprofit accountability, which is mentioned here as it refers in its minimal interpretation to the presence or absence of systems to report to stakeholders whether and how their objectives are pursued, to which in a more elaborate interpretation participatory elements are added. That information asymmetries related to this issue between funders and the organizations are substantial is illustrated by Bennett and Savani (2003), who asked 286 potential donors to estimate the percentage of total costs of well-known U.K. NPOs to effectively reach the beneficiaries. The average answer was 46%, whereas the cor­ rect value was 82%. Gugerty (2009) discusses 32 voluntary accountability programs, of which five include explicit standards with respect to fundraising. Unfor­ tunately, their effect on fundraising is not assessed. This is what Berman and Davidson (2003)8 accomplish, not finding any significant effect of an accountability rights index on donations, leading them to the, possibly controversial, conclusion that “donors do not care about the usage of funds” (Berman & Davidson, 2003, p. 428). Financial Reporting and Auditing A specific way to account for the use of (financial) resources is through disclosure of financial information and safeguarding its quality. In the sense they contain organizational behavior away from organizational objectives, accounting and auditing can be considered as (partial) gover­ nance mechanisms, the costs of which are borne by the organization. First of all, the effect of the (published or publicly available) data them­ selves on income or donations can be considered. Most of the literature finds a positive effect on donations of variables reflecting in one way or another the share of program expenses in total expenses (for an overview, see Jegers, 2018, pp. 100–101). However, perceived financial data quality also plays a role: the higher perceived quality, the stronger the effect of financial indicators on dona­ tions (Thornton & Belski, 2010;9 Tinkelman & Mankaney, 2007;10 Yetman & Yetman, 2013).11 Some authors look at the effect of being audited, which can be seen as one of the ways to assure financial data quality. The results available show a direct positive effect on donations (Harris et al., 2015; Neely, 2011)12 and a reinforcing effect on the rela­ tionship between financial indicators and donations (Thornton & Belski, 2010). An additional positive effect on donations by having appointed a Big (at that time) 5 auditor is documented by Kitching (2009).13

44

Jegers

Excessive Managerial Control Too powerful managers can be perceived by potential donors as ena­ bling a too high expropriation risk against which no effective governance exists. That is exactly what is found by Bae, Kim, and Kim (2012)14 for Korean universities: managerial control exceeding the share of contribu­ tions goes together with lower donations per student (net of foundation contributions). The relationship between ‘good management,’ in which they include ‘no relatives,’ and higher donations found by Harris et al. (2015), in fact tells the same story. External Governance External governance mechanisms can be defined as systems outside the NPOs fulfilling a governance role in the sense that they are meant to provide the necessary incentives to the organizations not to neglect stake­ holders’ interests, donors obviously being one group of stakeholders in this case. In some countries, watchdog websites covering and rating NPOs are prominently present on the donor market. The information they provide can be interpreted as a means to reduce the potential donor’s search costs for information perceived as relevant to them (Wong & Ortmann, 2016). However, Cnaan, Jones, Dickin, and Salomon (2011)15 observe that less than one fourth of the donors consult these websites before donating. Silvergleid (2003) provides a description of U.S. watchdog websites and finds16 mixed results as to their effect on donations. Gordon, Knock, and Neely (2009),17 on the other hand, find a positive correlation between rate changes and both donation levels and changes, as do Chen (2009)18 and Yörük (2016),19 who only looked at levels. In the latter study, this effect, however, was not present for organizations the scores of which in the ranking system were close to the threshold levels to be awarded an extra ‘star.’ Interestingly, only looking at small organizations, for which information asymmetry can be assumed to be substantial, moving from ‘three stars’ to ‘four stars’ goes together with donation increases as high as 30%. In a way, scandals becoming public through traditional and modern news media is a limiting case of ‘watchdogging,’ and, according to Bottan and Perez-Truglia (2015),20 does not stimulate donations, as they find the negative effect of publicized scandals on donations to Catholic organi­ zations in the U.S. being even larger than the direct costs to the church generated by them. Apart from watchdog websites, other forms of external governance mechanisms might have an effect on donations. Galle (2017)21 documents that, for foundations, the possibility for donors to sue “wayward manag­ ers of nonprofits” (Galle, 2017, p. 413) increases donations by between

Governance and Philanthropic Income

45

5.5% and 14.7%, depending on the specification used. Moreover, this goes together with a reduction of administrative overhead, at least giving the impression that governance costs are externalized. Differentiating Donors In the above sections, donors were considered to be alike, but, obviously, nothing is further from the truth. Two, partly overlapping, distinctions are made in the literature: large versus small donors, and sophisticated versus unsophisticated donors. As to size, Harris et al. (2015, p. 597) note that “[o]verall . . . large donors are more likely to consider governance than are small donors,” based on the observation that for these donors most of the governance factors are positively related to direct donations. This is in line with the observation by Cnaan et al. (2011) that consulting watchdog websites is mostly done by the larger donors. Harris et al. (2015), however, also note for large donors a negative relation between ‘good management’ and financial transparency on the one hand, and direct donations on the other. According to Balsam and Harris (2014), donations by sophisticated donors are not only affected by press releases on managerial benefits (see above), but also by the (mandatory) disclosure in the organizations’ financial statements. Causality Despite the fact that most of the studies retrieved apply panel estima­ tion techniques, no undisputable ‘smoking gun’ is found to fully unveil a mechanism going from governance to donations. Moreover, other fac­ tors may interfere, such as the impact of subsidies/grants on governance together with their impact on donations (crowding-in or crowding-out; see Chapter 7). Harris et al. (2015, p. 600) find that “better govern­ ance is associated with more government funding,” which would imply that when crowding-out would prevail less donations will be collected. Guo (2007)22, on the other hand, finds the opposite result, namely that subsidies go together with decreasing governance quality, in that gov­ ernance quality is narrowly measured as community representation on the board.

Conclusion In the present chapter an attempt is made to bring together in a systematic way the empirical knowledge on the link between governance and dona­ tions. Given the rather modest number of available (peer reviewed) pub­ lications, applying widely diverging methods, definitions, and variable

46

Jegers

operationalizations, any general conclusion from this exercise can only be provisional, all the more because almost all work is executed with data pertaining to the U.S. I think it is fair to say that there is at least a strong impression that governance configurations influence donors (and donations). How­ ever, the exact way how this works needs further unraveling, not only from an empirical point of view, but even more urgently from a the­ oretical point of view. Therefore, a vast future research program is suggested.

Notes 1. 1,540 organizations (U.S.; surveyed in 2001). 2. 159,594 organization-years on 35,945 organizations (U.S.; 1998–2003). 3. 15,872 organization-years on 10,846 organizations (U.S.; 2008–2010). In the Harris et al. (2015) paper, seven governance factors are derived: policies (conflict of interest policy, whistleblower, etc.), audit, compensation policies and committees, board (size, independence), management (no outsourc­ ing, no relatives, presence, etc.), financial transparency, and availability of minutes. 4. 123 large New York state NPOs (1992–1996). 5. About 6,500 organization-years (U.S. nonprofit institutions for higher educa­ tion; 1997–2010). 6. 5,608 organization-years on 1,516 organizations (U.S.; 2002–2008). 7. 44,992 organization-years on 11,895 organizations (U.S.; 2008–2012). 57% of the organizations report to have paid at least once a bonus to their most earning manager, the average amount of which was 21% of total compensation. 8. 135 organizations (Australia; 1996). 9. 304,082 organizations (U.S.; 1998–2002). 10. 469,525 organizations and a restricted sample of 27,602 organizations (U.S.; 2000–2001). 11. 37,349 organization-years (U.S.; 1992–2007). 12. 1,070 Californian organizations (U.S.; 2003, 2005). The effect, how­ ever, is statistically weak (p = 10%) and disappears after removing three outliers. 13. 1,342 organization-years (U.S.; 1995–2002). However, in the special case of the aftermath of the collapse of Arthur Andersen, Harris and Krishnan (2012), 3,115 organization-years within the 1,000 largest U.S. organizations (1999–2004), do not observe a negative effect on donations. 14. 93 universities (Korea; 2001–2003). 15. 6,418 donor-years (U.S.; 2006–2008). 16. More than 300 national organizations and more than 120 locally (Minne­ sota) focused organizations (U.S.; 1997–2000). 17. 405 organizations receiving at least yearly public support exceeding $500,000 followed by the U.S. watchdog website Charity Navigator (U.S.; 2007). 18. 600 NPOs based in New York (U.S.; 2005–2006) followed by Better Business Bureau. The standards they use include governance items. 19. 5,400 organizations ranked by Charity Navigator (U.S.; 2004–2010). 20. 175,415 observations on 25,668 zip-codes/counties (U.S.; 1997–2008). 21. 1,326,233 foundation-years (U.S.; 1989–2012). 22. 95 Los Angeles charities (U.S.; 2002).

Governance and Philanthropic Income

47

References Aggarwal, R., Evans, M., & Nanda, D. (2012). Nonprofit boards: Size, per­ formance and managerial incentives. Journal of Accounting and Economics, 53(1–2), 466–487. Bae, K. H., Kim, S. B., & Kim, W. (2012). Family control and expropriation at not-for-profit organizations: Evidence from Korean private universities. Corporate Governance: An International Review, 20(4), 388–404. Balsam, S., & Harris, E. (2014). The impact of CEO compensation on nonprofit donations. Accounting Review, 89(2), 425–450. Balsam, S., & Harris, E. (2018). Nonprofit executive incentive pay. Review of Accounting Studies, 23(4), 1665–1714. Bennett, R., & Savani, S. (2003). Predicting the accuracy of public perception of charity performance. Journal of Targeting, Measurement and Analysis for Marketing, 11(4), 326–342. Berman, G., & Davidson, S. (2003). Do donors care? Some Australian evidence. Voluntas: International Journal of Voluntary and Nonprofit Organizations, 14(4), 421–429. Bottan, N., & Perez-Truglia, R. (2015). Losing my religion: The effects of reli­ gious scandals on religious participation and charity giving. Journal of Public Economics, 129, 106–119. Callen, J., Klein, A., & Tinkelman, D. (2010). The contextual impact of nonprofit board composition and structure on organizational performance: Agency and resource dependency perspectives. Voluntas: International Journal of Volun­ tary and Nonprofit Organizations, 21(1), 101–125. Chen, G. (2009). Does meeting standards affect charitable giving? An empirical study of New York metropolitan area charities. Nonprofit Management and Leadership, 19(3), 349–365. Cnaan, R., Jones, K., Dickin, A., & Salomon, M. (2011). Nonprofit watchdogs: Do they serve the average donor? Nonprofit Management and Leadership, 21(4), 381–397. Galle, B. (2017). Valuing the right to sue: An empirical examination of nonprofit agency costs. Journal of Law and Economics, 60(3), 413–440. Galle, B., & Walker, D. (2016). Donor reaction to salient disclosures of nonprofit executive pay: A regression-discontinuity approach. Nonprofit and Voluntary Sector Quarterly, 45(4), 787–805. Gill, M., Flynn, R., & Reissing, E. (2005). The governance self-assessment check­ list: An instrument for assessing board effectiveness. Nonprofit Management and Leadership, 15(3), 271–294. Gordon, T., Knock, C., & Neely, D. (2009). The role of rating agencies in the market for charitable contributions: An empirical test. Journal of Accounting and Public Policy, 28(6), 469–484. Gugerty, M. (2009). Signaling virtue: Voluntary accountability programs among nonprofit organizations. Policy Sciences, 42(3), 243–273. Guo, C. (2007). When government becomes the principal philanthropist: The effects of public funding on patterns of nonprofit governance. Public Adminis­ tration Review, 67(3), 458–473. Hager, M., Rooney, P., & Pollak, T. (2002). How fundraising is carried out in US nonprofit organizations. International Journal of Nonprofit and Voluntary Sector Marketing, 7(4), 311–324.

48

Jegers

Harris, E., & Krishnan, J. (2012). The impact of tarnished auditor reputation on nonprofit income. International Journal of Auditing, 16(2), 130–146. Harris, E., Petrovits, C., & Yetman, M. (2015). The effect of nonprofit govern­ ance on donations: Evidence from the revised Form 990. Accounting Review, 90(2), 579–610. Jegers, M. (2018). Managerial economics of non-profit organisations (4th ed.). Brussels, Belgium: VUB Press. Kitching, K. (2009). Audit value and charitable organizations. Journal of Accounting and Public Policy, 28(6), 510–524. Neely, D. (2011). The impact of regulation on the U.S. nonprofit sector: Ini­ tial evidence from the Nonprofit Integrity Act of 2004. Accounting Horizons, 25(1), 107–125. Silvergleid, J. (2003). Effects of watchdog organizations on the social capital market. New Directions for Philanthropic Fundraising, 41(Fall), 7–26. Thornton, J. P., & Belski, W. H. (2010). Financial reporting quality and price competition among nonprofit firms. Applied Economics, 42(21), 2699–2713. Tinkelman, D., & Mankaney, K. (2007). When is administrative efficiency asso­ ciated with charitable donations? Nonprofit and Voluntary Sector Quarterly, 36(1), 41–64. Van Puyvelde, S., Caers, R., Du Bois, C., & Jegers, M. (2012). The governance of nonprofit organizations: Integrating agency theory with stakeholder and stew­ ardship theories. Nonprofit and Voluntary Sector Quarterly, 41(3), 431–451. Wong, J., & Ortmann, A. (2016). Do donors care about the price of giving? A review of the evidence, with some theory to organise it. Voluntas: Inter­ national Journal of Voluntary and Nonprofit Organizations, 27(2), 958–978. Yetman, M. H., & Yetman, R. J. (2013). Do donors discount low-quality account­ ing information? The Accounting Review, 88(3), 1041–1067. Yörük, B. (2016). Charity ratings. Journal of Economics and Management Strat­ egy, 25(1), 195–219. Zimmerman, J., & Stevens, B. (2008). Best practices in board governance: Evi­ dence from South Carolina. Nonprofit Management and Leadership, 19(2), 189–202.

5

Accountability,

Transparency, and

Voluntary Disclosure in

Nonprofit Organizations

María del Mar Gálvez-Rodríguez, Manuel López-Godoy, and María del Carmen Caba-Pérez

Introduction Whilst the primary concern of nonprofit organizations (NPOs) is to legiti­ mize their social existence, entities within this sector are particularly vulner­ able due to their reliance on the trust and confidence that key stakeholders such as donors, public administration, and volunteers, as well as the pub­ lic at large, have placed in the sector (Burger & Owens, 2010). Accountability is crucial for gaining, reinforcing, and repairing legiti­ macy. Accountability is a complex and dynamic term which in general terms encompasses the NPO’s responsibility for actions taken both at an external level to meet the expectations of stakeholders and at inter­ nal level towards the entity itself, as a tool for self-assessment (Ebra­ him, 2003). For authors such as Ebrahim (2010), Murtaza (2012), and O’Dwyer and Unerman (2010), the execution of accountability practices involves transparency, answerability/justification, control, sanction or reward, and learning. In the current literature on accountability management in NPOs, three growing concerns can be identified. The first concern is centered around the actual influence of information disclosed by the organization on a voluntary basis and its importance to stakeholders when deciding if they will trust the organization and engage with their social cause (Li & McDougle, 2017). Furthermore, the emerging phenomenon of social net­ working sites forces NPOs to revise their web communication strategies in order to enhance the organization’s capability to meet the information needs of stakeholders. This leads to questioning the relative importance of web pages versus social networking sites (Alonso-Cañadas, GalánValdivieso, Saraite-Sariene, & Caba-Perez, 2019; Hoefer & Twis, 2018). Another issue that still arises in the literature is the question of what type of information NPOs should disclose to attain an adequate accountabil­ ity (Cabedo, Fuertes-Fuertes, Maset-Llaudes, & Tirado-Beltrán, 2018; Tripathi & Verma, 2018).

50

Gálvez-Rodríguez, López-Godoy, and Caba-Pérez

This chapter aims to provide a state of art in these issues and more specifically addresses the following questions: • Is organizational transparency important to donors and public administrations? • Are websites still important despite the growth of social networks? • How can voluntary disclosure be measured?

Is Organizational Transparency Important to Donors and Public Administrations? Transparency truly adds value to donors and public administrations when it is oriented towards an adequate accountability. Hence, a clarifi­ cation of the role that transparency has on the concept of accountability should be carried out in addition to delving further into attitudes towards accountability. Transparency is a broad concept that implies information made avail­ able by the organization (Marcuello, Bellostas, Marcuello, & Moneva, 2007). Transparency can be opaque or clear (Fox, 2007). The latter gen­ erates accountability, implying responsibility, and provides an answer to stakeholders’ information needs. Accountability practices aim to justify the actions of NPOs, have them be evaluated on the results they obtain, and, as a consequence, permit them to be sanctioned or awarded mainly through the attainment of external funding and legitimacy. On the other hand, accountability should also be implemented as a learning tool to improve the NPO’s mission (Ebrahim, 2010; Murtaza, 2012; O’Dwyer & Unerman, 2010). The attitude and manner of being accountable can be either reactive or proactive. The reactive manner implies the disclosure of information that is conditioned by a previous request, and it is an organizational behavior that denotes a desire for information privacy. In proactive accountability, the information is disclosed periodically independently of whether or not it has been previously requested. This proactive disclosure of information generates value for NPOs’ stakeholders (Costa & Goulart da Silva, 2019; Gálvez-Rodríguez, Caba-Perez, & López-Godoy, 2014). The effect of proactive accountability in donors and public adminis­ trations is a reduction of information asymmetries regarding the man­ agement of the organization. Delving further into the donors’ point of view, Saxton, Neely, and Guo (2014) have evidenced a positive relation­ ship between the level of charitable contributions that an NPO receives and the proactive disclosure of information via web sites in the previ­ ous period. Other studies have identified the reasons for that positive influence, identifying perceptions that donors have of accountability and indicating its usefulness for monitoring how monies are spent in accordance with their social causes as well as to check how an NPO is

Accountability, Transparency, and Disclosure

51

attending to a social need (Connolly & Hyndman, 2013; Populus, 2016). In addition, divulging information that demonstrates the NPO’s compli­ ance with its responsibilities, based on its regulatory framework, is also welcomed by donors, specifically to recognize the professionalism of the organization (Connolly & Hyndman, 2013; Striebing, 2017). For donors who volunteer their time, accountability helps them to understand and learn about the social causes of the organization and is an effective tool for ensuring the provision of better volunteer services (Christensen & Ebrahim, 2006). With respect to public administrations, these are salient stakeholders as they have the power to influence NPOs due to their legislative role and as significant resource providers (often on a contractual basis for ser­ vices) (Hyndman & McMahon, 2010). A significant difference between public administrations and individual donors is that the former have a greater appreciation for more quantitative accountability. The account­ ability measures taken by NPOs are also useful for public administra­ tions as a pre-post control system for granting funds or tax exemptions (O’Dwyer & Boomsma, 2015). Moreover, accountability helps improve government/NPOs relations. In some specific cases, proactive account­ ability is considered to be useful for supplementing the lack of regulatory framework in certain accountability aspects (Bies, 2010; Sidel, 2010).

Are Websites Still Important Despite the Growth of Social Networks? The ability to be accountable strongly depends on adequate communi­ cation systems (Alawattage, How, & Tibbetts, 2011). In this respect, Internet resources provide availability, low cost, and accessibility of infor­ mation as well as new interaction avenues that allow NPOs to enhance accountability (Kim, Chun, Kwak, & Nam, 2014). The use of websites has been the first big step towards online commu­ nication models (Ozcelik, 2008). This was followed by the use of Web 2.0 tools (Greenberg & MacAulay, 2009). More recently, the presence of social networking sites has become an emergent phenomenon in the vir­ tual environment (Alonso-Cañadas et al., 2019). These more recent tech­ nologies are online platforms that include several Web 2.0 tools such as video files and postcards that foster the collaboration, joint learning, and exchange of information amongst users. Among the available platforms, Facebook, Twitter, and YouTube are the most utilized by the nonprofit sector (Kim et al., 2014; Tripathi & Verma, 2018). With a view towards improved transparency which can lead to greater accountability, some differences between websites and social network­ ing sites are identified. Websites are hierarchical and centralized mass communication tools (Eimhjellen, Wollebæk, & Strømsnes, 2014), where NPOs disseminate large volumes and diverse information in order to

52

Gálvez-Rodríguez, López-Godoy, and Caba-Pérez

satisfy the information needs of those inside and outside the organiza­ tion (Gandía, 2011; Hoefer & Twis, 2018). In addition, websites have evolved to include two-way communication tools (e.g., emails, forums, links) for providing a high level of accessibility that will not lose visitors who would otherwise ‘bounce out’ of the website and seek out an alter­ nate organization where their questions could be answered more readily. This evolution is highly recommended as it fosters stakeholders’ engage­ ment with the NPO’s mission (Dumont, 2013; Hoefer & Twis, 2018). Social networking sites use a decentralized communication model that implies a loss of full control over content generated via a network. They possess unique attributes for generating ‘many to many’ communication which include the capacity to expand social connections by displaying one’s social connections to others and vice versa (Kim et al., 2014). By means of these social networking sites, NPOs can explain and justify their actions in a more informal manner, thus providing new channels for a ‘closer’ accountability (Gálvez-Rodríguez, Haro-de-Rosario, & Caba‐Pérez, 2019). In particular, by means of these platforms, NPOs can benefit from a helpful channel for exchanging ideas between peers, for exchanging feelings of gratitude between the NPOs and stakehold­ ers (such as volunteers) and vice versa, and for promoting discussion between individuals and organizations (Tripathi & Verma, 2018). Looking at the extant literature on the comparative analysis of the use of websites versus social networking sites, it is observed that NPOs make greater use of websites than social networking sites for information disclosure and dialogic purposes. In general, websites more often contain information about the organization’s profile (Kim et al., 2014), activi­ ties carried out (Eimhjellen et al., 2014), strategy, and economic-financial management (Waters & Feneley, 2013). Likewise, NPOs incorporate Web 2.0 technology tools such as regularly scheduled news forums, FAQs, or calendars of events in their websites and utilize these more often than social networking sites (Kim et al., 2014). Hence, social networking sites appear to play a secondary role by mainly supplementing the dialogic features that are limited on websites and thus take advantage of their unique ‘comment or posting function’ which provides ample opportunity for user-response (Eimhjellen et al., 2014; Kim et al., 2014). Despite this reality, an effective and efficient use of both websites and social networking sites is fundamental for providing a complete account­ ability that truly satisfies the purposes of different NPO stakeholders. In this sense, websites have a clear role in information disclosure (from NPO to stakeholders) and social networking sites should be a springboard for boosting and spreading such information (via website links in posts, etc.). In this regard, previous authors warn that NPOs should not waste the potential of social networking sites, because they share more information concerning external topics rather than solely focusing on being account­ able for the organization’s actions (Maxwell & Carboni, 2016).

Accountability, Transparency, and Disclosure

53

In addition, despite the progress of websites in providing a greater degree of answerability to stakeholders via the use of Web 2.0 technolo­ gies, there is no doubt that social networking sites possess formidable attributes for staying in touch with stakeholders and thus fostering greater levels of informal accountability (Gálvez-Rodríguez et al., 2019). Foster­ ing interactions via social networking sites is crucial for being transpar­ ent and demonstrating the sense of NPOs’ organizational responsibility. Based on current literature, it seems that much more effort should be made in this regard as the volume of stakeholders’ interactions with the social networking sites of NPOs can still be improved (Alonso-Cañadas et al., 2019).

How Can Voluntary Disclosure Be Measured? Voluntary disclosure, as previously mentioned, implies that the NPO pro­ vides organizational information to its stakeholders on a voluntary basis. In this regard, based on Legitimacy Theory (Suchman, 1995), voluntary information disclosure is carried out with the aim of reinforcing gener­ alized perceptions of NPOs as agents that serve society (Christensen & Mohr, 2003). To this end and according to Institutional Theory (DiMag­ gio & Powell, 1983; Meyer & Rowan, 1977) and Stakeholder Theory (Freeman, 1984; Mitchell, Agle, & Wood, 1997), NPOs adopt account­ ability models from other sectors as an attempt to respond to the demand for information, not only from legislators, but also from other stakehold­ ers (Lister, 2003; Verbruggen, Christiaens, & Milis, 2011). In line with Resource Dependence Theory (Froelich, 1999; Pfeffer & Salancik, 1978), in general terms, the running of an NPO relies on fundraising, from both individual contributors and large donors, and on external human capital (volunteers). As a result NPOs opt to voluntarily disclose information as part of the strategy to ensure their survival (Bies, 2010). Voluntary information disclosure as a means of increasing account­ ability is strongly linked to power relationships between the organization and its stakeholders (Porter, 1980). In practice, most NPOs are likely to invest greater effort in upward accountability (Bies, 2010; O’Dwyer & Unerman, 2008). However, proper voluntary disclosure should have a 360 degree view. This implies disclosing information that corresponds to the information needs of those stakeholders who are important for the organization’s survival as well as those who are part of the organization’s value creation (Murtaza, 2012). Hence, voluntary information disclosure should be oriented towards a more holistic accountability (O’Dwyer & Unerman, 2008). To meas­ ure this, and based on a literature review, NPOs should be transparent regarding six dimensions: transparency of organizational profile, trans­ parency of organization governance, transparency of organizational performance, transparency of economic and financial management,

54

Gálvez-Rodríguez, López-Godoy, and Caba-Pérez

Table 5.1 Dimensions to Measure NPO Transparency Dimensions

Authors

Organizational profile

Gandía (2011); Greenberg and MacAulay (2009); Ingenhoff and Koelling (2009); Kang and Norton (2004); Taylor et al. (2001). Ebrahim (2010); Gandía (2011); GálvezRodríguez et al. (2012a); Jordan (2005). Andreaus and Costa (2014); Cabedo et al. (2018); Goatman and Lewis (2007); Hyndman and McConville (2018); Kang and Norton (2004); Lee and Joseph (2013); Tripathi and Verma (2018); Waters (2007); Waters et al. (2014). Andreaus and Costa (2014); Connolly and Hyndman (2013); Gandía (2011); GálvezRodríguez et al. (2014); O’Dwyer and Boomsma (2015); Saxton et al. (2014); Saxton and Guo (2011). Dumay et al. (2010); Gálvez-Rodríguez et al. (2012b); Gray (2006, 2010); Jones and Mucha (2014). Ebrahim (2010); Goatman and Lewis (2007); O’Dwyer and Unerman (2010); Waters (2007).

Governance Performance

Economic-financial management

Social responsibility Stakeholder participation

Source: Compiled by the authors, based on their literature review

transparency of organizational social responsibility, and transparency of stakeholder-participation (see Table 5.1). Transparency of organizational profile relates to the NPO’s visible dis­ closure regarding its history, contact data, alliances and network with other organizations (Greenberg & MacAulay, 2009; Ingenhoff & Koe­ lling, 2009), the legal structure of the organization, and the social base (contracted employees, volunteers, beneficiaries) that support the organ­ ization (Gandía, 2011). In this ‘introduction’ to the organization, the procedures to become affiliated and contribute financially to the organi­ zation in order to enhance the potential stakeholders’ involvement are very welcome (Kang & Norton, 2004; Taylor, Kent, & White, 2001). With regards to transparency of organization governance, some authors and self-regulation initiatives of NPOs state the importance of providing information about board members and the management team, compensation of board members, and family relations as well as rela­ tionships with members of the board and with the management team (Gálvez-Rodríguez, Caba Perez, & Lopez Godoy, 2012a; Jordan, 2005). In addition, visibility of good governance practices aimed at preventing or avoiding potential conflicts of interest among different stakeholders

Accountability, Transparency, and Disclosure

55

(Ebrahim, 2009) such as internal rules and minutes of board meetings are also recommended (Gandía, 2011). Transparency of organizational performance implies disclosing infor­ mation about key aspects of organizational strategy as well as the outcomes achieved to demonstrate the effectiveness of projects (Hynd­ man & McConville, 2018). Hence, stakeholders must be informed of the NPO’s mission and vision (Andreaus & Costa, 2014; Goatman & Lewis, 2007; Kang & Norton, 2004; Waters, 2007). Based on the mis­ sion and vision, NPOs should provide information about their strate­ gic plan (Connolly & Hyndman, 2013) and how this strategy is being realized in current (Cabedo et al., 2018) and future projects (Tripathi & Verma, 2018). To this end, not only is it important to provide quantita­ tive data (numerical outputs on the impact of the project carried out) (Hyndman & McConville, 2018) but also qualitative data such as stories or testimonies (Waters & Feneley, 2013). A basic report used to compile a great number of the aforementioned aspects is the annual report pub­ lished by the NPO (Lee & Joseph, 2013). Transparency of economic and financial management is the process of reporting on costs and revenues received for the delivered social services as well as on the financial equilibrium or the balance between invested capital and sources of collateral (Andreaus & Costa, 2014). On this issue, there is a vast amount of literature that supports the publication of audit reports, financial statements, and other data that show the compliancy of the NPO with respect to their taxation duties. It also includes the need for publishing the NPO’s budget, allocation of resources, and sources of funding (Gálvez-Rodríguez et al., 2014; Gandía, 2011). Although this information seems to become more important to larger or publicly funded institutions than to individual donors (Connolly & Hyndman, 2013; O’Dwyer & Boomsma, 2015; Saxton et al., 2014), NPOs should not forget the visibility of this aspect to ensure that funds are allocated appropriately and thus mitigate any apparent prejudice towards the sec­ tor regarding misappropriation of funds. In the transparency of social responsibility, NPOs should communi­ cate to their stakeholders and to the larger community their responsibil­ ity for the positive and negative impacts, at an economic, social, and environmental level of their activities. This responsibility is important for all types of NPOs, as all organizations, to varying degrees, should respond to society’s expectations and work towards becoming sustain­ able and socially responsible organizations (Jones & Mucha, 2014). To that end, NPOs should report on the programs and policies aimed at social responsibility such as reducing consumption of resources, improv­ ing treatment of employees, and increasing engagement with the com­ munity (Gálvez-Rodríguez, Caba Perez, & Lopez Godoy, 2012b). Finite measures of sustainability have not yet been developed, and it is likely to be an impossible task (Dumay, Guthrie, & Farneti, 2010). In this respect

56

Gálvez-Rodríguez, López-Godoy, and Caba-Pérez

three approaches have been identified: managerialist, triple bottom line, and the ecological and eco-justice approach (Gray, 2006, 2010). This notwithstanding, there are still few studies that delve deeper into how NPOs are addressing this dimension. Transparency of stakeholder-participation in the organization pro­ motes the participation of internal and external stakeholders in the organization in order to obtain fruitful feedback on continued improve­ ment (O’Dwyer & Unerman, 2010). This is part of the NPO’s relational accountability to stakeholders by providing them with information needed to react to the organization’s actions. This includes assessment reports based on participation processes such as surveys, meetings and forums, and other information that shows the participative procedures carried out by NPOs to evaluate projects (Waters, 2007) as well as infor­ mation access regarding the receipt and handling of complaints and inquiries (Ebrahim, 2010; Goatman & Lewis, 2007).

Conclusions Transparency is essential for generating a significant level of account­ ability to NPOs’ key stakeholders, such as individual donors and public administrations. As they are external stakeholders, a proactive disclo­ sure of information is an effective mechanism for: monitoring processes, knowing the benefits/impacts of an NPO’s activities, and learning how the organization can be helped. An effective accountability should be carried out with: 1) relevant information disclosure; and 2) suitable communication systems. With respect to what information should be disclosed, it is important to have a holistic view because NPOs have multiple actors. Although six trans­ parency dimensions are identified to measure an adequate information disclosure towards accountability, not all have been discussed in the same depth in the literature. In this regard, current literature points out the importance of reporting on performance and economic and financial management. Transparency on performance aims to demonstrate actual benefits and/or impact of the project, without forgetting narrative infor­ mation disclosure on future projects. Economic and financial issues seem to attain greater attention from public administrations; however, their management is important to avoid prejudice against the organization. This is an expected information disclosure, that is to say, even if donors do not read it or pay much attention to the information itself, they want or expect it to be available. Other dimensions are mentioned less frequently in the current litera­ ture but should not be forgotten. In particular, the visibility of an organi­ zation’s profile and the state of the NPO’s good governance practices. In addition, there is still scarce literature on social responsibility trans­ parency. Considering recent scandals in the sector, such as the Oxfam

Accountability, Transparency, and Disclosure

57

sex scandal, greater effort in reporting ethical values of the organiza­ tion is necessary. Moreover, not only should NPOs exert pressure on the sustainability practices of corporations, they should also enable greater visibility of these practices. Likewise, little attention has been paid to the transparency on mechanisms that promote and increase participation from stakeholders. With respect to communication systems, it appears that social network­ ing sites do not replace the primary place of websites with regards to accountability and engaging with NPOs’ stakeholders in virtual environ­ ments. Based on existent literature that compares the usage of both, web pages are still the primary source for both information dissemination and dialogic purpose. Nevertheless, more studies are needed to increase under­ standing of the evolution in the use of both technologies due to the unstop­ pable nature of the digital transformation currently taking place in society. Moving forward, both web pages and social networking sites should be part of the communication strategy. NPOs should consider social networking sites as complementary tools to webpages. Nowadays, the accountability model should comprise updating and energizing both websites and social networking sites, albeit with an awareness that both should empower different accountability. In this regard, websites are more suited to a formal accountability and social networking sites should be a springboard for boosting and spreading such information (via web­ site links in post, etc.). By doing so, social networking sites serve to foster a more ‘informal accountability,’ implying a ‘spontaneous accountability’ via interactive conversations. Related to this, previous authors observe that stakeholders seek out informal information sources when deciding to engage with NPOs, such as personal recommendations or by personally verifying how NPOs are carrying out their social causes (Li & McDou­ gle, 2017). Hence, social networking sites would be an excellent space to generate trust and foster interactions, not only between the NPOs and their users but also among the users themselves. In such interactions, the NPO has the opportunity to justify or explain actions that have not met users’ expectations.

References Alawattage, C. G., How, S. M., & Tibbetts, L. A. (2011). Accounting and account­ ability: The context of accounting. Andover, England: Cengage Learning. Alonso-Cañadas, J., Galán-Valdivieso, F., Saraite-Sariene, L., & Caba-Perez, M. C. (2019). Unpacking the drivers of stakeholder engagement in sustainable water management: NPOs and the use of Facebook. Water, 11(4), 775. Andreaus, M., & Costa, E. (2014). Toward an integrated accountability model for nonprofit organizations. In E. Costa, L. D. Parker, & M. Andreaus (Eds.), Accountability and social accounting for social and non-profit organizations (pp. 153–176). Bradford, UK: Emerald Group Publishing.

58

Gálvez-Rodríguez, López-Godoy, and Caba-Pérez

Bies, A. L. (2010). Evolution of nonprofit self-regulation in Europe. Nonprofit and Voluntary Sector Quarterly, 39(6), 1057–1086. Burger, R., & Owens, T. (2010). Promoting transparency in the NGO sector: Examining the availability and reliability of self-reported data. World Develop­ ment, 38(9), 1263–1277. Cabedo, J. D., Fuertes-Fuertes, I., Maset-Llaudes, A., & Tirado-Beltrán, J. M. (2018). Improving and measuring transparency in NPOs: A disclosure index for activities and projects. Nonprofit Management and Leadership, 28(3), 329–348. Christensen, A. L., & Mohr, R. M. (2003). Not-for-profit annual reports: What do museum managers communicate? Financial Accountability and Manage­ ment, 19(2), 139–158. Christensen, R. A., & Ebrahim, A. (2006). How does accountability affect mis­ sion? The case of a nonprofit serving immigrants and refugees. Nonprofit Man­ agement and Leadership, 17(2), 195–209. Connolly, C., & Hyndman, N. (2013). Charity accountability in the UK: Through the eyes of the donor. Qualitative Research in Accounting & Management, 10(3/4), 259–278. Costa, E., & Goulart da Silva, G. (2019). Nonprofit accountability: The view­ point of the primary stakeholders. Financial Accountability & Management, 35(1), 37–54. DiMaggio, P. J., & Powell, W. W. (1983). The iron cage revisited: Institutional isomorphism and collective rationality in organizational fields. American Soci­ ological Review, 48(2), 147–160. Dumay, J., Guthrie, J., & Farneti, F. (2010). GRI sustainability reporting guide­ lines for public and third sector organizations: A critical review. Public Man­ agement Review, 12(4), 531–548. Dumont, G. E. (2013). Nonprofit virtual accountability: An index and its appli­ cation. Nonprofit and Voluntary Sector Quarterly, 42(5), 1049–1067. Ebrahim, A. (2003). Accountability in practice: Mechanisms for NGOs. World Development, 31(5), 813–829. Ebrahim, A. (2009). Placing the normative logics of accountability in ‘thick’ per­ spective. American Behavioral Scientist, 52(6), 885–904. Ebrahim, A. (2010). The many faces of nonprofit accountability. In D. O. Renz (Ed.), The Jossey-Bass handbook of nonprofit leadership and management (pp. 110–121). San Francisco, CA: Jossey-Bass. Eimhjellen, I., Wollebæk, D., & Strømsnes, K. (2014). Associations online: Bar­ riers for using web-based communication in voluntary associations. Volun­ tas: International Journal of Voluntary and Nonprofit Organizations, 25(3), 730–753. Fox, J. (2007). The uncertain relationship between transparency and account­ ability. Development in practice, 17(4–5), 663–671. Freeman, R. E. (1984). Strategic management: A stakeholder approach. Boston, MA: Pitman. Froelich, K. A. (1999). Diversification of revenue strategies: Evolving resource dependence in nonprofit organizations. Nonprofit and Voluntary Sector Quar­ terly, 28(3), 246–268. Gálvez-Rodríguez, M. M., Caba Perez, M. C., & Lopez Godoy, M. (2012a). How self-regulatory nongovernmental organizations perceive transparency

Accountability, Transparency, and Disclosure

59

comparative analysis of Latin America versus Europe and the United States. Latin American Research Review, 47, 179–202. Gálvez-Rodríguez, M. M., Caba Perez, M. C., & Lopez Godoy, M. (2012b). Responsabilidad social y transparencia on-line de las ONG: análisis del caso español [Social responsibility and transparency on-line of NGOs: Analysis of the case of Spain]. CIRIEC-Revista de Economia Pública, Social y Coopera­ tiva, 74, 207–238. Gálvez-Rodríguez, M. M., Caba-Perez, M. C., & López-Godoy, M. (2014). Driv­ ers for the proactive online disclosure of information in the NPO sector: The Colombian case. Online Information Review, 38(6), 769–787. Gálvez-Rodríguez, M. M., Haro‐de‐Rosario, A., & Caba‐Pérez, M. C. (2019). The Syrian refugee crisis: How local governments and NGOs manage their image via social media. Disasters, 43(3), 509–533. Gandía, J. L. (2011). Internet disclosure by nonprofit organizations: Empirical evidence of nongovernmental organizations for development in Spain. Non­ profit and Voluntary Sector Quarterly, 40(1), 57–58. Goatman, A. K., & Lewis, B. R. (2007). Charity E-volution? An evaluation of the attitudes of UK charities towards website adoption and use. International Journal of Nonprofit and Voluntary Sector Marketing, 12(1), 33–46. Gray, R. (2006). Social, environmental and sustainability reporting and organisa­ tional value creation? Whose value? Whose creation? Accounting, Auditing & Accountability Journal, 19(6), 793–819. Gray, R. (2010). Is accounting for sustainability actually accounting for sustain­ ability . . . and how would we know? An exploration of narratives of organi­ sations and the planet. Accounting, Organizations and Society, 35(1), 47–62. Greenberg, J., & MacAulay, M. (2009). NPO 2.0? Exploring the web presence of environmental nonprofit organizations in Canada. Global Media Journal: Canadian Edition, 2(1), 63–88. Hoefer, R., & Twis, M. K. (2018). Engagement techniques by human services nonprofits: A research note examining website best practices. Nonprofit Management and Leadership, 29(2), 261–271. Hyndman, N., & McConville, D. (2018). Making charity effectiveness trans­ parent: Building a stakeholder‐focussed framework of reporting. Financial Accountability & Management, 34(2), 133–147. Hyndman, N., & McMahon, D. (2010). The evolution of the UK charity state­ ment of recommended practice: The influence of key stakeholders. European Management Journal, 28(6), 455–466. Ingenhoff, D., & Koelling, A. M. (2009). The potential of web sites as a relation­ ship building tool for charitable fundraising NPOs. Public Relations Review, 35(1), 66–73. Jones, K. R., & Mucha, L. (2014). Sustainability assessment and reporting for nonprofit organizations: Accountability ‘for the public good.’ Voluntas: Inter­ national Journal of Voluntary and Nonprofit Organizations, 25(6), 1465–1482. Jordan, L. (2005). Mechanisms for NGO accountability (Global Public Policy Institute Research Paper Series No. 3, Berlin, Germany). Retrieved from www. files.ethz.ch/isn/15446/NGO%20Accountabiliy.pdf Kang, S., & Norton, H. E. (2004). Nonprofit organizations’ use of the world wide web: Are they sufficiently fulfilling organizational goals? Public Relations Review, 30(3), 279–284.

60

Gálvez-Rodríguez, López-Godoy, and Caba-Pérez

Kim, D., Chun, H., Kwak, Y., & Nam, Y. (2014). The employment of dialogic principles in website, Facebook, and Twitter platforms of environmental non­ profit organizations. Social Science Computer Review, 32(5), 590–605. Lee, R. L., & Joseph, R. C. (2013). An examination of web disclosure and organ­ izational transparency. Computers in Human Behavior, 29(6), 2218–2224. Li, H., & McDougle, L. (2017). Information source reliance and charitable giv­ ing decisions. Nonprofit Management and Leadership, 27(4), 549–560. Lister, S. (2003). NGO legitimacy: Technical issue or social construct? Critique of Anthropology, 23(2), 175–192. Marcuello, C., Bellostas, A., Marcuello, C., & Moneva, J. M. (2007). Trans­ parencia y rendición de cuentas en las empresas de inserción [Transparency and accountability in work integration social enterprises]. CIRIEC-España, Revista de Economía Pública, Social y Cooperativa, 59, 91–122. Maxwell, S. P., & Carboni, J. L. (2016). Social networking sites management: Exploring Facebook engagement among high-asset foundations. Nonprofit Management and Leadership, 27(2), 251–260. Meyer, J. W., & Rowan, B. (1977). Institutional organizations: Formal structure as myth and ceremony. American Journal of Sociology, 83(2), 340–363. Mitchell, R. K., Agle, B. R., & Wood, D. J. (1997). Toward a theory of stake­ holder identification and salience: Defining the principle of who and what really counts. Academy of Management Review, 22(4), 853–886. Murtaza, N. (2012). Putting the lasts first: The case for community-focused and peer-managed NGO accountability mechanisms. Voluntas: International Jour­ nal of Voluntary and Nonprofit Organizations, 23(1), 109–125. O’Dwyer, B., & Boomsma, R. (2015). The co-construction of NGO accountabil­ ity: Aligning imposed and felt accountability in NGO-funder accountability relationships. Accounting, Auditing & Accountability Journal, 28(1), 36–68. O’Dwyer, B., & Unerman, J. (2008). The paradox of greater NGO accountabil­ ity: A case study of Amnesty Ireland. Accounting, Organizations and Society, 33(7–8), 801–824. O’Dwyer, B., & Unerman, J. (2010). Enhancing the role of accountability in promoting the rights of beneficiaries of development NGOs. Accounting and Business Research, 40(5), 451–471. Ozcelik, Y. (2008). Globalization and the internet: Digitizing the nonprofit sector. Journal of Global Business Issues, 2(1), 149–152. Pfeffer, J., & Salancik, G. R. (1978). The external control of organizations: A resource dependence perspective. New York, NY: Harper and Row. Populus. (2016). Public trust and confidence in charities: Research conducted by Populus on behalf of the Charity Commission. Retrieved from https://assets. publishing.service.gov.uk/government/uploads/system/uploads/attachment_ data/file/532104/Public_trust_and_confidence_in_charities_2016.pdf Porter, M. E. (1980). Competitive strategy: Techniques for analyzing industries and competitors. New York, NY: Free Press. Saxton, G. D., Neely, D. G., & Guo, C. (2014). Web disclosure and the market for charitable contributions. Journal of Accounting and Public Policy, 33(2), 127–144. Sidel, M. (2010). The promise and limits of collective action for nonprofit selfregulation: Evidence from Asia. Nonprofit and Voluntary Sector Quarterly, 39(6), 1039–1056.

Accountability, Transparency, and Disclosure

61

Striebing, C. (2017). Professionalization and voluntary transparency practices in nonprofit organizations. Nonprofit Management & Leadership, 28(1), 65–83. Suchman, M. C. (1995). Managing legitimacy: Strategic and institutional approaches. The Academy of Management Review, 20(3), 571–610. Taylor, M., Kent, M. L., & White, W. J. (2001). How activist organizations are using the Internet to build relationships. Public Relations Review, 27(3), 263–284. Tripathi, S., & Verma, S. (2018). Social media, an emerging platform for rela­ tionship building: A study of engagement with nongovernment organizations in India. International Journal of Nonprofit and Voluntary Sector Marketing, 23(1), e1589. Verbruggen, S., Christiaens, J., & Milis, K. (2011). Can resource dependence and coercive isomorphism explain nonprofit organizations’ compliance with reporting standards? Nonprofit and Voluntary Sector Quarterly, 40(1), 5–32. Waters, R. D. (2007). Nonprofit organizations’ use of the internet a content analysis of communication trends on the internet sites of the philanthropy 400. Nonprofit Management and Leadership, 18(1), 50–76. Waters, R. D., & Feneley, K. L. (2013). Virtual stewardship in the age of new media: Have nonprofit organizations’ moved beyond Web 1.0 strategies? International Journal of Nonprofit and Voluntary Sector Marketing, 18(3), 216–230.

6

Nonprofit Organization

Reputation and Its Role in

Success

Antecedents and Effects Esther de Quevedo-Puente and Clara Pérez-Cornejo

Introduction The business literature has shown that corporate reputation is one of the most important intangible assets in companies (Hall, 1992, 1993). Empirical research has found that corporate reputation is a source of sustainable competitive advantages (e.g., Roberts & Dowling, 2002) because it favors stakeholders’ cooperation with the company (Cable & Turban, 2003; Keh & Xie, 2009; Walsh, Mitchell, Jackson, & Beatty, 2009). There is already an extensive body of research that has analyzed the determinants and consequences of reputation in the for-profit sector (e.g., Ali, Lynch, Melewar, & Jin, 2015). However, reputation-related research on nonprofit organizations (NPOs) is still scarce. Nevertheless, in the last couple decades, several factors have highlighted the relevance of reputation for NPOs. On one hand, NPO reputation has gained impor­ tance due to the rapid proliferation of NPOs around the world (Ebrahim, 2003; Gibelman & Gelman, 2001; Young, Bania, & Bailey, 1996) cou­ pled with a progressive reduction of government grants (Valor, 2003) and a drop in donations since the last recession (Ainsworth, 2008; Sarstedt & Schloderer, 2010). On the other hand, NPOs have increased their collab­ orative relationships with businesses (Van Huijstee & Glasbergen, 2008; Wymer & Samu, 2003) in search of legitimacy and reputation, and there have been a series of highly publicized scandals that have eroded pub­ lic confidence in NPOs (Ebrahim, 2003). All these factors have created growing interest in the management of NPO reputation. Indeed, a recent survey of NPOs in Illinois revealed that enhancing their visibility and reputation is a major challenge for most of these organizations (Grønb­ jerg & Child, 2003; Laidler-Kylander, Quelch, & Simonin, 2007). These factors have prompted some researchers to focus on analyzing the determinants and consequences of reputation in the NPO context. However, scholars have not reached consensus regarding how to define and measure NPO reputation, which may stem from the heterogeneity of the NPO sector. Of the three conceptualizations of reputation in the

NPO Reputation and Its Role in Success

63

business literature (Lange, Lee, & Dai, 2011, p. 155), NPO reputation studies have focused on two of them: “being known for something” (i.e., reputation effectiveness) and “generalized favorability.” Both of these conceptualizations have been translated into different measures of this intangible asset in the literature on NPOs. Therefore, because prior research on this topic is scarce and heteroge­ neous, in this chapter, we review the NPO reputation literature to pro­ vide an overview of the state of the art. The structure of the rest of the chapter is as follows. The first section describes the different conceptu­ alizations of NPO reputation and the ways previous studies have trans­ lated them into measures and thus serves as a basis for the understanding of the subsequent sections. The following section analyzes the benefits derived from NPO reputation, mainly focusing on NPOs’ increased abil­ ity to attract and maintain resources. The next section reviews research contributions exploring the antecedents of NPO reputation. Finally, the chapter closes with a discussion section.

Measurement of NPO Reputation Despite practitioners’ and researchers’ interest in this increasingly important topic, the discussion on how to measure reputation in the NPO context is still limited (Sarstedt & Schloderer, 2010). There are several scientific rankings and ratings that basically assess how trust­ worthy organizations allocate donations, like the American Institute of Philanthropy (www.charitywatch.org), the Better Business Bureau (www.bbb.org), or the Charity Navigator (www.charitynavigator.org). However, none of these approaches explicitly considers NPO reputation (Sarstedt & Schloderer, 2010; Van Riel & Fombrun, 2007). There have also been a few approaches in the prior literature attempting to build an NPO reputation measure (see Tables 6.1 and 6.2), but none of them is considered a widespread measure, as opposed to corporate reputation, for which we can find consolidated rankings, such as Fortune’s Most Admired Companies, Reptrak Pulse (Reputation Institute), and Merco (in the Latin context).1 Most studies on NPO reputation have been based on definitions of for-profit corporate reputation (e.g., Bennett & Gabriel, 2003; Mitchell, 2015; Sarstedt & Schloderer, 2010; Willems, Jegers, & Faulk, 2016). More specifically, there are three main definitions of corporate reputa­ tion (Lange et al., p. 155): being known (i.e., generalized awareness or visibility of the firm; prominence of the firm in collective perceptions), being known for something (i.e., perceived predictability of organiza­ tional outcomes and behavior relevant to specific audience interests), and generalized favorability (i.e., perceptions or judgments of the overall organization as good, attractive, and appropriate). Of these, the NPO literature has focused on the two last conceptualizations: ‘being known

Type of NPO

Charities

Social service

Reference

Sargeant, Ford, and West (2001)

Padanyi and Gainer (2003)

Canada

United Kingdom

Country

Table 6.1 Effects of NPO Reputation

Peer reputation

Charity reputation

Name of Reputation Measure Items (measured on a five-point scale, where 1 = strongly disagree and 5 = strongly agree): 1. I felt X had a good reputation. 2. I found X’s original approach to be professional. 3. I believed X’s management to be professional. 4. X spends a high proportion of its income on the cause. 5. I found X’s communications were very persuasive. Items: 1. Reputation among other NPOs for attracting skilled staff and committed volunteers. 2. Reputation among other NPOs for achieving their mission.

How Reputation Was Measured

Impacts

Charity reputation has no effect on the total amount donated to date, on the amount given last year, nor on the percentage allocated to a particular charity.

An organization’s reputation among managers of similar NPOs influences its success in attracting resources (p < 0.01).

Method

Regression analysis

Covariancebased structural equation modeling (SEM)

Sample

Data were gathered from a sample of 5,000 donors to 10 different categories of causes (500 donors per charity where questioned).

Surveys were sent to the executive directors or general managers of 816 (205 received) social service organizations in the greater Toronto and greater Montreal areas in Canada.

Bennett and Gabriel (2003)

Charities

United Kingdom

Reputation

3. Reputation among other NPOs for attracting financial resources. 4. Effectiveness of your organization in achieving its mission. 5. Sustainability of your organization’s program/activity/ service delivery. Items were measured on a five-point scale, where 1 = declined significantly, 2 = declined somewhat, 3 = been stable, 4 = increased somewhat, 5 = increased significantly. Items (measured on fivepoint scales): The charity: 1. Uses its assets wisely. 2. Is financially sound. 3. Provides an excellent service to beneficiaries. 4. Is well managed. 5. Is capable. The authors questioned 161 members of the general public about their perceptions of the images and reputations of major U.K. charities.

Regression analysis

(Continued)

Charity reputation enhances individuals’ overall impression of a charity (p < 0.001). “The charity uses its assets wisely” (reputation item)

Type of NPO

Charities

Reference

Meijer (2009)

Table 6.1 (Continued)

Netherlands

Country

Charity reputation

Name of Reputation Measure To test their hypotheses, the authors developed a questionnaire and administered it to 161 members of the public who were considered typical of people who might donate to charity. Data were gathered by a large Dutch research agency. The random sample of the Giving in the Netherlands Panel Survey consisted of respondents selected from 40,000 households in the Capi@home­ pool. The final questionnaire was answered by 287 donors and 472 non-donors of this population. 6. Has a good long-term future. 7. Has excellent employees.

Items (measured on a five-point Likert scale): 1. The money given to charity X goes to good causes. 2. Much of the money donated to charity is wasted. 3. My image of charity X is positive. 4. Charity X has been quite successful in helping the needy/the environment. 5. Charity X performs a useful function in society.

Sample

How Reputation Was Measured

Multiple regression model

Method

Charity reputation has a positive and significant effect on being a donor of a charity or not (p < 0.001) (binary logistic regression). Charity reputation positively affects the amount of money donated (p = 0.076).

positively affects the amount individuals give to charity over a two-month period (p < 0.01).

Impacts

Charities

International NPOs: Red Cross, Greenpeace, UNICEF

Shier and Handy (2012)

Schloderer et al. (2014)

Germany

Worldwide

NPO reputation

Perceptions of a fundraising platform

This scale is the same as Sarstedt and Schloderer (2010) scale (see Table 6.2).

6. Charity X is well managed. 7. Charity X shows compassion. 8. I trust charity X. 9. Charity X is reliable. 10. Charity X is well known. Items (measured on a five-point Likert scale): 1. Reputation. 2. Feedback. 3. Information. 4. Trustworthiness. The inclusion criterion for participation in the study was visiting the GiveIndia website. In total, 738 surveys were collected, but due to non-response on some of the items, 479 were utilized in the final sample. This study drew on Sarstedt and Schloderer’s (2010) data, collected by the market research institute Psychonomics in 2009 (N = 984) by means of an online panel in Germany.

Perceptions of a fundraising platform (for which reputation was one of the items) positively affects individuals’ willingness to donate online (p < 0.01). Likeability (affective component of reputation) positively affects individuals’ willingness to donate (p < 0.05) and willingness to work as a volunteer (p < 0.05).

Logistic regression

Partial least squares (PLS) approach (PLS-SEM)

Type of NPO

Reputational effectiveness of VNPOs

Country Name of Reputation Measure

Smith and VolunteerUnited Shen (1996) managed States nonprofit organizations (VNPOs)

Reference

Table 6.2 Antecedents of NPO Reputation Method

Antecedents

The following factors were Bivariate Peer nominations 32 self-administered statistically significantly analysis questionnaires and received associated with the (t-test)— seven interviews, from leaders reputational effectiveness of separate for 39 protocols of other VNPOs at the p < 0.10 level variance in usable form responding or below: method—on answered by VNPO VNPOs, the means of —Nature of group: public leaders. where high or mixed (versus member) two sets of (four or more benefit, outside clients VNPOs. nominations) or users, more clients or Ordinary Least and low users, older nonprofit, more Squares (zero to three revenues in the past year, Multiplenominations) more revenues five years Regression in rated earlier. Analyses effectiveness. —Officers: president, vice president, treasurer, secretary. —Board of directors: has a board of directors, has more board members, board members know by-laws, good attendance at board meetings, board members chosen for outside relationships. —Committees: presence of committees, more committees, more active members of committees, more committee members, has nominating committee, more careful selection of committee chairs.

How Reputation Sample Was Measured

Padanyi and Gainer (2003)

Social service

Canada

Peer reputation

See Table 6.1.

Surveys were sent to the Covariancebased SEM executive directors or general managers of 816 (205 received) social service organizations in the greater Toronto and greater Montreal areas in Canada.

(Continued)

—Aspects of formalization: presence of by-laws, presence of formal membership list, leader group not mainly informal, leader says group has tax exemption, not tax-exempt through affiliate, has formal updated mission statement. The multivariate results of the seven strongest predictors show that having by-laws available (a formalization measure), having many active committee members (a committee structure, mobilization, and volunteer staffing measure), and having a regularly revised boardcreated formal mission statement (a formalization and board governance measure) positively affects reputational effectiveness. Organizations’ peer reputation is affected by the following nonprofit performance factors (p < 0.001): —Client satisfaction. —Ability to partner with other NPOs. —Effective governance.

Type of NPO

International NPOs: Red Cross, Greenpeace, UNICEF

Reference

Sarstedt and Schloderer (2010)

Table 6.2 (Continued) How Reputation Sample Was Measured

Germany NPO reputation Reputation was This study sampled the German general measured public. Overall, using two 900 panelists components. were contacted 1. Affective to participate in component a study on NPOs (likeability): conducted by a a. Identify major German better with. university. A total b. Likeable of 984 evaluations organization. were considered in c. Would the analysis. miss if no longer existed. 2. Cognitive component (competence): a. Recognized worldwide. b. Top NPO in this market. c. Performs at a premium level. Items were measured on seven-point Likert scales.

Country Name of Reputation Measure

Antecedents

Quality (p < 0.05), attractiveness (p < 0.05), and organizational social responsibility (OSR) (p < 0.05) positively affect the affective component of NPO reputation (likeability). Performance (p < 0.05), attractiveness (p < 0.05), and OSR (p < 0.10) positively affect the cognitive component of NPO reputation (competence).

Method

PLS-SEM

International NPOs: Red Cross, Greenpeace, UNICEF

Sociocultural

Schloderer et al. (2014)

Willems, Jegers, and Faulk (2015)

Belgium

Effectiveness reputation

PLS-SEM

CovarianceItems (measured Survey data (online questionnaires) came based SEM on a sevenfrom 284 diverse point Likert stakeholders of three scale, where publicly funded 1 = very organizations ineffective in Belgium: and 7 = very “member” (64.8%), effective): “volunteer” 1. Optimal use (63.7%), “director, of available executive manager, resources. and/or member 2. Deployment of the leadership of predefined team” (18.7%), strategy. “beneficiary” 3. Bringing (17.6%), “advisor planned and/or member strategic of an advisory actions to a committee” (8.5%), good end.

This study drew Germany NPO reputation This scale is on Sarstedt and the same as Schloderer’s (2010) Sarstedt and data, collected Schloderer by the market (2010) scale research institute (see earlier in Psychonomics in this Table 6.2). 2009 (N = 984) by means of an online panel in Germany.

(Continued)

Quality (p < 0.05), attractiveness (p < 0.05), and OSR (p < 0.05) positively affect the affective component of NPO reputation (likeability). Quality (p < 0.05), performance (p < 0.05), attractiveness (p < 0.05), and OSR (p < 0.05) positively affect the cognitive component of NPO reputation (competence). The results reveal that reputation effectiveness is affected by trust (p < 0.01), stakeholders’ level of satisfaction with communication (p < 0.01), and stakeholders’ level of satisfaction with representation (p < 0.01).

Type of NPO

Transnational NonGovernance Organization (NGO)

Reference

Mitchell (2015)

Table 6.2 (Continued)

United States

4. Keeping vision and mission up to date. 5. Creating efficient output from limited means available. 6. Enforcing changes to our society. 7. Realization of services to beneficiaries.

“representative of another and/or partner organization in the field” (8.5%), “customer” (7.7%), “representative of an umbrella organization or federation” (7.7%), and “funder, sponsor, and/or donor” (2.8%).

How Reputation Sample Was Measured

Method

This was an interview Negative Reputation for Recognition binomial study of 152 leaders organizational from NGO regression of transnational effectiveness managers. NGOs registered Leaders made in the United States 484 references representing all to 298 major sectors of particularly NGO activities. effective NGOs.

Country Name of Reputation Measure

NGOs with leaders who value the following factors have a better reputation for effectiveness: —Similarity (similarity to one’s own organization or philosophy, similarity in vision or approach, common qualities) (p < 0.10).

Antecedents

—Grassroots approach (engagement with beneficiaries at the local level, local capabilities, bottom-up approach, mobilization) (p < 0.10). —Diversity of strategies (multiple types of programs, multipronged approach) (p < 0.05). —Dedication (passion and intensity, commitment, aggressive, serious, fearless) (p < 0.05). —Professional (collegial, integrity, dependable, trustworthy, reliable, transparent, attention to detail) (p < 0.01). —Organizational structure (type of organizational structure, such as unitary, federation, coalition) (p < 0.05). Contrary NGOs with leaders who value the implementation of sound principles or strategy (programs exemplify good underlying vision, principles, strategy) have a lower reputation for effectiveness.

74

de Quevedo-Puente and Pérez-Cornejo

for something,’ which is sometimes referred to as reputation effectiveness in the NPO literature, and ‘generalized favorability,’ generally named as NPO reputation. Whereas most of the NPO reputation measures based on the general­ ized favorability conceptualization are inspired by the corporate reputa­ tion literature (e.g., Bennett & Gabriel, 2003; Meijer, 2009; Sarstedt & Schloderer, 2010; Schloderer, Sarstedt, & Ringle, 2014), the reputa­ tion effectiveness measures (Mitchell, 2015; Padanyi & Gainer, 2003; Sargeant, West, & Ford, 2001; Smith & Shen, 1996; Willems et al., 2016) have emerged in the NPO literature. This later approach arises from the importance of goal achievement for NPOs to get volunteers and funding support (Heller, 2008). Due to the relevance of goal effectiveness for consolidating NPO reputation, high-quality NPOs find themselves in a reputation trap (Gent, Crescenzi, Menninga, & Reid, 2015). That is, looking for support, NPOs have an incentive to focus their efforts on achieving immediate targets that are easily attributable to them as organizations and foster their reputation for effectiveness. This incentive can lead some NPOs to myopic short-term behavior. Both conceptualization approaches—namely, being known for something/reputation effectiveness or generalized favorability/NPO reputation—have been translated into a heterogeneous range of reputa­ tion measurements with wide differences in the number of items, rater profiles, and even the items. Reputation effectiveness approach has been translated into either multi-item (Padanyi & Gainer, 2003; Sargeant et al., 2001; Willems et al., 2016) or mono-item measures (Mitchell, 2015; Shier & Handy, 2012; Smith & Shen, 1996). Indeed, prior research using mono-item reputation effectiveness measures generally has been based on peer nominations by leaders of other responding NPOs (Mitch­ ell, 2015; Smith & Shen, 1996). The second approach (i.e., NPO rep­ utation) has been translated into multi-item measures (e.g., Bennett & Gabriel, 2003; Meijer, 2009; Sarstedt & Schloderer, 2010; Schloderer et al., 2014). In terms of rater profiles, studies have used NPO manag­ ers’ opinions (Mitchell, 2015; Padanyi & Gainer, 2003; Smith & Shen, 1996), donors’ perceptions (Meijer, 2009; Sargeant et al., 2001), volun­ teers’ valuations (Smith & Shen, 1996), and general public assessments (Bennett & Gabriel, 2003; Michel & Rieunier, 2012), and others have taken a multi-stakeholder approach (Willems et al., 2016). Tables 6.1 and 6.2 provide an overview of these differences and also of the hetero­ geneous items used in the NPO reputation literature.

Effects of NPO Reputation Previous research, although still scarce, has shown the positive influ­ ence of NPO reputation in attracting resources (e.g., Bennett & Gabriel, 2003; Meijer, 2009; Padanyi & Gainer, 2003; Schloderer et al., 2014).

NPO Reputation and Its Role in Success

75

Specifically, previous research has found a positive relationship between a strong NPO reputation and 1) individuals’ willingness to donate money to NPOs (Schloderer et al., 2014); 2) effective donor attraction (Mei­ jer, 2009); and 3) amount of money donated (Bennett & Gabriel, 2003; Meijer, 2009). Also, Shier and Handy (2012) found support for these relationships in the online context. Beyond attracting financial support, positive NPO reputation increases individuals’ willingness to voluntarily donate time and work (Schloderer et al., 2014). Although most empiri­ cal research in this area supports these positive relationships, the results are not unanimous. Indeed, Sargeant et al. (2001) did not find a signifi­ cant relationship between NPO reputation and the amount individuals donated. Table 6.1 presents the main results obtained by prior empirical research on this topic. This positive link between NPO reputation and resource attraction also has been demonstrated in relation to different NPOs crises as a decreased reputation can eventually lead to a drop in financial support. For exam­ ple, the publicity surrounding the misuse of funds by the American Red Cross following the September 11, 2001, terrorist attacks had a negative impact on the fundraising ability of Red Cross societies around the world (Laidler-Kylander et al., 2007). Similarly, when the president of United Way of America was accused of using charitable donations to finance his lavish lifestyle (Gibelman & Gelman, 2003; Shepard & Miller, 1994; Simross, 1992), charitable contributions to it and affiliates of the organi­ zation dropped dramatically. Another scandal in 2001 after a critical report about Foster Parents’ activities in Haiti led approximately 11,000 donors to cancel their mem­ berships and forced the organization to change its name to Plan Neder­ land (“Foster Parents,” 2001; Meijer, 2009). A recently exposed example is the Oxfam sexual scandal after the 2010 Haiti earthquake that has depleted the organization’s funds and has diminished public, govern­ ment, and donor confidence in Oxfam (Hopkins, 2018).

For-Profit and Nonprofit Alliances Another increasingly common source of funding for NPOs is collabora­ tions with companies. Indeed, the number of interactions between busi­ nesses and NPOs related to corporate social responsibility (CSR) has increased exponentially in the recent decades. During this period, the nature of these interactions has also changed from being overly confron­ tational to more collaborative or to a combination of the two (Argenti, 2004; Heap, 2000). These interactions have increased because firms and NPOs possess complementary resources (Austin, 2000; Das & Teng, 1998), and these partnerships have potential mutual benefits. Whereas NPOs’ main resources lie in their reputation and legitimacy within soci­ ety (Argenti, 2004; Austin, 2000; Lucea, 2010), trust in companies has

76

de Quevedo-Puente and Pérez-Cornejo

spiraled downward in the last decades (Argenti, 2004). On the other hand, corporations have human and financial resources (Austin, 1998; Berger, Cunningham, & Drumwright, 2004; Brown & Kalegaonkar, 2002; Elkington & Beloe, 2010), which have been in decline for NPOs. In fact, prior research has found a strong correlation between NPOs’ annual budgets and the number of ties they have to corporations (Hoff­ man & Bertels, 2010). Collaborating with NPOs enables firms to dem­ onstrate their awareness of and concern for social or environmental protection issues (Parker & Selsky, 2004; Selsky & Parker, 2005) as well as acquire ecological, scientific, and legal NPO expertise to improve their products and business models related to environmental or social issues (Hartman & Stafford, 1997; Milne, Iyer, & Gooding-Williams, 1996). Meanwhile, NPOs obtain higher budgets and influence on business ways of doing to further their missions (Graf & Rothlauf, 2012). Most of these partnerships have emerged because NPOs pressure has provoked firms’ reputational risk, and companies have engaged NPOs in their CSR efforts as a solution to reduce this reputational risk (Heap, 2000). Indeed, some of these alliances have emerged during company cri­ ses to avert or repair damage to companies’ reputations (van Huijstee & Glasbergen, 2008). Beyond risk management, some collaborations are a way to initiate a dialogue with stakeholders or even a means to pursue a competitive advantage. In these cases, the relationship between compa­ nies and NPOs has evolved from seeing each other as threats to cooperat­ ing for mutual gain (Marcuello Servos & Marcuello, 2007). These alliances have important implications not only for corporations but also for NPO partners (Graf & Rothlauf, 2012; Heller, 2008). Both bear the risk that their partner will behave in a scandalous manner, sul­ lying (by association) the reputation of the innocent partner (Wymer & Samu, 2008). However, this potential risk is even greater for NPO part­ ners than for business partners because NPOs’ ability to raise funds from private donors may be greatly reduced as a result of damage to their reputation (Wymer & Samu, 2008). Indeed, Heller (2008) found that individuals’ willingness to donate to NPOs with a positive reputation dramatically declines when their partners have a negative reputation. Therefore, NPOs need to pay close attention to alliance management because partner firms’ negative behavior can have a detrimental effect on NPOs’ reputation (Graf & Rothlauf, 2012).

Antecedents and Management of NPO Reputation The positive impacts of reputation have led to a growing interest in the antecedents and management of NPO reputation to understand what factors favor its consolidation. Among this scarce literature (see Table 6.2), a few studies have found support for the important role of nonprofit governance (Padanyi & Gainer, 2003; Smith & Shen, 1996;

NPO Reputation and Its Role in Success

77

Radbourne, 2003) in NPO reputation. Indeed, based on managers’ opin­ ions, Radbourne (2003) proposed a model that suggests good govern­ ance fosters effectiveness and strategic development, which in turn lead to enhanced NPO reputation. Along with this sparse evidence, there is a growing literature arguing that NPO accountability fosters reputation (Ebrahim, 2003; Tremblay-Boire, Prakash, & Gugerty, 2016; Willems, Waldner, Dere, Matsuo, & Högy, 2017). Many NPO stakeholders have a reduced capacity to observe these organizations’ operations (TremblayBoire et al., 2016), so reporting balances informational asymmetries (Hyndman & McConville, 2016; Tremblay-Boire & Prakash, 2015) and reduces managerial discretion (De la Fuente Sabaté & De Quevedo Puente, 2003; Owen, Swift, Humphrey, & Bowerman, 2000; SierraGarcía, Zorio-Grima, & García-Benau, 2015), consequently enhancing NPO credibility. Therefore, being accountable favors the consolidation and preservation of NPO reputation and contributes to the overall repu­ tation of the NPO sector. In this sense, consultancy firms recommend adapting good governance business practices to the specific characteris­ tics of the NPO context to strengthen stakeholders’ trust and therefore NPO reputation (PricewaterhouseCoopers, 2018). Furthermore, previous research has identified heterogeneous factors that have an impact on NPO reputation. For example, Sarstedt and Schlo­ derer (2010) and Schloderer et al. (2014) identified attractiveness, organ­ izational social responsibility (OSR), quality, and performance as factors influencing NPO reputation. Padanyi and Gainer (2003) also showed that client satisfaction and NPOs’ ability to partner with other NPOs positively affects peer reputation. Widening the approach to include all stakeholders, Willems et al. (2016) showed that an NPO’s relation­ ship with its stakeholders affects its reputation effectiveness. Similarly, Mitchell (2015) showed that NPOs’ leadership values are relevant for reputation effectiveness. Moreover, previous research has also revealed that organizational size (Mitchell, 2015), and some aspects related to the nature of NPOs, such as having an advocacy or service function or having public beneficiaries/users, among others (Mitchell, 2015; Smith & Shen, 1996), affect reputation effectiveness.

Conclusions From this previous literature, we can conclude that NPO reputation is a key asset to attract resources either from donors and governments or through company collaborations. These resources make it easier for NPO to achieve their goals (Smith & Shen, 1996), which enhances NPOs’ credibility and reputation (Lefroy & Tsarenko, 2013; Milne et al., 1996) and in turn improves their ability to attract donations, volunteers, and partnerships (Deephouse & Carter, 2005). So, these resources make NPOs more effective and enhance their reputation, generating an upward

78

de Quevedo-Puente and Pérez-Cornejo

spiral that makes reputation a very valuable asset for NPOs. Thus, the underlying managerial implication for NPO leaders is to build and pre­ serve their reputation. Research arguments, some auditors’ opinions, and the results of this budding empirical research suggest that governance mechanisms, accountability, and stakeholder involvement in decision processes may foster NPO reputation. All these tools reduce information asym­ metries between NPO stakeholders and favor the consolidation of NPO reputation. Due to the diverse nature of NPOs, the scarce empirical research on NPO reputation, and the heterogeneous methodological approaches used in this research, future efforts exploring the antecedents and con­ sequences of NPO reputation are welcome and are likely to help NPO practitioners manage this valuable resource.

Note 1. More information available at http://fortune.com/worlds-most-admired­ companies/; www.reputationinstitute.com/solutions; www.merco.info/es/.

References Ainsworth, D. (2008, September 24). Company collapse hit charity income and volunteer support. Third Sector. Retrieved from www.thirdsector.co.uk/ company-collapses-hit-charity-income-volunteer-support/finance/ article/847987 Ali, R., Lynch, R., Melewar, T. C., & Jin, Z. (2015). The moderating influences on the relationship of corporate reputation with its antecedents and consequences: A meta-analytic review. Journal of Business Research, 68(5), 1105–1117. Argenti, P. A. (2004). Collaborating with activists: How Starbucks works with NGOs. California Management Review, 47(1), 91–116. Austin, J. E. (1998). The invisible side of leadership. Leader to Leader, 8, 38–46. Austin, J. E. (2000). Strategic collaboration between nonprofits and businesses. Nonprofit and Voluntary Sector Quarterly, 29(1), 69–97. Bennett, R., & Gabriel, H. (2003). Image and reputational characteristics of UK charitable organizations: An empirical study. Corporate Reputation Review, 6(3), 276–289. Berger, I. E., Cunningham, P. H., & Drumwright, M. E. (2004). Social alliances: Company/nonprofit collaboration. California Management Review, 47(1), 58–90. Brown, L. D., & Kalegaonkar, A. (2002). Support organizations and the evo­ lution of the NGO sector. Nonprofit and Voluntary Sector Quarterly, 31(2), 231–258. Cable, D. M., & Turban, D. B. (2003). The value of organizational reputation in the recruitment context: A brand-equity perspective. Journal of Applied Social Psychology, 33(11), 2244–2266.

NPO Reputation and Its Role in Success

79

Das, T. K., & Teng, B. S. (1998). Between trust and control: Developing confi­ dence in partner cooperation in alliances. Academy of Management Review, 23(3), 491–512. De la Fuente Sabaté, J. M., & De Quevedo Puente, E. (2003). Empirical analysis of the relationship between corporate reputation and financial performance: A survey of the literature. Corporate Reputation Review, 6(2), 161–177. Deephouse, D. L., & Carter, S. M. (2005). An examination of differences between organizational legitimacy and organizational reputation. Journal of Manage­ ment Studies, 42(2), 329–360. Ebrahim, A. (2003). Accountability in practice: Mechanisms for NGOs. World Development, 31(5), 813–829. Elkington, J., & Beloe, S. (2010). The twenty-first-century NGO. In T. P. Lyon (Ed.), Good cop bad cop: Environmental NGOs and their strategies toward business (pp. 17–47). Washington, DC: Resources for the Future Press. Foster Parents verliest 11.000 donateurs [Foster parents loses 11.000 donors]. (2001, October 18). NRC Handelsblad, p. 3. Retrieved from www.nrc. nl/nieuws/2001/10/18/foster-parents-verliest-11000-donateurs-7561455­ a262039 Gent, S. E., Crescenzi, M. J., Menninga, E. J., & Reid, L. (2015). The reputation trap of NGO accountability. International Theory, 7(3), 426–463. Gibelman, M., & Gelman, S. R. (2001). Very public scandals: Nongovernmen­ tal organizations in trouble. Voluntas: International Journal of Voluntary and Nonprofit Organizations, 12(1), 49–66. Graf, N. F., & Rothlauf, F. (2012). Firm-NGO collaborations. Zeitschrift für Betriebswirtschaft, 82(6), 103–125. Grønbjerg, K. A., & Child, C. (2003). Illinois nonprofits: A profile of charities and advocacy organizations. Chicago, IL: Donors Forum of Chicago. Hall, R. (1992). The strategic analysis of intangible resources. Strategic Manage­ ment Journal, 13(2), 135–144. Hall, R. (1993). A framework linking intangible resources and capabilities to sustainable competitive advantage. Strategic Management Journal, 14(8), 607–618. Hartman, C. L., & Stafford, E. R. (1997). Green alliances: Building new business with environmental groups. Long Range Planning, 30(2), 184–149. Heap, S. (2000). NGO-business partnerships: Research-in-progress. Public Man­ agement an International Journal of Research and Theory, 2(4), 555–563. Heller, N. A. (2008). The influence of reputation and sector on perceptions of brand alliances of nonprofit organizations. Journal of Nonprofit and Public Sector Marketing, 20(1), 15–36. Hoffman, A. J., & Bertels, S. (2010). Who is part of the environmental move­ ment? In T. P. Lyon (Ed.), Good cop bad cop: Environmental NGOs and their strategies toward business (pp. 48–69). Washington, DC: Resources for the Future Press. Hopkins, N. (2018, June 15). Oxfam to axe jobs and aid programmes in £16m cuts after scandal. The Guardian. Retrieved from www.theguardian.com/ world/2018/jun/15/oxfam-warns-staff-urgent-savings-16m-haiti-scandal Hyndman, N., & McConville, D. (2016). Transparency in reporting on charities’ efficiency: A framework for analysis. Nonprofit and Voluntary Sector Quar­ terly, 45(4), 844–865.

80

de Quevedo-Puente and Pérez-Cornejo

Keh, H. T., & Xie, Y. (2009). Corporate reputation and customer behavioral intentions: The roles of trust, identification and commitment. Industrial Mar­ keting Management, 38(7), 732–742. Laidler-Kylander, N., Quelch, J. A., & Simonin, B. L. (2007). Building and valu­ ing global brands in the nonprofit sector. Nonprofit Management and Leader­ ship, 17(3), 253–277. Lange, D., Lee, P. M., & Dai, Y. (2011). Organizational reputation: A review. Journal of Management, 37(1), 153–184. Lefroy, K., & Tsarenko, Y. (2013). From receiving to achieving: The role of rela­ tionship and dependence for nonprofit organisations in corporate partnerships. European Journal of Marketing, 47(10), 1641–1666. Lucea, R. (2010). How we see them versus how they see themselves: A cog­ nitive perspective of firm NGO relationships. Business & Society, 49(1), 116–139. Marcuello Servos, C., & Marcuello, C. (2007). NGOs, corporate social respon­ sibility, and social accountability: Inditex vs. Clean Clothes. Development in Practice, 17(3), 393–403. Meijer, M. M. (2009). The effects of charity reputation on charitable giving. Cor­ porate Reputation Review, 12(1), 33–42. Michel, G., & Rieunier, S. (2012). Nonprofit brand image and typicality influ­ ences on charitable giving. Journal of Business Research, 65(5), 701–707. Milne, G. R., Iyer, E. S., & Gooding-Williams, S. (1996). Environmental organi­ zation alliance relationships within and across nonprofit, business, and govern­ ment sectors. Journal of Public Policy & Marketing, 15, 203–215. Mitchell, G. E. (2015). The attributes of effective NGOs and the leadership val­ ues associated with a reputation for organizational effectiveness. Nonprofit Management and Leadership, 26(1), 39–57. Owen, D. L., Swift, T. A., Humphrey, C., & Bowerman, M. (2000). The new social audits: Accountability, managerial capture or the agenda of social cham­ pions? European Accounting Review, 9(1), 81–98. Padanyi, P., & Gainer, B. (2003). Peer reputation in the nonprofit sector: Its role in nonprofit sector management. Corporate Reputation Review, 6(3), 252–265. Parker, B., & Selsky, J. W. (2004). Interface dynamics in cause-based partner­ ships: An exploration of emergent culture. Nonprofit and Voluntary Sector Quarterly, 33(3), 458–488. PricewaterhouseCoopers. (2018). Radiografía del Tercer Sector Social en España: retos y oportunidades en un entorno cambiante [Analysis of the third social sector in Spain: Challenges and opportunities in a changing environment]. Retrieved from www.pwc.es/es/publicaciones/tercer-sector-publicaciones/ radiografia-tercer-sector-social-2018.html Radbourne, J. (2003). Performing on boards: The link between governance and corporate reputation in nonprofit arts boards. Corporate Reputation Review, 6(3), 212–222. Roberts, P. W., & Dowling, G. R. (2002). Corporate reputation and sustained superior financial performance. Strategic Management Journal, 23(12), 1077–1093. Sargeant, A., West, D. C., & Ford, J. (2001). The role of perceptions in predicting donor value. Journal of Marketing Management, 17(3–4), 407–428.

NPO Reputation and Its Role in Success

81

Sarstedt, M., & Schloderer, M. P. (2010). Developing a measurement approach for reputation of non-profit organizations. International Journal of Nonprofit and Voluntary Sector Marketing, 15(3), 276–299. Schloderer, M. P., Sarstedt, M., & Ringle, C. M. (2014). The relevance of rep­ utation in the nonprofit sector: The moderating effect of socio-demographic characteristics. International Journal of Nonprofit and Voluntary Sector Mar­ keting, 19(2), 110–126. Selsky, J. W., & Parker, B. (2005). Cross-sector partnerships to address social issues: Challenges to theory and practice. Journal of Management, 31(6), 849–873. Shepard, C. E., & Miller, B. (1994, September 14). Former United Way chief is indicted in fund misuse. Washington Post. Retrieved from www.washingtonpost.com/ archive/politics/1994/09/14/former-united-way-chief-is-indicted-in-fund-misuse/ fdfdfecf-b188-422b-b799–16d2ecea683d/ Shier, M. L., & Handy, F. (2012). Understanding online donor behavior: The role of donor characteristics, perceptions of the internet, website and program, and influence from social networks. International Journal of Nonprofit and Volun­ tary Sector Marketing, 17(3), 219–230. Sierra-García, L., Zorio-Grima, A., & García-Benau, M. A. (2015). Stakeholder engagement, corporate social responsibility and integrated reporting: An exploratory study. Corporate Social Responsibility and Environmental Man­ agement, 22(5), 286–304. Simross, L. (1992, April 28). Charities in a bind. Washington Post, p. C5. Smith, D. H., & Shen, C. (1996). Factors characterizing the most effective non­ profits managed by volunteers. Nonprofit Management and Leadership, 6(3), 271–289. Tremblay-Boire, J., & Prakash, A. (2015). Accountability.org: Online disclosures by US nonprofits. Voluntas: International Journal of Voluntary and Nonprofit Organizations, 26(2), 693–719. Tremblay-Boire, J., Prakash, A., & Gugerty, M. K. (2016). Regulation by repu­ tation: Monitoring and sanctioning in nonprofit accountability clubs. Public Administration Review, 76(5), 712–722. Valor, C. (2003). Social alliance for fundraising: How Spanish nonprofits are hedging the risks. Journal of Business Ethics, 47(3), 209–222. Van Huijstee, M., & Glasbergen, P. (2008). The practice of stakeholder dialogue between multinationals and NGOs. Corporate Social Responsibility and Envi­ ronmental Management, 15(5), 298–310. Van Riel, C. B., & Fombrun, C. J. (2007). Essentials of corporate communica­ tion: Implementing practices for effective reputation management. New York, NY: Routledge. Walsh, G., Mitchell, V. W., Jackson, P. R., & Beatty, S. E. (2009). Examining the antecedents and consequences of corporate reputation: A customer perspec­ tive. British Journal of Management, 20(2), 187–203. Willems, J., Jegers, M., & Faulk, L. (2016). Organizational effectiveness repu­ tation in the nonprofit sector. Public Performance & Management Review, 39(2), 454–475. Willems, J., Waldner, C. J., Dere, Y. I., Matsuo, Y., & Högy, K. (2017). The role of formal third-party endorsements and informal self-proclaiming signals in nonprofit reputation building. Nonprofit and Voluntary Sector Quarterly, 46(5), 1092–1105.

82

de Quevedo-Puente and Pérez-Cornejo

Wymer, W. W., Jr., & Samu, S. (2003). Dimensions of business and nonprofit collaborative relationships. Journal of Nonprofit and Public Sector Marketing, 11(1), 3–22. Young, D. R., Bania, N., & Bailey, D. (1996). Structure and accountability a study of national nonprofit associations. Nonprofit Management and Leader­ ship, 6(4), 347–365.

7

Crowding-Out or

Crowding-In

The Dynamics of Different

Revenue Streams

Arjen de Wit, René Bekkers,

and Pamala Wiepking

Introduction In public economics, a large body of literature has examined the ques­ tion whether government funding ‘crowds out’ private donations. There has been a vast number of empirical studies on this question, with dispersed and even contrasting findings. In this chapter we 1) give an overview of the most important theoretical perspectives on the relationship between government support and philanthropic giving; 2) evaluate the available evidence on these perspectives; and 3) identify the most promising directions for future research, taking into account the importance of the dynamics of funding portfolios and the contex­ tual differences that influence these dynamics. We argue that it is not very useful to estimate ‘the’ crowding-out effect, because the associa­ tion between government support and private giving varies strongly between contexts. A better understanding of the dynamics of different revenue sources is crucial for the future of nonprofit organizations (NPOs), given the impor­ tance of resources for organizational performance (Pfeffer & Salancik, 1978). The size and composition of the revenue portfolio has important consequences for the financial health and governance of NPOs. Resources are necessary for NPOs to deliver goods and services that cannot be pro­ vided by the state or the market, to form a space where citizens express themselves, and to defend minority and animal rights in public debates. As such, the nonprofit sector plays a crucial role in today’s diverse socie­ ties. To increase organizational effectiveness of NPOs it is important to know, for both funders and recipients, how different revenue streams interact within different local contexts. In the next section, we first discuss the theoretical foundations of the literature studying the association between government support and pri­ vate donations, and the possible explanations for the mixed empirical support for the theoretical claims.

84

de Wit, Bekkers, and Wiepking

Theoretical Perspectives Micro-Economic Perspective Theory: a vast literature in economics examines how changes in gov­ ernment funding affect private individual donations. Economic theory predicts that altruistic donors reduce donations by $1 for each $1 con­ tributed through tax-funded government subsidies (Roberts, 1984; Stein­ berg, 1991; Warr, 1982). Because the crowd-out was found to be less than dollar-for-dollar, this theory was later refined by the addition of a ‘warm glow’ component to the donors’ utility function, representing all motives that are not responsive to changing mandatory contributions (Andreoni, 1989, 1990). Key actors: individual private donors. Empirical evidence: experimental designs testing predictions of micro­ economic theory typically provide participants with a small endowment that they can divide between themselves and the public good. When there is a larger mandatory contribution (‘tax’) to the public good, participants generally give lower amounts as a voluntary donation. Such designs on average find that a $1 increase in mandatory contributions corresponds with a $0.64 decrease in voluntary contributions—this is fairly robust, with a 95% confidence interval around this average between -0.70 and -0.58 (De Wit & Bekkers, 2017). These results show that even in tightly controlled laboratory circumstances philanthropic donations cannot completely be substituted by a government tax or vice versa. Two limitations of the micro-economic theory are the following. First, the theory and laboratory experiments testing it imply a number of assumptions, including full information on the actions of ‘the govern­ ment.’ These assumptions are not likely to be true in real life because donors know very little about the level of government funding NPOs receive (De Wit, Bekkers, & Broese van Groenou, 2017; Eckel, Gross­ man, & Johnston, 2005; Horne, Johnson, & Van Slyke, 2005). Second, the theory uses the term ‘warm glow’ as a catch-all phrase to refer to all impure altruistic motives, but it is unsure what motivations or mechanisms are included here. Giving for reasons of reputation or psychological ben­ efits are just a few of the possible mechanisms that make donations unre­ sponsive to government support. Donors may be insensitive to changes in government funding because of a habit, because giving sends a costly signal to potential partners, because giving is a social norm that implies a duty, or because not giving would create guilt (Vesterlund, 2006). Evaluation: in laboratory experiments there is strong evidence for impure altruism, but the external validity of such experiments is uncer­ tain. This theoretical perspective does little to explain why donations would not be responsive to changes in government funding.

Crowding-Out or Crowding-In

85

Institutional-Political Perspective Theory: Weisbrod’s (1977) government failure theory posits that the gov­ ernment, whereas aiming to provide public goods that the market is not able to produce, is not equipped to fulfill all needs in society. Democratic governments are bound to the desires of the median voter, which leaves demands from different minorities unfulfilled. This is where NPOs step in, with their ability to provide a wide variety of public goods. Thus, where societies are more heterogeneous, government failure theory would predict a larger nonprofit sector and a smaller government. Salamon and Anheier (1998) argue that the government failure theory is not sufficient to explain the mechanisms that are at work in differ­ ent national contexts. Their social origins theory posits that social and political developments in the history of specific countries define current civil society sector dimensions: traditional, liberal, welfare-partnership, social-democratic, and statist. These dimensions reflect different power relationships between state, market, and nonprofit sector in each country (Salamon, Sokolowski, & Haddock, 2017). Key actors: NPOs, political parties, trade unions, and lobby groups. Empirical evidence: analyses with data aggregated on the country, state, or county level show mixed evidence for government failure theory. Some studies find a negative correlation between government expendi­ tures and the size of the nonprofit sector, as predicted by government fail­ ure theory (Matsunaga & Yamauchi, 2004; Matsunaga, Yamauchi, & Okuyama, 2010); other studies find positive correlations (Paarlberg & Zuhlke, 2019); and some studies find zero correlation (Grønbjerg & Paarlberg, 2001). The social origins theory as put forward by Salamon and Anheier has been widely cited but not often empirically scrutinized. Correlational analyses with aggregated data show to some extent support for the theo­ retical predictions based on the social origins theory (Einolf, 2015; Sala­ mon et al., 2017), but the longitudinal comparative data needed to test this theory do not exist. Two limitations of the institutional-political perspective are the fol­ lowing. First, the theoretical arguments are not universally applicable. Government failure theory requires a government that responds to the median voter and is thus most likely to occur in majority democracies (Sokolowski, 2013). Likewise, many countries do not fit in the five ideal types proposed in social origins theory. Einolf (2015, p. 518) concludes that “[e]ven for wealthy, democratic countries with a European culture and history, Salamon and Anheier’s social origins theory is of limited use.” Second, there is a lack of reliable quantitative data to test the hypoth­ eses of these theories. Government failure theory is typically tested with proxy measures of heterogeneity, like ethnic or socio-economic diversity,

86

de Wit, Bekkers, and Wiepking

which do not measure voter demands directly. Heterogeneity is not only a demand-side variable, but also related with social cohesion and other factors on the supply side (Corbin, 1999). Measures of philanthropy are problematic, too. Despite very useful attempts to collect all informa­ tion that is currently available (Salamon & Anheier, 1998; Wiepking & Handy, 2015), there is a lack of reliable cross-national data on philan­ thropic giving, which makes comparative research problematic. Evaluation: inconclusive. Historical political processes certainly con­ tribute to the development of the nonprofit sector vis-à-vis the state, but the current data do not allow for strong conclusions about specific theo­ retical predictions. The strongest contribution of this perspective lies in the extensive analysis of country-specific political processes, rather than in quantitative testing of the theoretical expectations. Institutional Signaling Perspective Theory: institutional theories assume that attitudes and behaviors of citizens are shaped by formal (rules, legislation, organization) and infor­ mal (norms, habits) institutions (North, 1991; Rothstein, 1998). When in search for cues to guide their choices, people are guided by social rules (Ingram & Clay, 2000). Government support may serve as a sig­ nal that NPOs are trustworthy, which could explain a positive associa­ tion between government funding and philanthropic donations (Handy, 2000; Heutel, 2014; Schiff, 1990). Key actors: individual private donors. Empirical evidence: theories on institutional signaling are typically tested with cross-national data, often finding positive correlations between government expenditure and civic engagement (Van Oors­ chot & Arts, 2005). For monetary giving, there is evidence that extensive social welfare spending does not reduce the total size of philanthropy, but rather affects the distribution over different causes, such that donors give more to ‘expressive’ organizations (De Wit, Neumayr, Handy, & Wiepking, 2018; Pennerstorfer & Neumayr, 2017; Sokolowski, 2013). Studies may also use more fine-grained datasets on specific charities. Heutel (2014) finds more strongly positive correlations between govern­ ment funding and philanthropic donations among younger charities, for which the signaling effect would be stronger because they are less wellknown among the public. A first limitation is the availability of data. Similar to the institutionalpolitical perspective, research in the signaling literature mainly examines cross-national variety, because the largest differences between institu­ tional arrangements are between countries. Yet, these studies are limited by the available cross-country datasets, which primarily cover WEIRD (Western, Educated, Industrialized, Rich, and Democratic) countries.

Crowding-Out or Crowding-In

87

A second limitation in this perspective is the issue of causality. Wel­ fare state institutions not only guide behavior through norms and sig­ nals, but also redistribute resources that encourage philanthropic giving (Stadelmann-Steffen, 2011; Van Ingen & Van der Meer, 2011). Further­ more, individual values, government expenditures, and civic engagement can all be driven by the same underlying variables, and it is problematic to treat government spending as an exogenous variable (Payne, 2009). Insights from the institutional-political perspective can be helpful in this sense, which pays more attention to the political processes that lead to the establishment of institutional arrangements in the public and non­ profit spheres. Evaluation: inconclusive. There are large differences between countries in terms of institutional arrangements and levels of philanthropy, but the causal mechanisms are difficult to disentangle. Organizational Perspective Theory: resource dependency theory (Pfeffer & Salancik, 1978) assumes that funders exercise control over NPOs. NPOs can reduce their depend­ ence by attracting resources from additional funders. Because efforts to do so require investment of resources, a self-sustaining feedback loop emerges that reduces the chances of survival for organizations in a down­ ward spiral and makes winners even more successful. Such a ‘Matthew Effect’ was described by Merton (1968) for careers of scientists—one grant leads to another. Other scholars argued for an opposite effect, in which organizational behavior would explain a negative association between government sup­ port and private donations. As described in the ‘nonprofit starvation cycle’ (Gregory & Howard, 2009), funders require low overhead costs, which gives pressure on NPOs to present themselves in that way, whereas performing with mediocre infrastructure. This leads again to unrealistic expectations of funders, and the cycle starts over again. In this argument, receiving government support could be detrimental for fundraising and administration expenditures that are necessary to obtain private income, because organizations are pressured to cut back on their indirect costs. Andreoni and Payne (2003) argue that NPOs that receive lower gov­ ernment funding will invest more in fundraising behavior. Fundraising becomes less efficient, however, when individual giving is indeed crowded out by government support: if individual giving is lower, it is more costly to acquire funds. The result is incomplete crowding-out. This process has been labeled ‘indirect crowding-out.’ Key actors: fundraising organizations. Empirical evidence: Andreoni and Payne (2003, 2011a, 2011b) find that charities in the United States and Canada increase fundraising efforts

88

de Wit, Bekkers, and Wiepking

when confronted with lower government support. In Germany, however, Schubert and Boenigk (2019) show that declines of government funding start a ‘starvation cycle’ in which organizations have increasing difficul­ ties to acquire income. In terms of limitations, there are relatively few reliable data on organ­ izational revenues in many countries, and more analyses can reveal how these mechanisms work in different national contexts and among dif­ ferent types of organizations. Another limitation might be that financial indicators are not always proper indicators of the proposed theoretical constructs, and there is ample room for discussion about the best way to measure constructs like liquidity, financial health, and revenue diver­ sification (e.g., Chikoto-Schultz, Ling, & Neely, 2016; Prentice, 2016). Also, analyses on financial statistics usually do not provide insights in decision-making processes within organizations. Research has exam­ ined the relationships between different types of revenue streams and NPOs’ mission, autonomy, and degree of formalization (Froelich, 1999; O’Regan & Oster, 2002; Seo, 2016; Verschuere & De Corte, 2014). Because revenue portfolios are also driven by organizational charac­ teristics and choices made by the receiving organizations, however, these relationships do not necessarily imply causal influences (Fischer, Wilsker, & Young, 2011). Evaluation: organizational behavior is important for the association between government support and philanthropic giving. It is uncertain to what extent the proposed mechanisms work differently in different contexts and for different types of organizations.

Towards a Dynamic Approach To some extent, the divergence of findings in the empirical literature can be attributed to differences in the data and methods used. Whereas it is clear that different research designs lead to different findings (Lu, 2016; De Wit & Bekkers, 2017), there is no consensus about the internal and external validity of such choices. In addition, there are substantial reasons why studies have reached such different conclusions. It has been argued that crowding-out effects vary with the level of government support (Bor­ gonovi, 2006; Brooks, 2000, 2003), the salience of the tax (Eckel et al., 2005), the number of other donors (Ribar & Wilhelm, 2002), differences between types and costs of public goods (Tinkelman, 2010), the number of people who do or do not contribute to a public good (Chan, God­ byb, Mestelman, & Muller, 2002; Ribar & Wilhelm, 2002; Tinkelman, 2010), and the availability of information (De Wit et al., 2017). Some of these contextual differences may explain differences in the findings from between research designs as well. Laboratory experiments typically have a small number of other donors (Ribar & Wilhelm, 2002) and a salient message about the government contribution that is ‘taxed’ from

Crowding-Out or Crowding-In

89

the participants (Eckel et al., 2005). These conditions create a stronger crowding-out effect. In a large economy of donors, imperfect informa­ tion about government support is likely to reduce the effect of changes in government funding on private giving. Different choices in data and methods, however, do not fully explain why crowding-out effects look very different from the four perspectives. The four perspectives we have discussed also identify different actors as pivotal in the relationship between government funding and private giving. The four perspectives are not mutually exclusive. In reality, all actors involved probably all have their influences. These influences vary considerably between contexts—i.e., between ‘types,’ cultures, countries, regions, and over time. Therefore, we argue it is not very useful to try to estimate ‘the’ crowding-out effect. Different funding sources do not oper­ ate in a vacuum but are in constant interaction with other actors within and around the beneficiary organization. Therefore, theory and research on NPO revenues will benefit from adopting a dynamic approach. Below we discuss two broad factors to consider in future research: interactions between different revenue streams, and the context in which these fund­ ing streams interact. The Influence of Other Revenue Streams A first reason why the effects of changes in government funding vary so strongly is that they interact with changes in other revenue streams. Compared to the sizeable literature on the effects of government funding on private donations, research on the interaction between funding from other sources, including households, foundations, businesses, and gov­ ernments, is rare. It is uncertain how these funding sources are related, and how these interactions affect outcomes such as organizational effec­ tiveness. This is surprising, because different actors all contribute to the same goals and it is likely that they influence each other. On the one hand, revenues can substitute each other. From the institutional-political perspective we learn that country-specific politi­ cal processes lead to a certain division of labor between the state and the nonprofit sector. Non-governmental actors may step in where gov­ ernments are not able to fulfill all demands, and this argument may be applicable to all types of private actors that contribute to those needs. Households, foundations, and businesses may fill the gaps of the gov­ ernment and give money to organizations with lower levels of public funding. Philanthropic foundations are a special case because they are tax-exempt in many countries. Whereas households and businesses may perceive government subsidies as something that they pay for with their taxes, foundations provide grants that are often completely independent from government subsidies. If there is substitution, it would be because other funding sources reduce the social needs in society.

90

de Wit, Bekkers, and Wiepking

The government in its turn may decide to decrease subsidies to organizations that receive high levels of private funding. Previous stud­ ies showed that private giving crowds out government subsidies in U.S. higher education (Becker & Lindsay, 1994; Sav, 2012), because increas­ ing private donations affords politicians and bureaucrats “opportunities for reallocating tax supplied dollars away from education to other selfpromoting and vote gathering pursuits” (Sav, 2012, p. 1133). Individual philanthropic donors may not only respond to levels of government support, but also to other types of funding. The theoretical rationale is largely similar to economic theories on government support and donations, with altruistic donors expected to reduce their contribu­ tions in the presence of other funding sources. Experimental evidence suggests that business funding crowds out individual donations (Bennett, Kim, & Loken, 2013). There is some literature on the idea that charitable lottery players donate less to philanthropic organizations, although evi­ dence suggests that charitable gambling and donations are complements rather than substitutes (Apinunmahakul & Devlin, 2004; Lin & Wu, 2007). It is likely that individual responses depend on how donors per­ ceive the other funder. Business funding may be perceived as a signal of undesired corporate influences on NPOs strategies, crowding-out private donations, whereas income from foundations or governments may be evaluated more positively, crowding-in donations (Khovrenkov, 2019). Organizational behavior may partly explain substitution effects between revenue streams. Insights from the organizational perspective are useful not only for the association between government support and private donations, but also for interactions between other types of funding. On the other hand, revenues may complement each other. Governments often work together with NPOs, businesses, and foundations in publicprivate partnerships (Ansell & Gash, 2008). In such collaborations, it is common that all partners contribute knowledge and/or resources. With different types of contracts, including Social Impact Bonds, the initiators ensure the (conditional or unconditional) engagement of multiple public and private funders. For receiving organizations, this automatically leads to a diverse portfolio. This can be helpful to NPOs in achieving its mis­ sion, although there are also some cautions for working with complex partnerships and having strong revenue diversification, largely dependent on the type of NPO (Hung & Hager, 2019). Besides such organizational collaborations, it could be that funding streams complement each other in a less visible way. From the literature on institutional signaling we learn that funding from other sources can serve as a norm to direct individual behavior. This may not only hold for individual donors but also for businesses and foundations, who are look­ ing for cues to guide their own financial decisions. Even policy makers, who are supposed to make robust decisions based on voter preferences,

Crowding-Out or Crowding-In

91

may have a bias towards organizations that are already successful in attracting funds. The behaviors of the recipient organizations themselves may also pro­ duce positive correlations between revenue streams. Large and success­ ful organizations may be better able to hire professional fundraisers and establish and maintain connections with funders. The Context in Which NPOs Operate Besides interactions between different revenue streams, the context in which NPOs operate defines how government funding may affect philan­ thropic donations. Three factors are briefly mentioned here and are more extensively discussed in De Wit (2018). First, institutional arrangements on the macro level may affect the dynamics between different revenue streams. An important hypothesis which is not sufficiently tested is that crowding-out is most likely in the U.S. and other Anglo-Saxon countries. These countries are characterized by a highly professionalized fundraising regime (Wiepking & Handy, 2015) and a more critical attitude towards government interventions (Andreß & Heien, 2001; Svallfors, 1997). More cross-national research in the realm of the institutional-political and institutional signaling per­ spective could examine how dynamics between NPOs revenues vary across macro contexts. Second, dynamics between NPOs revenues may depend on the subsectors of the nonprofit sector. A meta-analysis finds stronger negative correlations between government funding and charitable giving among human service NPOs, whereas it finds stronger positive correlations for the arts and health care sectors (Lu, 2016). Theoretical arguments about why such effects would vary across the nonprofit sector are scarce. Each subsector is unique in the types of public goods that are produced, the actors that are most prominent, and the type of NPOs that are active in that area. Furthermore, those subsectors are not isolated: it has been argued that changing social needs do not decrease total donations, but rather lead donors to shift their donations towards other subsectors (De Wit et al., 2018; Pennerstorfer & Neumayr, 2017; Sokolowski, 2013). Research on the organizational level should consider such contextual dynamics when making generalizable statements about the association between government funding, philanthropic donations, and other rev­ enue streams. The third contextual factor is the availability and framing of infor­ mation. Whereas behavioral experiments often aim to make predictions about macro effects, they generally fail to take the availability of informa­ tion into account. Citizens adapt their giving behavior only when they are aware of external changes like changing government support. Although this sounds like ‘stating the obvious,’ there has been surprisingly little

92

de Wit, Bekkers, and Wiepking

academic attention for the availability of information among prospective donors (notable exceptions are De Wit et al., 2017; Horne et al., 2005; Li & McDougle, 2017; McDougle & Handy, 2014). More experimental and non-experimental data on citizen perceptions and NPO communica­ tion could shed light on the role of information in donor decisions.

Concluding Remarks In this chapter, we discussed the arguments, key actors, and empirical evidence of four prominent theoretical perspectives on the relationship between government financial support and private individual giving. The micro-economic perspective convincingly revealed that individual donors are impure altruists in laboratory experiments, but it is uncertain to what extent this behavior occurs in daily situations. The institutional-political perspective contributed important insights in how interest groups con­ tribute to constellations of public and nonprofit institutions, and the institutional signaling perspective makes strong arguments about how institutions guide individual donor behavior. However, both institutional perspectives are not backed up with strong causal evidence. The organi­ zational perspective, finally, delivers strong theoretical and empirical arguments on organizational behavior as a cause and a consequence of changing revenues, although the proposed mechanisms will likely work differently in different contexts. The theoretical discussion leads us to propose a dynamic approach towards NPO revenues. Supposed effects of government support on pri­ vate donations do not occur in a vacuum but are shaped by contextual factors like the institutional environment, the organizational structure, the political context, and the media landscape. Philanthropic founda­ tions, individual donors, government bodies, and corporate enterprises may all contribute to public goods, and they all interact with each other. Future research should go beyond estimations of ‘the’ crowding-out effect and pay more attention to the ecosystem in which such interactions take place. Such insights will help funders to better evaluate the value and consequences of their contributions, thus helping the nonprofit sector to continue contributing to essential public goods.

References Andreß, H. J., & Heien, T. (2001). Four worlds of welfare state attitudes? A com­ parison of Germany, Norway and the United States. European Sociological Review, 17(4), 337–356. Andreoni, J. (1989). Giving with impure altruism: Applications to charity and Ricardian equivalence. Journal of Political Economy, 97(6), 1447–1458. Andreoni, J. (1990). Impure altruism and donations to public goods: A theory of warm-glow giving. Economic Journal, 100(401), 464–477.

Crowding-Out or Crowding-In

93

Andreoni, J., & Payne, A. A. (2003). Do government grants to private charities crowd out giving or fund-raising? American Economic Review, 93, 792–812. Andreoni, J., & Payne, A. A. (2011a). Is crowding out due entirely to fund­ raising? Evidence from a panel of charities. Journal of Public Economics, 95, 334–343. Andreoni, J., & Payne, A. A. (2011b). Crowding-out charitable contributions in Canada: New knowledge from the north (NBER Working Paper No. 17635). Retrieved from National Bureau of Economic Research website www.nber.org/ papers/w17635.pdf Ansell, C., & Gash, A. (2008). Collaborative governance in theory and practice. Journal of Public Administration Research and Theory, 18(4), 543–571. Apinunmahakul, A., & Devlin, R. A. (2004). Charitable giving and charitable gambling: An empirical investigation. National Tax Journal, 57(1), 67–88. Becker, E., & Lindsay, C. M. (1994). Does the government free ride? Journal of Law & Economics, 37(1), 277–296. Bennett, C. M., Kim, H., & Loken, B. (2013). Corporate sponsorships may hurt nonprofits: Understanding their effects on charitable giving. Journal of Con­ sumer Psychology, 23(3), 288–300. Borgonovi, F. (2006). Do public grants to American theatres crowd-out private donations? Public Choice, 126(3–4), 429–451. Brooks, A. C. (2000). Public subsidies and charitable giving: Crowding out, crowding in, or both? Journal of Policy Analysis and Management, 19(3), 451–464. Brooks, A. C. (2003). Do government subsidies to nonprofits crowd out dona­ tions or donors? Public Finance Review, 31(2), 166–179. Chan, K. S., Godbyb, R., Mestelman, S., & Muller, R. A. (2002). Crowdingout voluntary contributions to public goods. Journal of Economic Behavior & Organization, 48, 305–317. Chikoto-Schultz, G. L., Ling, Q., & Neely, D. G. (2016). The adoption and use of the Hirschman—Herfindahl index in nonprofit research: Does revenue diver­ sification measurement matter? Voluntas: International Journal of Voluntary and Nonprofit Organizations, 27(3), 1425–1447. Corbin, J. J. (1999). A study of factors in influencing the growth of nonprofits in social services. Nonprofit and Voluntary Sector Quarterly, 28(3), 296–314. De Wit, A. (2018). Philanthropy and the welfare state: Why charitable dona­ tions do not simply substitute government support (Doctoral dissertation). VU Amsterdam. De Wit, A., & Bekkers, R. (2017). Government support and charitable donations: A meta-analysis of the crowding-out hypothesis. Journal of Public Administra­ tion Research and Theory, 27(2), 301–319. De Wit, A., Bekkers, R., & Broese van Groenou, M. (2017). Heterogeneity in crowding-out: When are charitable donations responsive to government sup­ port? European Sociological Review, 33(1), 59–71. De Wit, A., Neumayr, M., Handy, F., & Wiepking, P. (2018). Do government expenditures shift private philanthropic donations to particular fields of wel­ fare? Evidence from cross-country data. European Sociological Review, 34(1), 6–21. Eckel, C. C., Grossman, P. J., & Johnston, R. M. (2005). An experimental test of the crowding out hypothesis. Journal of Public Economics, 89, 1543–1560.

94

de Wit, Bekkers, and Wiepking

Einolf, C. J. (2015). The social origins of the nonprofit sector and charitable giving. In P. Wiepking & F. Handy (Eds.), The Palgrave handbook of global philanthropy (pp. 509–529). London, England: Palgrave Macmillan. Fischer, R. L., Wilsker, A., & Young, D. R. (2011). Exploring the revenue mix of nonprofit organizations: Does it relate to publicness? Nonprofit and Voluntary Sector Quarterly, 40(4), 662–681. Froelich, K. A. (1999). Diversification of revenue strategies: Evolving resource dependence in nonprofit organizations. Nonprofit and Voluntary Sector Quar­ terly, 28(3), 246–268. Gregory, A. G., & Howard, D. (2009). The nonprofit starvation cycle. Stanford Social Innovation Review, 7(4), 49–53. Grønbjerg, K. A., & Paarlberg, L. (2001). Community variations in the size and scope of the nonprofit sector: Theory and preliminary findings. Nonprofit and Voluntary Sector Quarterly, 30(4), 684–706. Handy, F. (2000). How we beg: The analysis of direct mail appeals. Nonprofit and Voluntary Sector Quarterly, 29(3), 439–454. Heutel, G. (2014). Crowding out and crowding in of private donations and gov­ ernment grants. Public Finance Review, 42(2), 143–175. Horne, C. S., Johnson, J. L., & Van Slyke, D. M. (2005). Do charitable donors know enough—And care enough—About government subsidies to affect pri­ vate giving to nonprofit organizations? Nonprofit and Voluntary Sector Quar­ terly, 34(1), 136–149. Hung, C., & Hager, M. A. (2019). The impact of revenue diversification on non­ profit financial health: A meta-analysis. Nonprofit and Voluntary Sector Quar­ terly, 48(1), 5–27. Ingram, P., & Clay, K. (2000). The choice-within-constraints new institutionalism and implications for sociology. Annual Reviews of Sociology, 26(1), 525–546. Khovrenkov, I. (2019). Does foundation giving stimulate or suppress private giving? Evidence from a panel of Canadian charities. Public Finance Review, 47(2), 382–408. Li, H., & McDougle, L. (2017). Information source reliance and charitable giv­ ing decisions. Nonprofit Management and Leadership, 27(4), 549–560. Lin, E. S., & Wu, S. Y. (2007). Lottery expenses and charitable contributions— Taiwan’s experience. Applied Economics, 39(17), 2241–2251. Lu, J. (2016). The philanthropic consequence of government grants to nonprofit organizations: A meta-analysis. Nonprofit Management and Leadership, 26(4), 381–400. Matsunaga, Y., & Yamauchi, N. (2004). Is the government failure theory still rel­ evant? A panel analysis using US state level data. Annals of Public and Coop­ erative Economics, 75(2), 227–263. Matsunaga, Y., Yamauchi, N., & Okuyama, N. (2010). What determines the size of the nonprofit sector? A cross-country analysis of the government failure theory. Voluntas: International Journal of Voluntary and Nonprofit Organiza­ tions, 21(2), 180–201. McDougle, L. M., & Handy, F. (2014). The influence of information costs on donor decision making. Nonprofit Management and Leadership, 24(4), 465–485. Merton, R. K. (1968). The Matthew effect in science. Science, 159(3810), 56–63. North, D. C. (1991). Institutions. Journal of Economic Perspectives, 5(1), 97–112.

Crowding-Out or Crowding-In

95

O’Regan, K., & Oster, S. (2002). Does government funding alter nonprofit gov­ ernance? Evidence from New York City nonprofit contractors. Journal of Pol­ icy Analysis and Management, 21(3), 359–379. Paarlberg, L. E., & Zuhlke, S. (2019). Revisiting the theory of government failure in the face of heterogeneous demands. Perspectives on Public Management and Governance, 2(2), 103–124. Payne, A. A. (2009). Does government funding change behavior? An empirical analysis of crowd out. Tax Policy and the Economy, 23(1), 159–184. Pennerstorfer, A., & Neumayr, M. (2017). Examining the association of welfare state expenditure, non-profit regimes and charitable giving. Voluntas: Inter­ national Journal of Voluntary and Nonprofit Organizations, 28(2), 532–555. Pfeffer, J., & Salancik, G. R. (1978). The external control of organizations: A resource dependence perspective. New York, NY: Harper & Row. Prentice, C. R. (2016). Why so many measures of nonprofit financial perfor­ mance? Analyzing and improving the use of financial measures in nonprofit research. Nonprofit and Voluntary Sector Quarterly, 45(4), 715–740. Ribar, D. C., & Wilhelm, M. O. (2002). Altruistic and joy-of-giving motivations in charitable behavior. Journal of Political Economy, 110(2), 425–457. Roberts, R. D. (1984). A positive model of private charity and public transfers. Journal of Political Economy, 92(1), 136–148. Rothstein, B. (1998). Just institutions matter—The moral and political logic of the universal welfare state. Cambridge: Cambridge University Press. Salamon, L. M., & Anheier, H. K. (1998). Social origins of civil society: Explain­ ing the nonprofit sector cross-nationally. Voluntas: International Journal of Voluntary and Nonprofit Organizations, 9(3), 213–248. Salamon, L. M., Sokolowski, S. W., & Haddock, M. A. (2017). Explaining civil society development: A social origins approach. Baltimore, MD: Johns Hop­ kins University Press. Sav, G. T. (2012). Government free riding in the public provision of higher educa­ tion: Panel data estimates of possible crowding out. Applied Economics, 44(9), 1133–1141. Schiff, J. (1990). Charitable giving and government policy: An economic analysis. Westport, CT: Greenwood Press. Schubert, P., & Boenigk, S. (2019). The nonprofit starvation cycle: Empirical evidence from a German context. Nonprofit and Voluntary Sector Quarterly, 48(3), 467–491. Seo, J. (2016). Resource dependence patterns and organizational behavior/struc­ ture in Korean nonprofit organizations. Nonprofit Management and Leader­ ship, 27(2), 219–236. Sokolowski, S. W. (2013). Effects of government support of nonprofit institu­ tions on aggregate private philanthropy: Evidence from 40 countries. Volun­ tas: International Journal of Voluntary and Nonprofit Organizations, 24(2), 359–381. Stadelmann-Steffen, I. (2011). Social volunteering in welfare states: Where crowding out should occur. Political Studies, 59(1), 135–155. Steinberg, R. (1991). Does government spending crowd out donations? Annals of Public and Cooperative Economics, 62(4), 591–612. Svallfors, S. (1997). Worlds of welfare and attitudes to redistribution: A compari­ son of eight western nations. European Sociological Review, 13(3), 283–304.

96

de Wit, Bekkers, and Wiepking

Tinkelman, D. (2010). Revenue interactions: Crowding out, crowding in, or nei­ ther? In B. A. Seaman & D. R. Young (Eds.), Handbook of research on non­ profit economics and management (pp. 18–41). Cheltenham, England: Edward Elgar Publishing Limited. Van Ingen, E., & Van der Meer, T. (2011). Welfare state expenditure and inequal­ ities in voluntary association participation. Journal of European Social Policy, 21(4), 302–322. Van Oorschot, W., & Arts, W. (2005). The social capital of European welfare states: The crowding out hypothesis revisited. Journal of European Social Pol­ icy, 15(1), 5–26. Verschuere, B., & De Corte, J. (2014). The impact of public resource dependence on the autonomy of NPOs in their strategic decision making. Nonprofit and Voluntary Sector Quarterly, 43(2), 293–313. Vesterlund, L. (2006). Why do people give? In W. E. Powell & R. S. Steinberg (Eds.), The nonprofit sector: A research handbook (2nd ed., pp. 568–590). New Haven, CT: Yale University Press. Warr, P. G. (1982). Pareto optimal redistribution and private charity. Journal of Public Economics, 19(1), 131–138. Weisbrod, B. A. (1977). The voluntary nonprofit sector: An economic analysis. Lexington, MA: Lexington Books. Wiepking, P., & Handy, F. (Eds.). (2015). The Palgrave handbook of global phi­ lanthropy. London, England: Palgrave Macmillan.

Part II

Revenues, Funding, and Financial Health

8

Revenue Diversification, Growth, and Stability Grace L. Chikoto-Schultz and Narttana Sakolvittayanon

Introduction In order to survive, all organizations must acquire and maintain the resources they need (Pfeffer & Salancik, 2003). In the case of nonprofit organizations (NPOs), the general recommendation has been to adopt a revenue diversification strategy, as part of their revenue-seeking behavior. Financial crises have demonstratively shown the uncertainty and insta­ bility of the economic environment and the resultant grave impacts on many NPOs. For example, in discussing the effects of the weak 2008 U.S. economy on NPOs, Chris Abele, then-president of the Argosy Foun­ dation, believed that many NPOs would not survive the economic con­ ditions (Schuyler, 2008). His prediction was confirmed by the closure of a large arts group, the Milwaukee Shakespeare (Milwaukee Shake), because its principal funder, the Argosy Foundation, was unable to honor its grant commitment of $925,000 of Milwaukee Shake’s total $1.3 mil­ lion expected budget for the 2008–2009 season (Milwaukee Journal Sentinel, 2008). Three observations can be made from this case: first, the Milwaukee Shake’s financial position was characterized by a serious case of resource dependence, in this case extreme revenue concentration. About 90% of the NPO’s revenue came from just one source. Second, NPOs need to ensure they have sufficient funds to be able to achieve their missions in the short term. And three, NPOs need to adopt measures and strategies that enhance their ability to withstand external crises and shocks that threaten their financial stability. A revenue diversification strategy is meant to mitigate against such environmental conditions of uncertainty and scarcity by relying on diverse sources of income and providing more financial cushion for the organization. Revenue diversification is generally cited as a key strat­ egy for achieving financial stability (Carroll & Stater, 2009; Chang & Tuckman, 1994; Froelich, 1999; Kim, 2017), effectively lowering the risk of financial crisis and improving the odds of organizational sur­ vival (Altman, 1968; Gilbert, Menon, & Schwartz, 1990; Ohlson, 1980). However, a revenue concentration strategy, which relies on

100

Chikoto-Schultz and Sakolvittayanon

fewer revenue streams, is not without its merits. Others have found empirical evidence in support of revenue concentration as a strategy for enhanced efficiency (Frumkin & Keating, 2011), and increased financial growth or capacity (Chikoto & Neely, 2014; Lin & Wang, 2016; von Schnurbein & Fritz, 2017). However, a recent meta-analysis of revenue diversification research found “a small, positive, yet statistically significant association between revenue diversification and nonprofit financial health” (Hung & Hager, 2019, p. 5). The authors concluded that the overall “effect is small, with negative and null effects largely counter-balancing the positive assess­ ment” of revenue diversification on financial health (Hung & Hager, 2019, p. 21). This same meta-analysis also found that whether financial health was measured as “static capacity or dynamic sustainability meas­ ures” (Hung & Hager, 2019, p. 22), as observed by Prentice (2016), it did not influence the effect of revenue diversification. What did matter was whether revenue diversification was measured as granular or aggre­ gated, as this distinction affected the financial health effects as observed in Chikoto, Ling, and Neely’s (2016) study. Lest we ‘toss out the baby with the bath water,’ it is still worth con­ sidering the richness of the collection of revenue diversification research and its contributions to the overall nonprofit finance debate. Each contri­ bution still draws attention to a particular dimension of the complexity of the revenue diversification strategy and the many factors that should or could influence an organization’s decision to diversify or concentrate. With these considerations in mind, this chapter addresses the definition of revenue diversification, how revenue diversification has been meas­ ured in the nonprofit field, some of the theoretical frameworks that have influenced its application and the respective effects on financial health, and some of its drivers as identified in select studies. In response to the question of whether revenue diversification is always positive, this chap­ ter concludes that it depends on each NPO’s mission and the services that flow from it, the strategic alignment of a revenue diversification strategy to that mission, and other factors that may be unique to each NPO and its environment.

Revenue Diversification and How It Is Measured NPOs’ activities can be financed through multiple funding streams, rang­ ing from government grants, contracts for services, the sale of goods and services, in-kind donations of goods (e.g., food aid) and services (e.g., volunteers), charitable giving from individuals and philanthropic organizations, membership dues, and investment income or returns on investments (Boris & Steuerle, 2006; Chang, Tuckman, & ChikotoSchultz, 2018; Young, 2007). The degree to which an NPO narrowly or broadly relies on these funding streams is what is referred to as ‘revenue

Revenue Diversification, Growth, and Stability

101

concentration’ or ‘revenue diversification.’ The ability to attract multiple funding sources is an opportunity unique to NPOs (compared to govern­ ments and for-profit corporations), whereas, managing multiple stake­ holders or funders can be a challenge. Within the nonprofit sector, revenue diversity has been measured through a revenue concentration index that is based on the HirschmanHerfindahl Index (HHI), which is traditionally used by economists to measure market concentration (Chang & Tuckman, 1994). The index’s roots can be traced to both Hirschman (1945, 1964) and Herfindahl (1950), both of whom independently developed it as a measure of “trade and industry concentration or inequality” (Chikoto et al., 2016, p. 1427). Since its debut in the nonprofit literature through Tuckman and Chang’s (1991) work, the HHI has been widely adopted (Chikoto et al., 2016). When originally introduced into nonprofit research, rev­ enue diversity was constructed as a revenue concentration index akin to the HHI. The revenue concentration index (RCI) was therefore calcu­ lated by summing the squared percentage share of each revenue stream, or by summing the squared portions of each revenue stream and dividing that by the square of total revenue (Tuckman & Chang, 1991; Chang & Tuckman, 1994). As shown in the equation below, each revenue source is denoted as i: RCI = ' ( Revenue Sourcei / Total Revenue )

2

Calculating RCI in this way demonstrates several properties: first, if total revenue came from a single source, RCI would be equal to ‘1,’ denoting revenue concentration (Chang & Tuckman, 1994); second, the value of RCI would also drop, indicating more diversification, as the proportion of each revenue source becomes more equally distributed; finally, RCI is not dependent on organizational size. Therefore, an RCI approaching ‘0’ would indicate that an organization’s revenue streams are more diversified, whereas, an RCI equal to ‘1’ or approaching ‘1’ indicates more concentrated revenue streams. To obtain a measure of revenue diversification (what we will refer to as the HHI), one would have to subtract RCI from ‘1.’ HHI = 1 - I ( Revenue Sourcei / Total Revenue )

2

Note, however, that Chabotar (1989) had earlier discussed the idea of diversified revenues to mitigate against a dependence on any single source, measuring diversity using common-size ratios based on the rev­ enue source as a proportion of total expenditures. To our knowledge, the only other study that measured revenue diversification in ways other than shown above is by Despard, Nafziger-Mayegun, Adjabeng, and Ansong (2017), who measured diversification using a count of the number of

102

Chikoto-Schultz and Sakolvittayanon

different revenue types and an ordinal variable based on the proportions of funding from international sources, ranging from ‘0’ (no international funding), to ‘2’ (receiving more than 50% from international sources). Recently, researchers have more commonly used a modified HHI which “considers the relative position of an NPO’s revenue structure [relative] to its maximal diversification scenario” (Yan, Denison, & Butler, 2009, p. 57), to measure revenue diversification, where n denotes the number of revenue sources for a given NPO: Modified HHI =

1 - L ( Revenue Sourcei / Total Revenue )

2

(1 - n ) / n

Sensitivity of the Measurement Primarily as a function of the available data, or to maintain consistency with prior research, studies have tended to calculate the HHI using vary­ ing numbers of revenue streams. In other words, varying numbers of revenue streams came from aggregated and disaggregated measures of different revenue streams. For example, donative income can be con­ sidered one revenue stream or it can be disaggregated into individual donations, institutional donations, and government grants. Conse­ quently, HHI calculations have ranged from three to 21 sources: dona­ tive, earned, and investment income (Carroll & Stater, 2009; Frumkin & Keating, 2002; Keating, Fischer, Gordon, & Greenlee, 2005); donative, earned, investment income, and government grants (Yan et al., 2009); five sources (Hager, 2001), 11 sources (Calabrese, 2011), 13 (Chikoto & Neely, 2014), 19 (Wicker & Breuer, 2013), and 21 (Wicker, Longley, & Breuer, 2015). Whereas the number of revenue streams used in the calculation of the HHI may seem innocuous, Chikoto et al. (2016) warned against infor­ mation loss that occurs through aggregation, which “in turn affects the estimation results” (p. 1439) in non-trivial ways. This finding has been confirmed by Hung and Hager’s (2019) recent meta-analysis. There­ fore, researchers should opt to use more disaggregated revenue streams, whenever possible, to avoid information loss in the aggregation process (Chikoto et al., 2016).

Revenue Diversification Perspectives and Their Application At least four rational behavior lenses are associated with the revenue diversification strategy, namely, resource dependence theory, transac­ tion costs theory, organizational institutionalism theory, and the modern portfolio theory. These theoretical perspectives regard NPOs as objec­ tive maximizers that “develop income portfolios that allow them to

Revenue Diversification, Growth, and Stability

103

maximize total outputs or resources that can be converted into outputs” (Kearns, 2007, p. 297). First, resource dependence theory is premised on the idea that organizations establish relationships with others in order to obtain the resources they lack (Pfeffer & Salancik, 2003). This theory explains NPOs’ funded relationships through the nature of the resource exchange and power asymmetry associated with the exchange (Oliver, 1990; Pfeffer & Salancik, 2003). As such, an organization is “con­ trolled by an external source to the extent [it depends] on that source for a large proportion of inputs or outputs” (Pfeffer & Salancik, 2003, p. 271), as observed in the Milwaukee Shake case. Because NPOs oper­ ate in resource-scarce, highly competitive and therefore uncertain envi­ ronments, choosing to diversify funding sources is expected to reduce the uncertainty associated with a dependence on a single funding source (Chang & Tuckman, 1994; Grønbjerg, 1993). Revenue diversification becomes a combative strategy for loosening resource dependencies (Pfeffer & Salancik, 2003). Organizational institutionalism bases organizational success on the degree to which an organization responds and adapts to changes in its external environment. For an NPO, having diverse funding streams establishes favorable linkages with the community due to buy-in, thus enhancing organizational legitimacy and recognition (Bielefeld, 1992; Galaskiewicz, 1990; Galaskiewicz & Bielefeld, 1998). This in turn leads to additional support from the community (Kearns, 2007), thus bolster­ ing an NPO’s financial stability (Carroll & Stater, 2009; Chang & Tuckman, 1994; Tuckman & Chang, 1991). Using the above perspectives, some researchers have examined the efficacy of revenue diversification as a combative strategy for loosening resource dependencies in order to minimize NPOs’ financial vulnerabili­ ties and volatility. For example, Tuckman and Chang (1991) and Chang and Tuckman (1994) found revenue diversification to be positively asso­ ciated with financial health, measured in terms of higher operating mar­ gins and net assets. Greenlee and Trussel (2000) and Trussel (2002) also found revenue diversifiers less financially vulnerable and less likely to cut program expenses or face losses in net assets over three consecutive years. Hager (2001) also found arts NPOs less likely to close when they had diversified funding sources. Using a more robust dataset from the National Center for Charitable Statistics (NCCS) Core 990 data, Carroll and Stater (2009) found a positive association between revenue diver­ sification and financial stability. The authors concluded that over time NPOs can increase their financial stability by equalizing their reliance on contributions, earned income, and investment income (Carroll & Sta­ ter, 2009). Focusing on a subset of larger NPOs, Frumkin and Keating (2011) also found the revenue diversification strategy to benefit NPOs through “greater surplus margins and liquidity and a lower insolvency risk” (p. 161).

104 Chikoto-Schultz and Sakolvittayanon The transaction costs theory, on the other hand, points to the nega­ tives of revenue diversification. According to this theory, the complexities of revenue diversification result in inefficiencies from managing multi­ ple funding relationships, especially because funding sources are charac­ terized by diverse motivations, preferences, and objectives (Grønbjerg, 1993; Pfeffer & Salancik, 2003; Young, 2007). Moreover, additional transaction costs of time, attention, and money (Hager & Hung, 2019) are required to support individual solicitations, fundraising competen­ cies (Chikoto-Schultz & Neely, 2016), and the differential accountability requirements (Chikoto, 2015; Ebrahim, 2003) of each revenue source. This theory, therefore, cautions NPOs to review and understand each funding source, as it relates to their missions and their ability to achieve those missions using different funding streams. A few empirical studies found support for the transaction costs associ­ ated with revenue diversification. For instance, Foster and Fine (2007) attributed the growth of 110 of the 144 NPOs that grew their annual revenues to $50 million, between 1970 and 2003, to revenue concentra­ tion. The authors found that 90% of those 110 NPOs relied on a single funding source (Foster & Fine, 2007). However, the authors did note that it was within the single funding sources that these NPOs diversified (Fos­ ter & Fine, 2007), a phenomenon Chikoto and Neely (2014) referred to as ‘within-source diversification.’ Frumkin and Keating (2011), however, found no systematic influence of revenue concentration on mean growth in total revenue, fixed assets, and program expenses for the sample of larger NPOs on which their study focused. Using more robust NCCS Form 990 digitized data (1998–2003), Chikoto and Neely (2014) confirmed Foster and Fine’s (2007) finding and found the revenue concentration strategy to be positively associated with five-year growth in total revenue. This relationship also has been confirmed by Lin and Wang (2016), who focused their study on New Jersey human services and community improvement NPOs, as well as by von Schnurbein and Fritz (2017), who focused on Swiss fundrais­ ing charities. However, “increasingly becoming more [revenue] concen­ trated over time may be unwise,” suggesting that revenue concentration may be more effective at financial capacity building “when deployed as a one-time strategy” (Chikoto & Neely, 2014, p. 579). Nonetheless, the revenue concentration strategy has been associated with efficiency benefits in the form of lower administrative and fundraising expenses (Frumkin & Keating, 2011). ‘Revenue concentrators’ tend to rely on earned income from government funders, and due to government’s high accountability demands, such organizations are compelled to be costconscious and to effectively manage their cash flows (Chikoto, 2015; Frumkin & Keating, 2011). Finally, Markowitz’s (1952) modern portfolio theory (MPT) is con­ cerned with how each funding source adds to the portfolio (i.e., expected

Revenue Diversification, Growth, and Stability

105

return) and its volatility (risk). According to this theory, investors should build their portfolios by balancing expected return and risk (or standard deviation of return) of all revenues together, rather than simply diversi­ fying revenue sources (Markowitz, 1952). Because this theory is rooted more in business investment allocation strategies, it is not necessarily about directing NPOs on how to access the appropriate funding sources that help maximize their missions. Nonetheless, the theory allows for an appreciation of the complexities of the risks and rewards associated with multiple funding streams (Hung & Hager, 2019). The MPT proposes three key features of portfolio selection. First, all sources of revenue face risks from both economic and non-economic conditions. These conditions can affect revenue from one or all sources (Markowitz, 1959). Second, sources of revenue have different levels of correlation among them. Simply diversifying revenue sources will not eliminate risk if all sources are highly correlated. Therefore, the recom­ mendation is that organizations’ portfolios should consist of revenue sources that are low or negatively correlated with each other (Markowitz, 1959). Third, managers should design their portfolios based on organiza­ tions’ objectives; the two most common objectives are high return and low risk. However, there is a trade-off between high expected return and low risk. A portfolio with high return is likely to be subject to a high degree of risk; therefore, the choice of portfolio will depend on the will­ ingness and ability of an organization to take risk (Markowitz, 1959). In their meta-analysis, Hung and Hager (2019) observed a disconnec­ tion between how revenue diversification is predominantly measured and the MPT foundation upon which the HHI has been purported to rest. Consequently, only a handful of empirical investigations have more closely applied the MPT perspective in an effort to understand the influ­ ence of revenue diversification on nonprofit financial health (Grasse, Whaley, & Ihrke, 2016; Jegers, 1997; Kingma, 1993; Mayer, Wang, Egginton, & Flint, 2014). For example, Kingma (1993) applied the MPT to study the financial predictability of nonprofit foster care organizations in New York state. The author found that these organizations gained more financial predictability through increased funding from the govern­ ment; however, relying on a revenue mix comprising donations, fees for services, and special events increased organizations’ financial risk. These results demonstrate that neither depending on one revenue source nor complete revenue diversification will minimize an NPO’s income risk. Instead, an NPO can choose the right level of revenue diversification by considering the expected return, risk, and correlation between different sources of revenue (Kingma, 1993). In recognition of the MPT’s suggestion that diversification can increase financial stability at the expense of reduced expected revenue, Mayer et al. (2014) sought to test this relationship, in addition to testing the effects of different revenue diversification compositions on volatility and

106 Chikoto-Schultz and Sakolvittayanon expected revenue. The authors concluded that the efficacy of the rev­ enue diversification strategy on reducing financial volatility (or increas­ ing stability) was largely influenced by the composition of one’s revenue portfolio or mix and how that composition changed (Mayer et al., 2014). For instance, a diversification strategy of replacing investment income with donations reduced volatility (increased stability) and also increased expected revenue. However, a diversified revenue mix achieved through replacing earned income with donations only increased financial stability at the expense of expected revenues (Mayer et al., 2014). Qu (2016) sought to understand the optimal mix of revenue sources that best serve an NPO by applying the MPT on nonprofit finance, using the NCCS Form 990 digitized data (1998–2003). Focusing on five rev­ enue sources—contributions and grants; land, buildings, and equipment for investment (rental properties); savings and temporary cash invest­ ments; securities; and sales from special events, Qu (2016) found that revenues from contributions and grants and sales from special events had the highest and second-highest expected return and risk, respectively, compared to the remaining three revenue sources. In addition, sales from special events and rental properties had a low level of correlation with contributions and grants, suggesting that they were a good revenue mix for minimizing financial risk (Qu, 2016). Conversely, savings and tempo­ rary cash investments, and securities, and contributions and grants were highly correlated, suggesting that the revenue mix was incompatible and therefore, prone to high financial risk (Qu, 2016). Although the featured studies above demonstrate mixed results, they each reveal an aspect of the revenue diversification strategy that NPOs ought to pay close attention to, as they select a revenue strategy that best helps them remain financially health and to ultimately achieve their mis­ sions. Below we address factors that influence revenue diversification.

Drivers of Revenue Diversification Studies have shown that NPOs have different abilities in diversifying their revenue structures, depending on their organizational character­ istics, management, and environment (Chang & Tuckman, 1994; Lin, 2010; Young, 2007; Zhu, Ye, & Liu, 2018). One key organizational characteristic that affects NPOs’ ability to diversify their revenue sources is the type of activities in which they engage (Chang & Tuckman, 1994; Young, 2007). For example, services offered by a cancer clinic confer or generate private, group, and public benefits, making it easier to attract funding from multiple sources, such as patients, donations, governments, and community organizations (Chang & Tuckman, 1994; Fischer, Wil­ sker, & Young, 2010; Wilsker & Young, 2010; Young, 2007). This result is different from an environmental group’s services, which confer group benefits and thus primarily attract membership dues from those who are

Revenue Diversification, Growth, and Stability

107

concerned about the environment, along with government grants, due to the benefit that protecting the environment may confer on the general public. Additional organizational characteristics that positively drive rev­ enue diversification include organizational age, employee size, volunteer size, and growth of programs and services (Lin, 2010). From a management perspective, research has found the following fac­ tors to positively drive revenue diversification: spending more money on fundraising (Chang & Tuckman, 1994), having an internal fund develop­ ment staff, attaching more importance to revenue diversification, having more board meetings each year (Lin, 2010), involving boards in resource acquisition, and being more accountable to multiple stakeholders (Zhu et al., 2018). In terms of environmental factors, NPOs that operate in less competitive regions (i.e., high GDP per capita and low number of organi­ zations in the region) and have better relationships with external partners were more likely to diversify their revenues (Lin, 2010; Zhu et al., 2018). Hager and Brudney (2011) and von Schnurbein and Fritz (2017) referred to some of the above drivers in terms of ‘nature,’ that is, those conditions that are not readily amenable to managerial interventions or response, such as legal form, organizational age, and size; or ‘nurture,’ those that can be influenced by management. Focusing on Swiss NPOs, von Schnurbein and Fritz (2017) found that the wider the geographic radius of an NPO’s activity (e.g., international focus), the higher the revenue concentration of particular revenue sources, and the larger a Swiss NPO became (measured by total revenue, thus signifying increased professionalism), the more diverse their revenue streams become. With regards to nurture factors, such as shifting one’s primary source of income over time, board diversity, and board size, the authors found that NPOs that did not shift their primary funding source over time tended to have more concentrated revenues (von Schnurbein & Fritz, 2017). However, the authors found that the more diversified and the larger the board, the higher the diversity of revenues an organization had.

Discussion and Conclusions What we know so far is that “revenue diversification is a central feature of many financial health and sustainability models” (Hung & Hager, 2019, p. 6). However, is revenue diversification always a net positive? Hung and Hager’s (2019) meta-analysis found a small, positive asso­ ciation between revenue diversification and financial health across 40 studies done predominantly in the United States. These findings dem­ onstrate that the relationship between revenue diversification and nonprofit financial health, whether measured as capacity or stability, is neither simple nor straightforward, nor has this complication been comprehensively reflected in the applications of the HHI. On the one hand, revenue diversification has been associated with financial stability

108

Chikoto-Schultz and Sakolvittayanon

and reduced financial distress (Carroll & Stater, 2009; Chang & Tuckman, 1994; Greenlee, 2002; Greenlee & Trussel, 2000; Hager, 2001); on the other, its inverse has been associated with financial growth (Chikoto & Neely, 2014; Chikoto-Schultz & Neely, 2016; Foster & Fine, 2007; Lin & Wang, 2016; von Schnurbein & Fritz, 2017). Fur­ thermore, revenue diversification itself is influenced by other nature and nurture factors. As noted above, the rich revenue diversification literature to date can be summarized into several theoretical advantages and disadvantages of the revenue diversification strategy, all amply captured by Hager and Hung (2019). On the positive, relying on broader funding streams pro­ vides some NPOs with flexibility and autonomy when donor preferences and motivations change, and when economic downturns cause signifi­ cant funding drops and cuts (Carroll & Stater, 2009; Chang & Tuckman, 1994; Froelich, 1999; Greenlee & Trussel, 2000; Hager, 2001; Mitchell, 2014; Pfeffer & Salancik, 2003). Not only are NPOs able to weather financial storms, but having a cushion also allows NPOs to be less resource-dependent on a single funder, thus allowing them to shift strategic direction when needed (Pfeffer & Salancik, 2003). Efforts NPOs take to diversify their funding sources have also been linked to the need to establish community embeddedness or network connectedness (Hager, Galaskiewicz, & Larson, 2004; Hung & Hager, 2019), thus improving NPOs’ community buy-in, legitimacy, relevance, or recognition in the community (Bielefeld, 1992; Galaskiewicz, 1990). In the event of financial shocks, NPOs may be able to leverage their com­ munity connections for financial stability. Finally, diversified revenues can theoretically “represent opportunities for growth” (Hung & Hager, 2019, p. 8), by allowing NPOs the confidence to pursue new revenue streams. However, corroborating Foster and Fine’s (2007) research, Chikoto and Neely (2014) found that relying on narrower or fewer fund­ ing streams contributed to financial growth, but for a season. On the negative, the revenue diversification strategy has been associ­ ated with increased complexity and risk resulting from the reliance on multiple and diverse funding sources. Consistent with the risk-return concept in modern portfolio theory (Markowitz, 1952), by failing to account for how different revenue sources may relate to one another (Qu, 2016), or misunderstanding the risks associated with each funding stream (Grasse et al., 2016), or how revenue sources might crowd others in or out (Andreoni & Payne, 2011; Brooks, 2000), merely diversifying for diversification’s sake might adversely affect an organization’s finan­ cial health. Revenue diversification has also been associated with increased admin­ istrative costs, fundraising costs (Frumkin & Keating, 2011; Kingma, 1993), and management complexity (Grønbjerg, 1993). Given the diver­ sity and mutability of donor motivations, preferences, and expectations

Revenue Diversification, Growth, and Stability

109

(Fischer et al., 2010; Wilsker & Young, 2010; Young, 2007), diversifi­ cation may mean establishing multiple management systems and hiring expertise to solicit, monitor, and provide differential accounts to multiple funding sources (Chikoto, 2015; Frumkin & Keating, 2011; Grønbjerg, 1993; Hung & Hager, 2019). Such administrative costs and manage­ ment complexity could inadvertently lead to goal conflicts from satisfy­ ing differential funding criteria (Ferris & Graddy, 1989; Froelich, 1999; Weisbrod, 1998), culminating in mission drift (Froelich, 1999; Sacristán López de los Mozos, Rodríguez Duarte, & Rodríguez Ruiz, 2016). Based on the preceding, it is clear that the relationship between rev­ enue diversification and financial health is indeed very complex and is influenced by multi-dimensional factors. Chief among them are nature drivers of revenue diversification (von Schnurbein & Fritz, 2017), espe­ cially NPOs’ missions and the services flowing from them (Fischer et al., 2010; Grønbjerg, 1993; Weisbrod, 1998; Wilsker & Young, 2010; Young, 2007). With the organizational mission as the touchstone, NPOs should aim to strategically align their funding streams more tightly with their missions, the services that flow from them, and the nature of the benefits those services confer on various beneficiaries and benefactors (Young, 2007). To confirm, Hung and Hager’s (2019) meta-analysis found revenue diversification to have a mildly positive effect on the finan­ cial health of NPOs in the arts, education, human services, religion, and health subsectors. This chapter concludes with two normative reminders for NPOs: one, that “the key to organizational survival” rests in an organization’s “abil­ ity to acquire and maintain resources” and in how effectively it manages and deploys them (Pfeffer & Salancik, 2003, p. 2). Whether NPOs rely on fewer or more funding streams should thus first be clarified through their missions and services, as suggested by Young (2007). Ultimately, the composition of an NPO’s funding portfolio or mix matters (Mayer et al., 2014), and the mix must be such that it addresses three basic issues: covering current operations, in terms of current costs to meet the organi­ zation’s mission achievement in the short term; financing longer term cap­ ital needs, should the NPO need to expand in the future; and addressing strategic adjustment issues such as possible interactions among funding sources, the guarantee of solvency, mission achievement, risk manage­ ment, and administrative feasibility (for details, see Young, 2007). A second reminder is that, because of the power asymmetry inherent in resource exchanges within funded relationships, not all funding sources behave equally. NPOs should not neglect monitoring the degree to which different funding streams engender unhealthy dependencies, especially ones that threaten to undermine their sustainability, pose the risk of mission creep or mission dilution, or cause legitimacy erosion (Froelich, 1999). This awareness calls for a keen understanding of each funding stream’s motives, preferences, and objectives, as noted above, vis-à-vis

110

Chikoto-Schultz and Sakolvittayanon

one’s organizational mission, identity, and ability to achieve the mission. This necessity is in addition to understanding the risk-return tradeoffs associated with different funding sources. Taking all these factors into account, how and whether an NPO diversifies should be a thoughtful, strategic choice or decision. Whether diversification is a net positive or negative will vary based on each NPO and its unique internal and exter­ nal circumstances.

References Altman, E. I. (1968). Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. The Journal of Finance, 23(4), 589–609. Andreoni, J., & Payne, A. A. (2011). Is crowding out due entirely to fundrais­ ing? Evidence from a panel of charities. Journal of Public Economics, 95(5–6), 334–343. Bielefeld, W. (1992). Non-profit-funding environment relations: Theory and application. Voluntas: International Journal of Voluntary and Nonprofit Organizations, 3(1), 48–70. Boris, E. T., & Steuerle, C. E. (2006). Scope and dimensions of the nonprofit sec­ tor. In W. W. Powell & R. Steinberg (Eds.), The nonprofit sector: A research handbook (pp. 66–88). New Haven, CT: Yale University Press. Brooks, A. C. (2000). Public subsidies and charitable giving: Crowding out, crowding in, or both? Journal of Policy Analysis and Management, 19(3), 451–464. Calabrese, T. D. (2011). The accumulation of nonprofit profits: A dynamic analy­ sis. Nonprofit and Voluntary Sector Quarterly, 41(2), 300–324. Carroll, D. A., & Stater, K. J. (2009). Revenue diversification in nonprofit organi­ zations: Does it lead to financial stability? Journal of Public Administration Research and Theory, 19(4), 947–966. Chabotar, K. J. (1989). Financial ratio analysis comes to nonprofits. The Journal of Higher Education, 60(2), 188–208. Chang, C. F., & Tuckman, H. P. (1994). Revenue diversification among non­ profits. Voluntas: International Journal of Voluntary and Nonprofit Organiza­ tions, 5(3), 273–290. Chang, C. F., Tuckman, H. P., & Chikoto-Schultz, G. L. (2018). Income diver­ sity and nonprofit financial health. In B. A. Seaman & D. R. Young (Eds.), Handbook of research on nonprofit economics and management (2nd ed., pp. 11–34). Northampton, MA: Edward Elgar Publishing. Chikoto, G. L. (2015). Steering international NGOs through time: The influence of temporal structuring in government accountability requirements. Nonprofit Policy Forum, 6(1), 59–90. Chikoto, G. L., Ling, Q., & Neely, D. G. (2016). The adoption and use of the Hirschman—Herfindahl Index in nonprofit research: Does revenue diversifica­ tion measurement matter? Voluntas: International Journal of Voluntary and Nonprofit Organizations, 27(3), 1425–1447. Chikoto, G. L., & Neely, D. G. (2014). Building nonprofit financial capacity: The impact of revenue concentration and overhead costs. Nonprofit and Voluntary Sector Quarterly, 43(3), 570–588.

Revenue Diversification, Growth, and Stability

111

Chikoto-Schultz, G. L., & Neely, D. G. (2016). Exploring the nexus of nonprofit financial stability and financial growth. Voluntas: International Journal of Vol­ untary and Nonprofit Organizations, 27(6), 2561–2575. Despard, M. R., Nafziger-Mayegun, R. N., Adjabeng, B. K., & Ansong, D. (2017). Does revenue diversification predict financial vulnerability among non­ governmental organizations in sub-Saharan Africa? Voluntas: International Journal of Voluntary and Nonprofit Organizations, 28(5), 2124–2144. Ebrahim, A. (2003). Accountability in practice: Mechanisms for NGOs. World Development, 31(5), 813–829. Ferris, J. M., & Graddy, E. (1989). Fading distinctions among the nonprofit, government, and forprofit sectors. In V. Hodgkinson & R. Lyman (Eds.), The future of the nonprofit sector (pp. 123–139). San Francisco, CA: Jossey-Bass. Fischer, R. L., Wilsker, A., & Young, D. R. (2010). Exploring the revenue mix of nonprofit organizations: Does it relate to publicness? Nonprofit and Voluntary Sector Quarterly, 40(4), 662–681. Foster, W., & Fine, G. (2007). How nonprofits get really big. Stanford Social Innovation Review, 5(2), 46–55. Froelich, K. A. (1999). Diversification of revenue strategies: Evolving resource dependence in nonprofit organizations. Nonprofit and Voluntary Sector Quar­ terly, 28(3), 246–268. Frumkin, P., & Keating, E. K. (2002). The risks and rewards of nonprofit rev­ enue concentration (Faculty Research Working Paper Series). Cambridge, MA: Hauser Center for Nonprofit Organizations. Frumkin, P., & Keating, E. K. (2011). Diversification reconsidered: The risks and rewards of revenue concentration. Journal of Social Entrepreneurship, 2(2), 151–164. Galaskiewicz, J. (1990). Growth, decline, and organizational strategies: A panel study of nonprofit organizations, 1980–1988. Washington, DC: Independent Sector. Galaskiewicz, J., & Bielefeld, W. (1998). Nonprofit organizations in an age of uncertainty. New York, NY: Aldine De Gruyter. Gilbert, L. R., Menon, K., & Schwartz, K. B. (1990). Predicting bankruptcy for firms in financial distress. Journal of Business Finance & Accounting, 17(1), 161–171. Grasse, N. J., Whaley, K. M., & Ihrke, D. M. (2016). Modern portfolio theory and nonprofit arts organizations: Identifying the efficient frontier. Nonprofit and Voluntary Sector Quarterly, 45(4), 825–843. Greenlee, J. S. (2002). Revisiting the prediction of financial vulnerability. Non­ profit Management and Leadership, 13(1), 17–31. Greenlee, J. S., & Trussel, J. M. (2000). Predicting the financial vulnerability of charitable organizations. Nonprofit Management and Leadership, 11(2), 199–210. Grønbjerg, K. (1993). Understanding non-profit funding: Managing revenues in social services and community development organizations. San Francisco, CA: Jossey-Bass. Hager, M. A. (2001). Financial vulnerability among arts organizations: A test of the Tuckman-Chang measures. Nonprofit and Voluntary Sector Quarterly, 30(2), 376–392.

112

Chikoto-Schultz and Sakolvittayanon

Hager, M. A., & Brudney, J. L. (2011). Problems recruiting volunteers: Nature versus nurture. Nonprofit Management and Leadership, 22(2), 137–157. Hager, M. A., Galaskiewicz, J., & Larson, J. A. (2004). Structural embeddedness and the liability of newness among nonprofit organizations. Public Manage­ ment Review, 6(2), 159–188. Hager, M. A.,& Hung, C. (2019, April10). Is diversification of revenue good for non­ profit financial health? Nonprofit Quarterly. Retrieved from https://nonprofit­ quarterly.org/is-diversification-of-revenue-good-for-nonprofit-financial-health/ Herfindahl, O. C. (1950). Concentration in the U.S. steel industry (Unpublished doctoral dissertation). Columbia University, New York, NY. Hirschman, A. O. (1945). National power and the structure of foreign trade. Los Angeles: University of California Press. Hirschman, A. O. (1964). The paternity of an index. The American Economic Review, 54(5), 761. Hung, C., & Hager, M. A. (2019). The impact of revenue diversification on non­ profit financial health: A meta-analysis. Nonprofit and Voluntary Sector Quar­ terly, 48(1), 5–27. Jegers, M. (1997). Portfolio theory and nonprofit financial stability: A comment and extension. Nonprofit and Voluntary Sector Quarterly, 26(1), 65–72. Kearns, K. (2007). Income portfolios. In D. Young (Ed.), Financing nonprofits (pp. 291–314). New York, NY: Altamira Press. Keating, E. K., Fischer, M., Gordon, T. P., & Greenlee, J. S. (2005). Assessing financial vulnerability in the nonprofit sector (Faculty Research Working Paper Series, Paper No. 27). Cambridge, MA: Hauser Center for Nonprofit Organizations. Kim, M. (2017). The relationship of nonprofits’ financial health to program out­ comes: Empirical evidence from nonprofit arts organizations. Nonprofit and Voluntary Sector Quarterly, 46(3), 525–548. Kingma, B. R. (1993). Portfolio theory and nonprofit financial stability. Non­ profit and Voluntary Sector Quarterly, 22(2), 105–119. Lin, W. (2010). Nonprofit revenue diversification and organizational perfor­ mance: An empirical study of New Jersey human services and community improvement organizations (Doctoral dissertation). Retrieved from ProQuest Dissertations & Theses Global. (Order No. 3428096) Lin, W., & Wang, Q. (2016). What helped nonprofits weather the great reces­ sion? Evidence from human services and community improvement organiza­ tions. Nonprofit Management and Leadership, 26(3), 257–276. Markowitz, H. (1952). Portfolio selection. The Journal of Finance, 7(1), 77–91. Markowitz, H. (1959). Portfolio selection: Efficient diversification of investment. New Haven, CT: Yale University Press. Mayer, W. J., Wang, H. C., Egginton, J. F., & Flint, H. S. (2014). The impact of revenue diversification on expected revenue and volatility for nonprofit organi­ zations. Nonprofit and Voluntary Sector Quarterly, 43(2), 374–392. Milwaukee Journal Sentinel. (2008, October 28). Milwaukee Shakespeare to close after Argosy cuts funding. Retrieved March 4, 2019, from http://archive. jsonline.com/entertainment/arts/33456084.html/ Mitchell, G. E. (2014). Strategic responses to resource dependence among trans­ national NGOs registered in the United States. Voluntas: International Journal of Voluntary and Nonprofit Organizations, 25(1), 67–91.

Revenue Diversification, Growth, and Stability

113

Ohlson, J. A. (1980). Financial ratios and the probabilistic prediction of bank­ ruptcy. Journal of Accounting Research, 18(1), 109–131. Oliver, C. (1990). Determinants of interorganizational relationships: Integration and future directions. Academy of Management Review, 15(2), 241–265. Pfeffer, J., & Salancik, G. R. (2003). The external control of organizations: A resource dependence perspective. Stanford, CA: Stanford University Press. Prentice, C. R. (2016). Why so many measures of nonprofit financial perfor­ mance? Analyzing and improving the use of financial measures in nonprofit research. Nonprofit and Voluntary Sector Quarterly, 45(4), 715–740. Qu, H. (2016). Two essays on nonprofit finance (Doctoral dissertation). Retrieved from ProQuest Dissertations & Theses Global. (Order No. 10144403) Sacristán López de los Mozos, I., Rodríguez Duarte, A., & Rodríguez Ruiz, Ó. (2016). Resource dependence in non-profit organizations: Is it harder to fundraise if you diversify your revenue structure? Voluntas: International Journal of Voluntary and Nonprofit Organizations, 27(6), 2641–2665. Schuyler, D. (2008, December 7). Abele: Not all nonprofits will survive. Mil­ waukee Journal Sentinel. Retrieved from www.bizjournals.com/milwaukee/ stories/2008/12/08/story2.html Trussel, J. M. (2002). Revisiting the prediction of financial vulnerability. Non­ profit Management and Leadership, 13(1), 17–31. Tuckman, H. P., & Chang, C. F. (1991). A methodology for measuring the finan­ cial vulnerability of charitable nonprofit organizations. Nonprofit and Volun­ tary Sector Quarterly, 20(4), 445–460. von Schnurbein, G. V., & Fritz, T. M. (2017). Benefits and drivers of nonprofit revenue concentration. Nonprofit and Voluntary Sector Quarterly, 46(5), 922–943. Weisbrod, B. A. (1998). The nonprofit mission and its financing: Growing links between nonprofits and the rest of the economy. In B. A. Weisbrod (Ed.), To profit or not to profit (pp. 1–24). Cambridge: Cambridge University Press. Wicker, P., & Breuer, C. (2013). Examining the financial condition of sport gov­ erning bodies: The effects of revenue diversification and organizational success factors. Voluntas: International Journal of Voluntary and Nonprofit Organiza­ tions, 25(4), 929–948. Wicker, P., Longley, N., & Breuer, C. (2015). Revenue volatility in German non­ profit sports clubs. Nonprofit and Voluntary Sector Quarterly, 44(1), 5–24. Wilsker, A. L., & Young, D. R. (2010). How does program composition affect the revenues of nonprofit organizations? Investigating a benefits theory of non­ profit finance. Public Finance Review, 38(2), 193–216. Yan, W., Denison, D. V., & Butler, J. S. (2009). Revenue structure and nonprofit borrowing. Public Finance Review, 37(1), 47–67. Young, D. R. (2007). Financing nonprofits: Putting theory into practice. Lanham, MD: Altamira Press. Zhu, J., Ye, S., & Liu, Y. (2018). Legitimacy, board involvement, and resource competitiveness: Drivers of NGO revenue diversification. Voluntas: Interna­ tional Journal of Voluntary and Nonprofit Organizations, 29(6), 1176–1189.

9

Nonprofit Profits Slack, Surplus, and Reserves Thad D. Calabrese and Todd L. Ely

Introduction Despite the term ‘nonprofit,’ organizations classified as such are permit­ ted to earn profits, which are simply revenues in excess of expenses in any given year. The defining characteristic of these nonprofit organiza­ tions (NPOs) is the ‘non-distribution constraint,’ in which these annual or accumulated profits may not be distributed to a board of directors or other controlling entity (Hansmann, 1980). Other than this explicit dis­ tribution, NPOs have significant discretion over how these excess funds are ultimately used. This chapter addresses the issues of slack resources and surplus in NPOs, summarizes the current state of literature on these topics, provides an empirically-based snapshot of slack resources and surplus in NPOs, and considers what is currently unknown or unclear in the literature.

Definitions Managerially, slack resources are those excess and available funds that may be employed in times of need (caused perhaps by routine business cycles, natural disasters, or human-caused events), to take advantage of potential opportunities, or to grow and expand an organization’s service offerings. Whereas the term slack has a negative connotation in everyday use, it is widely accepted that NPOs require surplus annual revenues (that is, revenues in excess of expenses) to fulfill long-term missions (Bowman, 2011). Slack can take many forms in NPOs. Research has focused on rel­ atively liquid assets that might be easily accessed (Calabrese, 2013, 2018; Grizzle, Sloan, & Kim, 2015). However, as noted by Sloan, Charles, and Kim (2016), some NPO managers consider other forms of slack as well. For example, lines of credit which are short-term unsecured bor­ rowings are a common tool to manage liquidity concerns like periodic cash flow needs; investment accounts may serve a similar purpose by permitting managers to sell assets when needed or pledge these assets as collateral for borrowing;1 some even consider fixed assets a form of slack

Nonprofit Profits

115

if managers know they can sell these assets relatively quickly. However, for purposes here, slack refers to relatively liquid and available assets that can be inexpensively deployed when needed. One important source of slack is annual profits or surpluses. These annual profits are an important source of internal financing for NPOs. For-profit firms have well-developed equity markets for acquiring needed capital, and an equivalent market for NPOs (for example, for donations) does not exist. The nonprofit sector refers to annual profits or losses as ‘changes in net assets,’ even though all of these terms are function­ ally equivalent. The nonprofit sector has unique accounting require­ ments, however, that further complicate the topic and specifically affect availability of resources (a key criterion of slack). Donors may restrict how or when an NPO may use a particular contribution. These donorrestricted contributions can result in the recording of revenues (and sub­ sequently result in a profit) even though the organization cannot spend the resources. For example, suppose an NPO receives a $100,000 donation, and the contributor states that these funds are never to be spent directly, but any earnings derived from the donation may be spent. This is an example of what is termed a true endowment. From the perspective of the organiza­ tion, the $100,000 donation exists to generate future revenues that fund future spending. However, in the year the donation is recorded, the NPO would record a revenue of $100,000 in addition to any other surplus generated that year. Hence, when considering NPOs’ annual profits, one should consider the role of donor-imposed restrictions. Not all profits are available for an NPO to use at their discretion, as this true endowment example clearly illustrates. All available resources are best not thought of as ‘slack’ either. Here we further distinguish between assets that are held for working capital— that is, cash held largely for operational and transactional purposes— and operating reserves—that is, liquid available resources held primarily for temporary emergencies or growth opportunities. Operating reserves, then, may be defined as relatively liquid assets free from donor restric­ tions that NPOs can use with some degree of discretion. In some NPOs, these reserves may actually be partially or wholly comingled with work­ ing capital with no governance policy about how they may be used; other NPOs’ operating reserves may be held in separate bank accounts distinct from working capital and have strict policies about their usage. To sum­ marize, slack is typically represented by informal or formal operating reserves accumulated through annual operating surpluses. NPOs’ governing boards are also free to designate accumulated sur­ pluses as board-designated endowment, or ‘quasi-endowment’ (Cala­ brese & Ely, 2017). The designation serves as a formal earmarking of slack for specific purposes typically distinct from ongoing operations, although the funds remain technically unrestricted (from an accounting

116

Calabrese and Ely

perspective) in the absence of external donor restrictions. The quasiendowment satisfies the ‘available’ portion of the definition for slack, although NPO boards often hesitate to use the funds for anything but the non-binding designated purpose. If the quasi-endowment is invested sim­ ilarly to true endowment, then the funds may not fully meet the expecta­ tion of liquidity represented in the definition of slack. Throughout the chapter, we provide an historic look at key indica­ tors of annual and accumulated surplus for 501(c)3 NPOs, including the margin ratio (annual surplus or loss as a share of revenue) and operating reserves ratio (operating reserves as a share of annual expenses). The initial snapshot of NPO surplus and reserves is based on the 1998–2000 period using data from the National Center on Charitable Statistics (NCCS)—GuideStar National Nonprofit Research Database. This data­ base covers all public charities required to file Form 990, a standard­ ized annual tax filing required by the Internal Revenue Service (IRS). The subsequent snapshot captures the population of Form 990s filed during the 2015–2017 calendar years via the IRS Form 990 Annual Masterfile Extracts.2 We follow Blackwood and Pollak (2009) by primarily focusing our discussion on the relative median levels of surplus and reserves and do not consider the statistical significance of differences.

What We Know About NPOs and Surpluses/Margin At one point, theories about the behavior of NPOs assumed that the financial goal of these entities was to break even—that is, that managers sought to accumulate no surpluses and targeted annual expenses to equal revenues (for example, see Scanlon, 1980). Any profits, therefore, simply reflected bad financial planning, unexpected shocks, or good luck. The expectation was, nevertheless, that any slack generated would eventually be used to fund charitable output (Hansmann, 1980). Alternately, Weis­ brod (1988) suggested that surpluses provided managers with satisfac­ tion potentially beyond meeting the mission of the organization. Actual budgeting practices of NPOs reflect both of these views on NPO financial objectives. In fiscal year 2017, a Nonprofit Finance Fund (NFF) survey found that 52% of NPOs budgeted to break even financially and only 29% reported budgeting for an operating surplus. The actual financial results in 2017 flipped these figures with 50% of organizations achieving an operating surplus and 26% breaking even (NFF, 2018). Tuckman and Chang (1992) hypothesized that NPOs derived utility from earning and accumulating surpluses that was not explained simply by mission goals. They articulated five reasons NPOs might seek to accu­ mulate profits: 1) to subsidize clients unable to pay the full cost of the service (which is arguably a mission goal of NPOs); 2) diversification into new areas; 3) a rainy day fund; 4) independence from donors; and 5) a measure of success. The important takeaway from Tuckman and Chang

Nonprofit Profits

117

(1992) is that surpluses are not accidental and are a prime and rational financial goal of NPOs. Calabrese (2012) expanded upon this finding and modelled a goal of NPOs not just as surpluses, but as unrestricted surpluses free from donor rules. Further, whereas Tuckman and Chang (1992) implicitly assumed that NPOs would seek and accumulate any levels of surpluses, Calabrese (2012) finds low levels of surplus accumulations, perhaps because of concerns of appearing too wealthy. NPOs have several reasons to avoid excessive slack and not to appear too financially successful. Donors may wish that NPOs spend money now on programs rather than accumu­ lating savings for the future. Further, organizations that depend upon third-party payers (such as hospitals in the United States) may not want to report large amounts of slack lest insurance companies and other pay­ ers try to negotiate payments lower (Calabrese, 2011a). Nevertheless, the existing literature finds evidence supportive of NPOs seeking to earn annual surpluses, whereas avoiding reporting excessive amounts of accu­ mulated resources (Calabrese, 2011a). Measuring NPO surpluses or margin appears simple and straightfor­ ward, but existing research highlights the surprising complexity of the concept (Bowman et al., 2012). Surplus, or deficit if negative, represents the dollar amount of the revenues in excess of expenses, whereas mar­ gin typically communicates the surplus or deficit relative to the organi­ zation’s annual revenue and support. Measurement challenges stem, in large part, from the common use of administrative data via the IRS Form 990 to determine surpluses or margin, but also from the persistence of cash accounting in the nonprofit sector (Calabrese, 2011b). Bowman et al. (2012) present five different measures of NPO surplus and are espe­ cially critical of the most commonly used calculation, which they refer to as ‘Surplus per Form 990.’ Defining surplus or margin as ‘revenue less expenses’ is convenient, but it is important for researchers and prac­ titioners to be aware of the limitations and implications of surplus and margin measures generated using data from the IRS Form 990. Specifi­ cally, this simple measure of surplus or margin fails to include ‘unrealized capital gains and losses, donated services, and recovered grants,’ while including realized capital gains and restricted gifts and grants (Bowman et al., 2012). Surplus generated purely from operations also differs from surplus resulting from investment gains. The former suggests operating revenues are sufficient to support “mission-related expenses” (Zietlow, Hankin, Seidner, & O’Brien, 2018, p. 293). Despite these limitations of the surplus per Form 990, the measure pro­ vides a useful indicator that, when compared to total revenue as the mar­ gin ratio, illustrates the relative magnitude of excess resources acquired by the NPO during the year.3 The literature provides some guidance on the necessary size of average annual surpluses to sustain operations at existing levels. Bowman (2011), for example, argues for a ‘sustainability

118

Calabrese and Ely

principle’ where annual NPO surpluses are equal to or greater than a return on assets matching the long-term inflation rate. A majority of NPOs, 65% in 1998–2000 and 59% in 2015–2017, gen­ erated an annual surplus (see Table 9.1 for details). The median surpluses represented 3.7% and 2.4% of revenues for the 1998–2000 and 2015– 2017 periods, respectively. Adjusting for average inflation during these years, the median surpluses are similar at 1.3% and 1.4%, respectively. The numbers suggest that the median NPO during these periods gener­ ated a surplus sufficient to keep pace with rising costs. Median surplus levels differ substantially across nonprofit subsectors. Consistent across both time periods, ‘education’ organizations have relatively high margins whereas ‘human services’ organizations lag the sample averages. Organi­ zations with expenses in the lowest quartile have median margins more than double their sample medians, which may reflect that it does not take much absolute surplus relative to a small amount of revenue to have a significant margin ratio. Despite median margin ratios that are similar to the overall samples, NPOs with expenses in the top 5% of organizations more frequently earn a surplus. Older organizations, 20 years or more since the ruling date, more commonly operate with a surplus during the early period, but there is no difference in the later sample. NPOs with a majority of revenue from private contributions experi­ ence higher median margins, 5.5%, compared to those primarily depend­ ent on government grants, 1.7%, or program service revenue, 1.5%, in the 1998–2000 time period. The trend is also apparent in 2015–2017 financials, despite slightly different revenue categories.

What We Know About NPOs and Reserves The literature on surpluses assumes that one purpose of seeking profits is accumulating rainy day funds to protect the organization during an economic downturn. More recently, research has sought to analyze which NPOs accumulate reserves for this purpose and whether these reserves serve their purposes. Many financial experts recommend three months’ worth of reserves, equivalent to 25% of annual operating expenses, to protect an organization from revenue shocks. Blackwood and Pollak (2009) note that reserves are an indicator of financial health and found that 57% of the Washington, DC sample they examined had reserves less than three months’ worth of expenses. Their analysis found that older and larger NPOs were more likely to have the recommended reserve amount. Those that rely on government support and self-generated program rev­ enues reported less reserves than donative NPOs. These results contra­ dict theory, which would speculate that self-generated revenue is easier to retain than other revenue sources. At the same time, using funds received from government support and contracts to fund reserves rather than pro­ vide the associated service is occasionally discouraged or disallowed.

5.7% 7.4% 2.8% 2.4% 6.3% 8.9% 3.2% 2.5% 3.4% 3.5% 4.0% 5.5% – 1.7% 1.5%

22,681 33,989 58,167 107,814 49,875 68,534 137,067 54,842 13,691 155,276 110,790 106,454 – 47,431 103,039

69.1% – 63.0% 58.4%

62.5% 69.0%

66.1% 63.0% 67.1% 72.9%

65.9% 73.4% 64.2% 61.7% 67.6%

– 270,648 – 177,598

232,915 263,985

125,839 251,676 100,679 25,159

45,738 74,934 77,430 181,638 117,959

503,353

3.7%

274,134

65.1%

Number of Organizations

Margin Ratio (Median)

Number of Organizations

Share with a Positive Margin (Surplus)

2015–2017

1998–2000

– 3.1% – 1.3%

2.9% 2.0%

7.8% 1.7% 1.6% 2.3%

2.6% 3.6% 2.4% 1.4% 3.6%

2.4%

Margin Ratio (Median)

– 61.0% – 56.7%

59.8% 59.2%

62.0% 56.7% 60.6% 67.5%

58.3% 63.7% 60.7% 56.7% 60.7%

59.4%

Share with a Positive Margin (Surplus)

Note: Direct comparisons across time periods should be made with caution for two primary reasons. First, organizations using the cash basis of accounting are omitted from the 1998–2000 sample, but are necessarily included in the 2015–2017 sample. Second, the revised IRS Form 990 made changes to some fields used in the calculation of these financial ratios. The “Contributions, Gifts, and Grants” category for the 2015–2017 sample includes grants from gov­ ernment, unlike the “Private Contributions” category applied to the 1998–2000 sample.

All Subsector Arts, culture, and humanities Education Health Human services Other Size (total expense percentile) 25th percentile, 75th percentile, 95th percentile Organization age Ruling date ( 20 years ago) Revenue dependence (> 50%) Private contributions Contributions, gifts, and grants Government grants Program service revenue

Time Period

Table 9.1 Median Margin Ratio and Positive Margin Share of NPOs, 1998–2000 and 2015–2017

120

Calabrese and Ely

The classic question from practitioners related to NPO operating reserves is ‘How big should the reserves be?’ The realistic, but less than satisfying, answer is that ‘it depends’ on the organization (Nonprofit Operating Reserves Initiative Workgroup (NORI), 2008). The previously mentioned rule-of-thumb—reserves of at least three months of operat­ ing expenses—is simply a minimum goal. Sector-wide rules-of-thumb are typically accompanied by calls to tailor reserve requirements to the specific organization and risk profile. NPOs face a double-edged sword of being told to build adequate operating reserves, while being open to potential criticism when reserves are deemed excessive by external stake­ holders. A formal reserves policy justifies the NPO’s actual or desired level of reserves and communicates to stakeholders that the accumulated surpluses are neither arbitrary nor wasteful. A board-approved operating reserve policy provides guidelines for reserve accumulation, investment of reserves, drawdown, and replenishment with considerations of liquid­ ity, risk, and strategic priorities (for guidance, see ‘Developing a Written Operating Reserve Policy’ in NORI, 2010). Calabrese (2013), using a similar definition of reserves as Blackwood and Pollak (2009), finds organizational size is not a significant predictor of reserves. Further, Calabrese (2013) does find that the revenue portfo­ lio of the organization influences reserve size, which differs from Blackwood and Pollak’s (2009) descriptive analysis; those more dependent upon government funds hold less reserves, and donations are not a sig­ nificant predictor. To the extent that reserves are an indicator of financial health, these findings suggest that government funds may actually reduce the financial sustainability of the sector. Further, concerns that donors will withdraw future donations because of reserves is not supported— that reserves do not make NPOs appear ‘lean’ and face consequences as a result (Mitchell, 2017). In fact, the findings of Calabrese (2011a) in which donations are only affected by extremely high levels of accumu­ lated resources (measured in this case as net assets) may be applicable to reserves as well. Sloan et al. (2016), rather than relying exclusively on administra­ tive data, interview NPO managers directly and find that the low levels of reserves found in Blackwood and Pollak (2009) and Cala­ brese (2013) may reflect that managers rely on other sources for their reserves. Whereas reserves may reflect good business practices, Sloan et al. (2016) point out that NPO managers operate in a unique and dif­ ferent space in which sound business practices may not always be pos­ sible. Current needs may supersede future potential needs, and NPOs as a result may have a difficult time accumulating surpluses and sav­ ing for the future. Further, many NPO funders make saving for the future virtually impossible by providing contracts and awards that fail to reflect the total cost of delivering NPO services (Marwell & Cala­ brese, 2015). Nevertheless, these substitutes for reserves help explain

Nonprofit Profits

121

the levels of reserves in the sector and display management adaptation to the realities of the sector. Primarily, reserves are intended to help maintain organizational spend­ ing during difficult economic times. Such resources stave off challeng­ ing service cuts during times when there might be an increased demand for services. Tuckman and Chang (1991) define NPOs as financially vulnerable if they cannot withstand a fiscal shock without scaling back programs. Calabrese (2018) analyzes whether reserves do in fact help stabilize spending by NPOs during times of volatility. The results indicate that reserves help, but they are inadequate at low current levels. Fur­ ther, the three-month rule of thumb may be insufficient to stabilize NPO spending, as much of the volatility exceeds this level. Given the existing cultural taboo around NPOs accumulating too much wealth, whether or not the sector can accumulate the resources necessary to build reserves that provide effective relief during times of economic volatility remains an open issue. Whereas the benefits of reserves and slack are well known and artic­ ulated, others have also pointed out the potential costs of such excess resources. Unlike in the for-profit sector, no mechanism exists in the non­ profit sector to return unused or unneeded revenues to donors or provid­ ers (Core, Guay, & Verdi, 2006). Because the non-distribution constraint forbids claims on these resources, excess funds may sit indefinitely with the NPO. Core et al. (2006) find that NPOs with excess cash balances do exhibit lower program spending and higher chief executive officer (CEO) and director compensation compared to NPOs with lower cash balances. Frumkin and Keating (2010) also suggest that CEO compensation is higher when NPOs maintain excess revenues rather than spending them. However, Calabrese and Gupta (2019) report that these findings around agency problems and cash balances in NPOs are highly sensitive to model specification. Calabrese (2018) also finds no evidence of agency prob­ lems with respect to reserve accumulation in NPOs. Therefore, whether maintaining slack resources leads to organizations’ agency problems is an unsettled concern in the literature. The IRS Form 990 provides information, albeit imperfect, with which to calculate operating reserves and the operating reserves ratio.4 Oper­ ating reserves represent available funds, so the basis of the calculation is an organization’s unrestricted net assets (which are now termed ‘net assets without donor restrictions’ on audited financial statements). The unrestricted net assets are then reduced by any equity in fixed assets. The operating reserves ratio divides operating reserves by annual expenses less depreciation: (Unrestricted Net Assets − Property, Plant, and Equipment, net of Long-Term Debt) / (Total Expenses − Depreciation) (NORI, 2008). The operating reserves ratio, and its calculation using the Form 990, is criticized by some for potential measurement error due to the unrestricted net assets including receivables, prepaid expenses, and inventories, which

122

Calabrese and Ely

are not readily available for use as reserves (Zietlow et al., 2018). Work­ ing capital, cash for ongoing transactions, is also included in unrestricted net assets so the operating reserves ratio can overstate the level of reserves (Calabrese, 2013). A more conservative definition of operating reserves is available to address some of these concerns about the availability of illiquid assets (Calabrese, 2013; NORI, 2008). Operating reserves cannot be estimated for organizations filing the IRS Form 990-EZ, which does not differentiate between restricted and unrestricted net assets. Operating reserves for the median NPO are sufficient to cover 2.9 and 4.2 months of expenses in our 1998–2000 and 2015–2017 samples, respectively. Nearly a fifth of each sample has zero or negative operating reserves (see Table 9.2 for details). Alternately, 49% of organizations had the recommended minimum three months of operating reserves in the early sample and 57% in the later time period. The apparent growth in NPO operating reserves may reflect improved finances over time, changes in financial reporting via the Form 990, or a combination of factors. ‘Human services’ organizations consistently have lower median operat­ ing reserves ratios relative to other subsectors across the two samples, whereas those broadly classified as ‘other’ organizations have relatively large reserves. Smaller NPOs, based on expenses, have dramatically higher median reserves ratios than larger organizations in both samples. The lower reserve levels of larger NPOs may reflect the greater ability of such organizations to directly access capital markets rather than rely on accumulated internal savings, including the issuance of long-term taxexempt bonds (Calabrese & Ely, 2016; Ely & Calabrese, 2016). Older organizations have more opportunity to build reserves through accumu­ lated surpluses. Both samples reflect this expectation, as older organi­ zations have substantially higher median reserves ratios than younger NPOs. Similar to the surplus pattern, NPOs with a majority of revenue coming from government grants and program service revenues have much lower reserves levels, only 1.35 months’ worth for those depending on government grants, than those depending primarily on contributions. The difference is likely a reflection of restrictions that accompany govern­ ment grants compared to largely unrestricted private contributions and thin margins from program services. Overall, these descriptive findings on NPO operating reserves paint a more optimistic picture but gener­ ally align with those of Blackwood and Pollak (2009), despite their nar­ rower focus on Washington, DC-area organizations and the exclusion of hospitals, higher education institutions, and other organization types.

What Do We Still Not Know? Despite the importance of margins and reserves to the smooth opera­ tions of NPOs, whether to endure a fiscal shock or to finance growth opportunities or expansions, the literature is nascent and provides very

2015–2017

49.1% 46.8% 50.3% 50.6% 45.6% 55.5%

59.8% 46.9% 39.7% 55.2%

19.5%

25.4%

20.9% 17.5% 19.5%

17.6%

20.1% 19.4%

20.3%

14.4%

34.6%

23.9%

47.5% 30.6%

41.3%

36.0% 33.4% 29.7%

33.6%

33.7%

15.5%

13.1%

34.4% 17.7%

28.3%

23.2% 20.1% 16.9%

22.0%

20.9% 35.9%

25,159

21.0%

100,679 22.4%

125,839 84.3% 251,676 33.0%

117,959 42.4%

74,934 34.5% 77,430 36.3% 181,638 31.6%

45,738

503,353 35.0%

Number Operating Share of Organizations With: Number Operating of Orgs. Reserves of Orgs. Reserves No 3-Month 6-Month 12-Month Ratio Ratio (Median) Operating Operating Operating Operating (Median) Reserve Reserve Reserve Reserve

1998–2000

All 274,134 24.0% Subsector Arts, culture, 22,681 20.9% and humanities Education 33,989 25.3% Health 58,167 25.6% Human 107,814 20.8% services Other 49,875 33.2% Size (total expense percentile) 25th, 137,067 22.0% 75th, 54,842 16.2% 95th 13,691 29.9%

Time Period

20.6%

18.6%

19.3% 16.1%

16.2%

18.5% 15.8% 17.9%

20.1%

17.6%

46.1%

47.3%

68.6% 56.4%

60.3%

56.7% 58.4% 55.2%

56.8%

57.1%

28.0%

29.8%

59.3% 39.3%

46.5%

41.6% 42.4% 38.7%

43.1%

41.8%

(Continued)

13.6%

16.6%

46.9% 22.5%

32.0%

27.4% 27.0% 23.0%

29.9%

27.0%

No 3-Month 6-Month 12-Month Operating Operating Operating Operating Reserve Reserve Reserve Reserve

Share of Organizations With:

Table 9.2 Median Operating Reserves Ratio and Shares of NPOs by Operating Reserve Size, 1998–2000 and 2015–2017

2015–2017

21.9%

22.5%

11.2%

47,431

103,039 19.5%

–

17.4%

106,454 22.8%

–

16.1%

110,790 27.1%

–

21.7%

155,276 21.9%

43.9%

30.0%

–

48.0%

52.0%

47.2%

26.4%

15.2%

–

32.4%

35.2%

32.7%

12.5%

7.0%

–

20.0%

21.0%

20.8%

–

– 177,598 25.1%

–

270,648 35.8%

–

263,985 40.5%

232,915 29.5%

Number Operating Share of Organizations With: Number Operating of Orgs. Reserves of Orgs. Reserves No 3-Month 6-Month 12-Month Ratio Ratio (Median) Operating Operating Operating Operating (Median) Reserve Reserve Reserve Reserve

1998–2000

Note: See note in Table 9.1.

Organization age Ruling date ( 20 years ago) Revenue dependence (> 50%) Private contributions Contributions, gifts, and grants Government grants Program service revenue

Time Period

Table 9.2 (Continued)

21.6%

–

15.6%

–

15.4%

19.8%

50.1%

–

57.8%

–

60.7%

53.4%

32.9%

–

42.2%

–

45.0%

38.5%

17.3%

–

26.9%

–

29.2%

24.6%

No 3-Month 6-Month 12-Month Operating Operating Operating Operating Reserve Reserve Reserve Reserve

Share of Organizations With:

Nonprofit Profits

125

few definitive findings. Whereas we know positive margins should be a goal of average NPOs, we need additional studies with strong research methodologies to validate this. Further, how organizational governance influences (or not) the goal of profit accumulation is not explored in the current literature. Given the preponderance of NPO board members with experience operating in the for-profit sector, research that analyzes whether such experience affects this goal is a natural avenue for explo­ ration. This governance might relate to the entire board of directors, or to distinct components of the board such as finance or audit com­ mittees. The literature has little to offer NPOs who are currently not profitable but wish to become so. Does diversifying revenues lead to more profits? Or does expanding current service offerings? Does stream­ lining costs improve the bottom-line long term? Or does this reduce the quality of services and undermine the mission of the NPO? These ques­ tions about organizational revenue portfolios and cost structures could inform knowledge about best practices for NPOs. Future research might also expand into smaller voluntary agencies, in which the bulk of an organization’s resources take the form of donated labor or services. How do these cooperative entities view surpluses? Do they even seek to earn profits like charitable NPOs do? Or is this goal muted because much of the resources are nonfinancial anyway? Similarly, we know very little about reserves. Future research should examine NPOs of different sizes to determine if reserves help protect organizations from fiscal shocks. Calabrese (2018) focused on large NPOs, but the vast majority of the sector is small organizations. Another area unexplored is whether holding or using reserves improves financial outcomes of NPOs. Because some services offered by NPOs lose money, it is not clear whether maintaining these services during bad economic times using reserves should have a positive effect on long-term financial outcomes. Also, how do NPOs that have reserves manage these resources? Management research examining the policies and practices of NPOs around these reserve funds might reveal avenues for improved efficiency or better returns; or, it might find that NPOs are already managing these pools of funds well. New accounting standards introduced in the U.S. require increased disclosures on NPO liquidity and may add to future insights—assuming researchers are able to access such data. Given the range of reserves in the sector, additional research might examine how NPOs manage to muddle through the lean years. Whereas limited research on reserve substitutes does exist, a better understand­ ing of how NPO managers use different tools in their toolkit to work through hard times would be instructive. Such research might help us improve contracting relationships between NPOs and governments, foundations, and even for-profit entities. It might also help us develop tools or institutions, like organizations that provide short-term loans,

126

Calabrese and Ely

access to credit, or other financial inventions, that might help NPOs dur­ ing these lean times.

Notes 1. Although some long-term assets such as stocks and bonds are easy to convert to cash, Ramirez (2011) notes that managers may not know the precise value of these assets due to price fluctuations, reducing their utility as short-term cash management tools. Further, if these asset values fall because of macroeco­ nomic conditions, the organization may sell these assets at suboptimal times. 2. The 2015–2017 IRS Masterfile Extracts represent the calendar year in which the forms were filed and represent multiple tax years, primarily 2014–2016. The IRS revised Form 990 was phased in over multiple years beginning in the 2008 tax year. The balance sheet information provided on the revised Form 990 differs from the old form, so calculating the operating reserves ratio uses different fields for each form. We standardize the formula as much as possible to allow for comparison between the late 1990s using the digitized NCCS data and the more recent data from the IRS extracts. Importantly, both samples are limited to 501(c)(3) organizations who filed the long-form 990 (rather than the Form 990-EZ) in compliance with Statements of Financial Accounting Stand­ ards (SFAS) 117 for reporting net assets based on donor restrictions (Bowman, Tuckman, & Young, 2012). The 1998 to 2000 sample is further limited to organizations using accrual accounting. We are unable to identify and remove the organizations not using accrual accounting from the 2015 to 2017 sample organizations, but leaving the organizations using cash accounting in the 1998 to 2000 sample has little effect on the summary statistics presented here. 3. Margin, or ‘surplus per Form 990,’ is calculated using the revised Form 990 as ‘Total revenue’ (Part VIII, column (A), line 12) less ‘Total expenses’ (Part IX, column (A), line 25). The margin ratio is found by dividing the margin by ‘Total revenue.’ For the pre-2008 Form 990, ‘surplus per the Form 990’ is ‘Total revenue’ (Part I, line 12) minus ‘Total expenses’ (Part I, line 17). The margin ratio divides the surplus by ‘Total revenue.’ 4. Based on the revised IRS Form 990, operating reserves consist of ‘Unre­ stricted net assets’ (Part X, column (B), line 27) minus ‘Land, buildings, and equipment less accumulated depreciation’ (Part X, column (B), line 10c) less long-term debt. Long-term debt consists of ‘Tax-exempt bond liabilities’ (Part X, column (B), line 20), ‘Secured mortgages and notes payable to unrelated third parties’ (Part X, column (B), line 23), and ‘Unsecured notes and loans payable to unrelated third parties’ (Part X, column (B), line 24). The order of operations matters for the calculation of operating reserves and is as fol­ lows: = unrestricted net assets − (land, buildings, equipment − (tax exempt bonds + secured mortgages + unsecured notes)). The operating reserves ratio is calculated by dividing the operating reserves by total expenses (Part IX, column (A), line 25) less depreciation expense (Part IX, column (A), line 22): = operating reserves / (total expenses − depreciation expense). Calculat­ ing operating reserves using the pre-2008 Form 990 differs in two ways. First, fixed assets include both ‘Investments—land, buildings, and equipment’ less accumulated depreciation (Part IV, line 55c) and ‘Land, buildings, and equip­ ment’ less accumulated depreciation (Part IV, line 57c). Second, long-term debt includes ‘Tax-exempt bond liabilities’ (Part IV, line 64a) and ‘Mortgages and other notes payable’ (Part IV, line 64b). Excluding tax-exempt bond lia­ bilities from the long-term debt in the numerator biases the operating reserves ratio downward.

Nonprofit Profits

127

References Blackwood, A. S., & Pollak, T. H. (2009). Washington-area nonprofit operat­ ing reserves (Charting Civil Society Series, No. 20). Washington, DC: Urban Institute. Retrieved from http://webarchive.urban.org/uploadedpdf/411913_ dc_nonprofit_reserves.pdf Bowman, W. (2011, May9). The nonprofit difference. Nonprofit Quarterly. Retrieved from https://nonprofitquarterly.org/2011/05/09/the-nonprofit-difference/ Bowman, W., Tuckman, H. P., & Young, D. R. (2012). Issues in nonprofit finance research: Surplus, endowment, and endowment portfolios. Nonprofit and Voluntary Sector Quarterly, 41(4), 560–579. Calabrese, T. D. (2011a). Do donors penalize nonprofit organizations with accu­ mulated wealth? Public Administration Review, 71(6), 859–869. Calabrese, T. D. (2011b). Public mandates, market monitoring, and nonprofit financial disclosures. Journal of Accounting and Public Policy, 30(1), 71–88. Calabrese, T. D. (2012). The accumulation of nonprofit profits: A dynamic analy­ sis. Nonprofit and Voluntary Sector Quarterly, 41(2), 300–324. Calabrese, T. D. (2013). Running on empty: The operating reserves of U.S. non­ profit organizations. Nonprofit Management & Leadership, 23(3), 281–302. Calabrese, T. D. (2018). Do operating reserves stabilize spending by nonprofit organizations? Nonprofit Management & Leadership, 28(3), 295–301. Calabrese, T. D., & Ely, T. L. (2016). Borrowing for the public good: The grow­ ing importance of tax-exempt bonds for public charities. Nonprofit and Volun­ tary Sector Quarterly, 45(3), 458–477. Calabrese, T. D., & Ely, T. L. (2017). Understanding and measuring endowment in public charities. Nonprofit and Voluntary Sector Quarterly, 46(4), 859–873. Calabrese, T. D., & Gupta, A. (2019). A replication of “agency problems of excess endowment holdings in not-for-profit firms” (Journal of Accounting and Economics). Public Finance Review, 47(4), 747–774. Core, J. E., Guay, W. R., & Verdi, R. S. (2006). Agency problems of excess endowment holdings in not-for-profit firms. Journal of Accounting and Eco­ nomics, 41(3), 307–333. Ely, T. L., & Calabrese, T. D. (2016). Leveling the playing field: The taxpayer relief act of 1997 and tax-exempt borrowing by nonprofit colleges and univer­ sities. National Tax Journal, 69(2), 387–412. Frumkin, P., & Keating, E. K. (2010). The price of doing good: Executive com­ pensation in nonprofit organizations. Policy and Society, 29, 269–282. Grizzle, C., Sloan, M., & Kim, M. (2015). A look at the factors that influence the size of nonprofit operating reserves. Journal of Public Budgeting, Accounting, and Financial Management, 27(1), 67–99. Hansmann, H. B. (1980). The role of nonprofit enterprise. Yale Law Journal, 89(5), 835–901. Marwell, N. P., & Calabrese, T. D. (2015). A deficit model of collaborative gov­ ernance: Government-nonprofit fiscal relations in the provision of child wel­ fare services. Journal of Public Administration Research and Theory, 25(4), 1031–1058. Mitchell, G. E. (2017). Fiscal leanness and fiscal responsiveness: Exploring the normative limits of strategic nonprofit financial management. Administra­ tion & Society, 49(9), 1272–1296.

128

Calabrese and Ely

Nonprofit Finance Fund (NFF). (2018). 2017 nonprofit finance fund state of the nonprofit sector survey. Nonprofit Operating Reserves Initiative Workgroup (NORI). (2008). Maintaining nonprofit operating reserves: An organizational imperative for nonprofit financial stability. Washington, DC: National Center for Charitable Statistics. Retrieved from www.nonprofitaccountingbasics.org/sites/default/files/01-Operating ReservesWhitePaper2009.pdf Nonprofit Operating Reserves Initiative Workgroup (NORI). (2010). Operating reserve policy toolkit for nonprofit organizations. Washington, DC: National Center for Charitable Statistics. Retrieved from www.giarts.org/sites/default/ files/Operating-Reserve-Policy-Toolkit_1stEd_2010-09-16.pdf Ramirez, A. (2011). Nonprofit cash holdings: Determinants and implications. Public Finance Review, 39(5), 653–681. Scanlon, W. J. (1980). A theory of the nursing home market. Inquiry, 7(1), 25–41. Sloan, M. F., Charles, C., & Kim, M. (2016). Nonprofit leader perceptions of operating reserves and their substitutes. Nonprofit Management & Leader­ ship, 26(4), 417–433. Tuckman, H. P., & Chang, C. F. (1991). A methodology for measuring the finan­ cial vulnerability of charitable nonprofit organizations. Nonprofit and Volun­ tary Sector Quarterly, 20(4), 445–460. Tuckman, H. P., & Chang, C. F. (1992). Nonprofit equity: A behavioral model and its policy implications. Journal of Policy Analysis and Management, 11(1), 78–87. Weisbrod, B. A. (1988). The nonprofit economy. Cambridge, MA: Harvard Uni­ versity Press. Zietlow, J., Hankin, J. A., Seidner, A., & O’Brien, T. (2018). Financial manage­ ment for nonprofit organizations: Policies and practices (3rd ed.). Hoboken, NJ: John Wiley & Sons.

10 Treasury, Cash, and Liquidity Management in Nonprofit Organizations John Zietlow

Introduction Careful management of an organization’s short-term financial resources, or cash and treasury management, is critically important for mission achievement and is the key component of financial health or sustainabil­ ity. The time period especially in view here is from today through a year from now. Nonprofit financial managers focus heavily on this time frame in managing cash and treasury-related activities. Whether carried out by the chief financial officer, executive director acting as a chief financial officer, the board treasurer, the finance director, or a person with the title of cash manager, the focus is on liquidity, broadly defined. I adopt the convenient shorthand of labeling all these actors as nonprofit managers, even though the title and the exact role of the person(s) performing treas­ ury functions in the nonprofit may vary. Managers’ cash and treasury management domain includes four related short-term activities: manag­ ing cash, raising external financing, managing the short-term investment portfolio, and managing risk (Zietlow, Hill, & Maness, 2020). Nonprofit managers may extend their view beyond the one-year horizon, especially as they assess their organizations’ financial health (Zietlow, 2012) and engage in capital budgeting and long-range financial planning for antici­ pated capital expansion and related funding needs. Cash management principles apply whether an organization is a business or a nonprofit organization (NPO); any organization may be viewed as a cash flow sys­ tem (Zietlow & Chisholm, 1988). Cash and cash flow are critical for any organization to function. Managerial inattention to cash in (NPOs) is especially problematic, as detailed in this chapter. Mission achievement is enhanced by astute cash and treasury man­ agement. Inadequate liquidity emanating from improper cash and treas­ ury management limits programs from being carried out. Consequently, managers should 1) bring the cash in quickly; 2) slow the payout of cash, within ethical constraints; 3) make sure cash is in one or a very few loca­ tions and is accessible; and 4) manage the risks of cash and cash flow. I take the premise that nonprofit managers quickly become aware of the importance of liquidity management as they experience a cash flow

130

Zietlow

crunch—a temporary imbalance—or a cash flow crisis due to a struc­ tural, ongoing shortfall of cash inflows relative to cash outflows. Many NPOs encountered either a cash crunch or cash crisis during and after the 2008–2009 financial crisis, yielding a heightened value to liquidity due to the credit constraints and revenue stream compression during this period of financial stringency. Once aware, the nonprofit manager’s major chal­ lenge is to define, measure properly, and monitor a comprehensive liquid­ ity construct. I address how cash and treasury management in an NPO is tied to the organization’s primary financial objective. Nonprofit manag­ ers are also goal-driven, implicitly or explicitly guiding their organiza­ tions toward financial health and sustainability, a point often missed in the academic literature. The remainder of this chapter is laid out as follows. First, I will briefly review the academic literature in the business-sector field as it is more advanced and yields actionable findings. I then profile survey and field research evidence available on the espoused primary financial objective pursued by NPOs and profile the literature on nonprofit cash and treasury management. I provide a new look at the constructs that enable the non­ profit to achieve that primary financial objective. Building on this book’s previous chapter, I suggest ways in which nonprofit financial managers may measure and manage liquidity, including liquid reserves, to better achieve their missions. Managers successfully navigating this challenge are then equipped with a potent toolkit for addressing financial health and sustainability. I close the chapter with a call for further research.

Literature Review Introduction Cash and treasury management have been addressed in much greater detail for businesses in both the academic and practitioner bodies of knowledge. The organizing construct for cash and treasury management is liquidity management. Business Sector Contributions I begin our survey of the business sector literature by citing a representa­ tive textbook practitioner guide. I then selectively draw from academic journal contributions. Textbook/Practitioner Book Treatment The purpose of cash and treasury management is to assure adequate liquid­ ity (Zietlow, Hill, and Maness, 2019). Reduced organizational liquidity (i.e., illiquidity) may result in the reduced provision of services, a higher

Treasury, Cash, and Liquidity Management

131

cost of capital, and reduced capital investment. Chorafas (2002) argues that liquidity management aims to reduce the probability of an irreversible adverse situation and its aftermath. Academic Journals In this review of academic journals addressing liquidity in the corporate/ business sector, I have selected items that could have broad application to all NPOs. These focus on motives for holding liquidity, when an organi­ zation’s liquidity might be deemed ‘excessive’ rather than ‘enough,’ and why managers should focus their attention on cash flows, rather than accrual revenues, expenses, and profit. Ang (1991) argues that the issue of corporate slack might be consid­ ered as one of the great controversies in corporate finance. He defines corporate slack as “a firm’s excess holding of liquid assets, or claims, and options to liquid assets, above what it needs for the normal opera­ tion of its existing business.” Morris (1991) notes a great deal of dif­ ficulty determining where to draw the line between a necessary cushion and slack. Morris (1991) also suggests that any argument for an optimal level of slack represents a contradiction in terms, because if the firm has slack, but it is considered to be less than optimal and it obviously needs more—it would not then be appropriate to label it slack. Not surpris­ ingly, business (or nonprofit) treasury managers do not employ the con­ cept of slack. Morris (1991) properly reorients the viewpoint to be the holding of liquid assets, which may help the firm to meet its obligations and allow it to survive a difficult period. Cash holdings are most closely linked empirically to the transactions motive and the precautionary motive for holding cash. Kim, Mauer, and Sherman (1998) and Opler, Pinkowitz, Stulz, and Williamson (1999) examined the determinants of corporate cash holdings for United Statesbased firms over several decades and find that cash holdings vary directly with financial constraints, the cost of external financing, cash flow vola­ tility (or business risk), and growth opportunities. Of special interest to NPOs, cash policies varied significantly by industry. Firms that are most likely to benefit from cash holdings accumulate greater levels of internal liquidity. Graham and Leary (2018) studied the large increase in cash balances held by publicly-held businesses in the U.S. in recent years and find that riskier companies with growth opportunities, small or nonex­ istent profits, and little use of debt have high cash-to-assets ratios. They surmise that financial managers determine the amount of cash to hold by considering three items: 1) the projected amount of cash coming in within the upcoming year; 2) the amount of the investment the company expects to make in the upcoming year; and 3) how much in funds the firm can raise quickly and with limited costs. Notice that each of these involve forecasting an amount for the upcoming period, as opposed to analyzing

132

Zietlow

static indicators such as the current ratio or liquid unrestricted net assets relative to expenses. Financial constraints, particularly applicable to NPOs that are not able to issue stock and that are too small or young to tap the debt market, have been studied extensively in the business sector. Harford, Klasa, and Maxwell (2014) find that companies cope with refinancing risk by hold­ ing more cash and saving cash from cash flows. Both long-term debt and bank debt is now shorter-maturity than it has been in previous decades, implying that refinancing risk is a concern. Companies have met this increased refinancing risk by significantly increasing their cash holdings. Lopez-Gracia and Sogorb-Mira (2015) studied Spanish companies and find that financially constrained firms save significant amounts of cash out of their cash flow whereas those able to tap the equity market do not. The authors note that by doing so, these companies are sacrificing cur­ rent investments to safeguard potential future investment opportunities. The ‘speculative motive’ for holding liquidity also finds support in numerous studies. Simutin (2010) finds that high ‘excess cash compa­ nies’ (those holding more cash than one might anticipate based on logical predictors) invest considerably more in the future then do peers holding ‘low cash’—indicating that companies accumulate cash as they antici­ pate future investment opportunities in the presence of costly external financing. They have or are acquiring growth options, and during eco­ nomic expansions, these companies will use the cash to take advantage of investment opportunities and exercise their growth options. He also finds that high cash flow firms tend to save a smaller fraction of their cash flow but also tend to hold a higher fraction of assets as cash. The external economic environment and managers’ perceptions of how that might change in the future also affect cash holdings. Neam­ tiu, Shroff, White, and Williams (2014) studied the impact of economic uncertainty on cash holdings in companies. Even when controlling for real GDP growth and company earnings volatility, lagged cash holdings, and financing constraints, they find that companies reduced their capital investment and held higher levels of cash in the face of ambiguity and the inability to confidently project investment-related future cash flows. Bringing near-cash substitutes and short-term borrowing into the analysis further underscores the need for a cash forecast in determining cash holdings. Boileau and Moyen (2016) find that lower interest rates and companies’ volatility in selling, general, and administrative expenses (mostly unrelated to operations scale) have led to higher cash holdings. Their higher liquidity needs have forced companies to hold more cash and use more credit lines. Lins, Servaes, and Tufano (2010) find that the strongest factor that influences present-day cash policies is to buffer against future cash flow shortfalls and that credit lines are used to hedge against a different risk than holding non-operational cash. Credit lines provide com­ panies with an option to exploit future business opportunities that become

Treasury, Cash, and Liquidity Management

133

available in good economic times. Non-operational cash, on the other hand, protects against future cash flow shocks that might occur in bad times. They also find that credit lines are the dominant source of liquidity for companies around the world, as their survey spanning 29 countries finds that credit lines amount to roughly 15% of assets. Cash held by com­ panies for non-operational purposes comprises only about 2% of assets. Companies follow a very different liquidity sourcing than what we see in nonprofit asset and capital structures, motivating the inclusion of shortterm financing availability into our liquidity measurement and analysis. Synthesis—For-Profit To summarize the business sector findings regarding cash and liquidity, organizations start their determination of how much cash to hold by assess­ ing their transactions need for cash. The transactions demand for cash applies equally to NPOs. A thrift store needs coin and currency to make change. Other than all-volunteer organizations, NPOs hold money in their checking accounts to meet payroll and to buy supplies. The degree to which cash inflows and cash outflows are not synchronized will result in larger transactions balances being held or in a credit line being established or increased in amount. Businesses and NPOs have a precautionary demand for cash as well—the proverbial ‘money for a rainy day,’ emergency fund, or operating reserve. Cash held allows the organization to hedge itself against an unexpected drop in revenues and support, an unexpected increase in expenses, or an unexpected inability to borrow. On the revenue and sup­ port side, reduced future operating cash flows may arise from broad eco­ nomic downturns or firm-specific events such as losing a major customer. The availability of short-term investments not classified as cash equivalents, untapped credit lines, and significant positive operating cash flows are all factors that allow an organization to hold less cash as a precaution. The speculative demand for cash relates to cash held to quickly invest in finan­ cially attractive capital investments when they become available. Starting Point for Management and Board: What Is an NPO’s Primary Financial Objective? The importance of cash and treasury management is linked to the non­ profit manager’s primary financial objective, as noted earlier. Although academics focus more on profits, surpluses, or changes in net assets, man­ agers see these as a means to an end rather than the primary objective. What the Primary Financial Objective Is Not An NPO’s primary financial objective is not simply to break even finan­ cially, meaning that revenues and support are exactly equal to expenses

134 Zietlow for the period. Even if it breaks even, the organization has no assurance that cash inflows from operations equal or exceed cash outflows from operations, nor does breaking even provide needed funds for growth, emergency needs, acquisitions, building an endowment, self-financing a building, or other needs. Earning a surplus, or ‘profit,’ will not suffice, either. Whereas prefer­ able to breaking even, the same indictments just mentioned for breaking even apply to small surpluses as well. Being ‘in the black’ on the operat­ ing budget may occur when positions went unfilled, or supplies went unordered and the organization cut back its mission-related activities to achieve this end. Furthermore, pursuing this objective may lead to selling investments at inopportune times, taking on debt due to a cash crunch or cash crisis, or having to do emergency fundraisers. There is much confu­ sion in the field because most academics, board members, and consult­ ants have focused too heavily on operating budget outcomes, ‘profits,’ and changes in net assets as financial objectives. For example, some observers confuse cash holdings or reserves with profits, not understand­ ing that all assets are funded by either liabilities or net assets (only the latter are accumulated profits). Financial managers prefer to see surpluses as a means to an end (see survey evidence below), focusing more heavily on changes in the cash position, short-term investments, short-term debt, and incoming cash flows. Should one choose to focus on a single financial statement or report, that statement should be the statement of cash flows, not the statement of activities (or worse, the operating budget). Under­ standing changes that have occurred in the past allows the financial man­ ager to engage in the all-important task of projecting future cash flows. This book’s previous chapter defines slack resources as excess, rela­ tively liquid, and available funds that managers may inexpensively tap when needed for cyclical or emergency needs or for strategic reasons related to opportunities and service growth. Cash and treasury managers view liquidity more broadly as cash, cash flows, borrowing facilities, and other potential funding sources needed for transactions and intra-year cash receipt and disbursement mismatches as well as the items embedded in the concept of slack resources. The primary means of managing and controlling liquidity is to prepare and use a cash budget/forecast, and the timing of cash flows might be more critical than the total amounts of inflows and outflows (Gallinger & Healey, 1987). Encouraging evi­ dence that many NPOs make cash projections is found in Marwell and Calabrese (2015), who find that 78% of the 79 New York Human Ser­ vices nonprofit managers they surveyed prepare a cash forecast. Financial ratios do not provide the necessary information regarding within-period cash flows, past or present, nor do they provide insight into the pattern of future cash flows (Gallinger & Healey, 1987). Projecting cash inflows and outflows, and the resulting cash position, may be done daily for the next week, weekly for the next month, and monthly for the next year

Treasury, Cash, and Liquidity Management

135

in order to assure the manager that cash outflows are matched by cash inflows, cash holdings, short-term investments, or draws on a credit line (Gallinger & Healey, 1987). Financial flexibility, not part of the notion of slack, is valued by nonprofit managers. The Primary Financial Objective Is an Appropriate Liquidity Target The first reference to the NPO’s primary financial objective being an appropriate liquidity target came from a grounded theory multi-method study conducted 25 years ago (Hankin, Seidner, & Zietlow, 1998; Ziet­ low, 1994, 1997). The primary financial objective descriptive of non­ profit financial management behavior was labeled a ‘liquidity target.’ It appears that organizations strive to maintain, within some range they are comfortable with, a certain amount of liquidity. The target is man­ aged intertemporally, meaning that the liquidity may dip below or range above the targeted range in any given year, but the organization will attempt to return the level of liquidity to the prescribed range in the fol­ lowing year(s). A more recent and wider-scale study of 514 mid-sized NPOs in 2011 was conducted by researchers at Indiana University (Center on Phi­ lanthropy, 2012). The survey encompassed NPOs of all types, not just donatives. The Indiana University survey finds that “striving to meet an appropriate liquidity target over time—that is, maintaining a targeted level of cash reserves and financial flexibility” (37.6%) and “assuring an annual surplus so the mission can be achieved in down years (26.6%)— are the primary financial objectives selected by most organizations” (Center on Philanthropy, 2012, p. 7). Note the second objective presumes that the surplus is saved up for a period of one or more years, embodying the precautionary motive for holding cash and underscoring the objective of liquidity targeting (which, in turn, guides how much of a surplus to strive for). An additional 23.7% reported that breaking even financially was the primary financial objective for the organization. The reader may reference the previous chapter for studies of nonprofit operating reserves. It is not clear whether reserves include transactions demand for cash, particularly when part of a survey. The most careful study of actual nonprofit liquidity management practices to date was conducted by Ramirez (2011). Ramirez (2011) harnessed the methodol­ ogy used by the finest corporate finance research and applied it to NPOs. He studied cash as well as cash as a percentage of yearly expenses. His primary findings of interest include: • NPOs hold three months of annual expenses in cash and another nine months of expenses in savings (interest-bearing account bal­ ances and short-term investments).

136

Zietlow

• NPOs hold cash for the same reasons as businesses: 1) the transaction motive (it is the least expensive way to finance daily operations); 2) the precautionary motive (as a buffer against unpredictable declines in revenue and support); 3) the speculative motive (to take advantage of future investment opportunities, which may also be unanticipated); and 4) governance-related reasons (this may play out in one of two ways— the board and management superintend liquidity correctly and for good reasons or the board and management hold too little or too much liquid­ ity to gain personally or stand in the way of donors’ and other funders’ best interests from being carried out). Smaller NPOs, those with riskier (less predictable) revenues and support, and those with higher surpluses (surpluses divided by expenses; some of these surpluses, presumably, accumulate in the form of cash over time), tend to hold more cash. • Organizations that appear to hold ‘excess cash’ will then invest more in land, buildings, and equipment than similar organizations holding nor­ mal levels of cash. This use of cash to fund asset growth underscores the need to prefund growth by building up liquidity. These amounts serve as ‘strategic reserves’ (Zietlow, Hankin, Seidner, and O’Brien, 2018). • Organizations holding a higher level of liquid longer-term invest­ ments (public securities, including stocks and bonds), those that are easily and quickly sold for their fair market value, tend to hold less cash, which suggests that managers are aware of and manage substi­ tutes for cash wisely. Sloan, Charles, and Kim (2016) provide empiri­ cal support from survey evidence that arranging cash substitutes such as credit lines is intentional. • Donors do not penalize organizations that hold high levels of cash. They evidently do not see governance/agency problems that might result in too-high liquidity levels. Ramirez (2011, p. 664) hypothesizes that the uniqueness of NPOs implies that high cash levels could be seen as prudent management—“a precautionary cushion, agility for transactional purposes, and flexibility for speculative purposes—instead of an indication of agency problems.” He concludes (p. 675): “It appears that cash holdings in the nonprofit sector, like their for-profit counterparts, can be largely explained by pre­ cautionary and speculative measures. . . . Cash is very valuable for the organization, and donors seem to agree.” Recapping, the NPO’s primary financial objective is to ensure that finan­ cial resources are available when needed (timing), as needed (amount), and at reasonable cost (cost-effectiveness), and that once mobilized, these resources are protected from impairment and spent according to mission and donor purposes. The first and main part of this objective implies that the organization sets and manages an appropriate liquidity target. How might an NPO set its adequate liquidity target? From our litera­ ture review, we surmise that it might assess qualitative factors such as its

Treasury, Cash, and Liquidity Management

137

age and size, its industry, and its revenue mix as well as other business model factors. It might also engage a quantitative approach, assessing such factors as the volatility of its cash flows, growth, future economic conditions (especially credit conditions), market structure (Paarlberg, An, Nesbit, Christensen, & Bullock, 2018), as well as other items implicit in the new liquidity assessment required by the new accounting stand­ ards update in the U.S., ASU 2016–14. The remainder of this chapter introduces a new liquidity management measurement framework that addresses the relevant dimensions of liquidity and the empirical findings just summarized.

Desiderata—Measure and Manage Liquidity, Broadly Defined Some Definitions Nonprofit managers properly set their organizations’ appropriate liquid­ ity target by incorporating elements of solvency, liquidity, and financial flexibility. My starting point is solvency—the least helpful component, and yet the one that gets the most attention in academic discussions of liquidity. The only part of solvency that is truly liquid is cash. I build on the cash position by incorporating cash flow measures that repre­ sent liquidity coming into the organization. I then introduce items that are often off-balance sheet and perhaps invisible to the outside observer, which comprise financial flexibility. Together these provide the manager with the necessary ingredients for a composite view of liquidity that might serve as the liquidity target. What Is Solvency? Solvency is an accounting concept. If the book value of assets exceeds that of liabilities, then the organization is considered solvent because the potential cash proceeds from the sale of assets can be used to repay liabil­ ities. Alternatively, the firm is considered insolvent if liabilities exceed the book value of assets. For clarity, we further divide solvency into shortterm solvency and long-term solvency. Short-term solvency measures include net working capital, the current ratio, net assets, and liquid unrestricted net assets. These point-in-time measures are limited in terms of providing adequate insight into organi­ zational liquidity. Furthermore, the longer the time elapsing between the measurement of stocks, the greater the need to augment with liquid­ ity measures. When the manager measures statement of financial posi­ tion items only once a year or once a quarter, neither levels nor changes in levels will appropriately measure related cash flows. Furthermore, the time-to-cash dimension is not captured in these ratios regardless

138

Zietlow

of how often they are recalculated. Payables may come due and drain cash before receivables are collected. Because of these deficiencies, the best way to incorporate solvency is through a basic measure such as the sum of cash and short-term investments readily convertible to cash (to scale cash, one might calculate the modified cash ratio (net cash/ assets), where net cash is defined as cash minus accounts payable minus accrued expenses; Zietlow, 2012). The manager should not set the organization’s liquidity target solely based on one or a set of solvency measures. Long-term solvency measures include the debt-to-assets ratio and the coverage of debt-related payments. The primary insights from these are to gain a deeper understanding of financial flexibility, discussed later. What Is Liquidity? Liquidity is the “ability to meet current and future financial obligations in a cost-effective manner. . . . By definition, cash is completely liquid” (Association for Financial Professionals, 2013). We have seen how the manager may use cash, by itself or along with short-term investments readily convertible to cash, as the preferred solvency measure. A liquidity measure focuses on the flow of cash with respect to its amount, timing, or riskiness. The cash reserve ratio, calculated by dividing cash by total expenses, could serve as a liquidity measure if accrual-based expenses were reformulated into cash expenses (at a minimum, subtract deprecia­ tion and amortization expense, in-kind expense, pass-through expenses, and one-time expenses; Barr, 2019)—which is rarely done, unless cashbasis accounting is used. A key business metric used is the cash con­ version cycle, the number of days that it typically takes to move funds from inventory to receivables and from receivables to cash, after account­ ing for deferred payment from payables. When an organization’s cash conversion cycle is short, it takes less time to generate cash, indicating improved liquidity. Organizations plagued with irreducible and long cash conversion cycles wait longer to receive cash inflows and must, therefore, arrange for longer periods of gap financing as they exhaust their cash and short-term investments holdings or tap a credit line. Rather than rely on historical conversion cycle data, the nonprofit manager is best advised to project the cash inflows and cash outflows expected over the next week, month, quarter, and year. Correspondingly some experts argue that the single most important component of liquidity management is forecasting cash (Gallinger & Healey, 1987). What Is Financial Flexibility? An organization possesses financial flexibility when its financial policies (use of debt, excess of revenues over expenses, and the relationship of

Treasury, Cash, and Liquidity Management

139

revenues to assets) are consistent with its projected increase in revenues (Zietlow, Hankin, Seidner, & O’Brien, 2018). The business model of the organization sets the parameters for its financial flexibility. The Financial Accounting Standards Board (FASB, 1993) defines financial flexibility operationally, with a focus on unanticipated fundings needs. In particular, Financial flexibility is the ability of an entity to take effective actions to alter amounts and timing of cash flows so it can respond to unex­ pected needs and opportunities. Information about the nature and amount of restrictions imposed by donors on the use of contributed assets, including their potential effects on specific assets and on lia­ bilities or classes of net assets, is helpful in assessing the financial flexibility of a not-for-profit organization. (Financial Accounting Standards Board, 1993, p. 69) We underscore the focus on the amounts and timing of cash flows here. Peter Kramer, of the Nonprofit Finance Fund, alludes to financial flex­ ibility in his definition of financial sustainability as the “organization’s ability to manage the unexpected, adapt to changing circumstances, and pursue mission imperatives” (Kramer, 2018). How can this be translated into an operational measure? First, a full view of financial flexibility includes the willingness of board members to meet emergency needs by making above-normal donations or loans to the organizations. Second, finance staff need visibility into financial informa­ tion such as restrictions on the use of assets, the compensating balances that must be maintained in checking accounts as banks require, the matu­ rity structure of long-term assets and liabilities, or the designated amounts within unrestricted cash and short-term investments (Zietlow, Hankin, Seidner, and O’Brien, 2018). Combining one or more solvency measures, a measure of liquidity, and a measure of financial flexibility gives the nonprofit manager the ability to manage an organization’s liquidity comprehensively. Rather than sepa­ rately identify the measures as solvency, liquidity, and financial flexibility, the necessary elements will be reframed as CORE-1, CORE-2, CORE-3, and augmented liquidity. A New Liquidity Management Approach for NPOs Viewed Broadly Liquidity management, in essence, is aimed at ensuring an organization’s financial health and sustainability. In line with Kramer’s (2018) defini­ tion of financial sustainability (mentioned earlier), managers will want to employ an appropriate liquidity target that ensures their organizations’ financial health and sustainability.

140

Zietlow

Table 10.1 portrays a new look at liquidity that any nonprofit manager might apply. It addresses some of the shortcomings of existing liquidity and solvency measures by incorporating key components of liquidity and financial flexibility and by replacing solvency components (current asset and liability balance sheet items beyond cash and short-term investments) with forecasts of cash flows that will alter the future cash position. In Table 10.1, liquidity for the nonprofit treasurer or cash manager—a liquidity composite which I shall call LiquidityTreasury—has several components. Here are the primary components of liquidity Table 10.1 L iquidity Broadly Defined—A Recommended Measure of Liquidity for Nonprofit Managers Level CORE-1 “Core of the Core”

Description and Calculation Formula

1.Cash (Unrestricted and Undesignated).* Formula: Cash (unrestricted and undesignated) = (Cash and cash equivalents − Temporarily restricted cash and cash equivalents − Any designated amounts within cash and cash equivalents)** 2.Adjusted Liquid Reserve. CORE-2 “Other liquidity resources” a. Include all other cash beyond Item #1 that is not permanently restricted, unless in quasi-endowment. b.Include all short-term investments that are not permanently restricted, unless in quasi-endowment. c. Include the unused portion of an arranged credit line. d.Exclude current maturities of mortgage or other long­ term debt. e. Exclude current short-term borrowing amounts beyond any credit line outstanding. f. Exclude current portion of leases. Formula: Other liquidity resources = (Unrestricted and temporarily restricted cash and equivalents + Short-term investments (unless permanently restricted) + Unused credit line − (Current maturities of long-term debt or leases + Other noncredit-line short-term debt such as notes payable) − Item #1 above) CORE-3 “Net 3.Expected Operating Cash Flow. incoming cash a. Include all incoming operating cash expected in the from operations” next period (typically one year). b.Exclude all outgoing operating cash anticipated in the next period (typically one year). Formula: Expected operating cash flow = Incoming operating cash flow − Outgoing operating cash flow Estimation of expected operating cash flow if nonprofit manager: This would be the same as the projected operating cash flow in a period-ahead projected statement of cash flows.

Level

Description and Calculation Formula

Estimation of expected operating cash flow (OCF) if outside analyst: Proxy for expected operating cash flow = Average of last three years’ OCF Possible subjective ad-hoc adjustments to this proxy for outside analyst: One might make an upward adjustment if one or more of these cases hold: a. Adjust for low recent range (last three years’ average OCF ≤ 50% of average multi-year OCF). b.Adjust for high operating performance (last three years’ experienced positive net surplus each year). c. Adjust for high cash yield (average OCF for last three years ≥ 0.75 of three-year average surplus). One might make a downward adjustment if one or

more of these cases holds:

a. Adjust for high recent range (last three years’ average OCF > 200% of historical multi-year average OCF). b. Adjust for low operating performance (last three years’ experienced net deficit each year). c. Adjust for low cash yield (average OCF for last three years ≤ 0.25 of three-year average surplus). Augmented 4.Financial Flexibility. liquidity a. Include amounts in quasi-endowment that are not specifically encumbered by cash commitments due within one year. b.Include an unused portion of arranged credit line. c. If no credit line exists, use a proxy for likely line

approval amount:

i. Include 50% of the organization’s inventories. ii.Include 75% of the organization’s accounts receivable. d.Include written donor or foundation emergency

funding declaration.

e. Include parent organization guarantee. f. Include nonfinancial assets awaiting sale

(conservative market valuation) as well as long­

term unrestricted financial assets awaiting sale

(conservative market valuation).

g. Include other known factors, if relevant (such

as the ability to issue an added 25% beyond the

existing commercial paper outstanding, if any, or

the ability of an emergency fundraising appeal to

bring in $X).

Liquidity composite LiquidityTreasury = CORE-1 + CORE-2 + CORE-3 + Augmented liquidity. - Assess adequacy of LiquidityTreasury by calculating a supplemental measure, Target liquidity level lambda.*** (Continued)

142

Zietlow

Table 10.1 (Continued) An outside analyst may not have this specific information so may have to use cash and cash equivalents from the statement of financial position. Assumes that cash and cash equivalents, as shown at the top of the statement of financial position, does not include any permanently restricted cash. *** Target liquidity level lambda may be calculated as (Liquid reserve + Incoming oper­ ating cash flow) / Uncertainty of operating cash flows. Liquid reserve is the sum of cash and cash equivalents, short-term investments, and the unused portion of the credit line. In this formulation, it equals CORE-1 + CORE-2. Incoming operating cash flow is CORE-3 here. This item is now the first item to be shown under header “Table 10.1 (Continued).” Uncertainty of operating cash flows may be calculated as the standard deviation of historical operating cash flows. The lambda measure, also called the “rela­ tive liquidity index,” is interpreted as a standard normal score and allows for a calcu­ lation of the probability running out of cash (Zietlow, Hankin, Seidner, and O’Brien, 2018). The manager might calculate target lambdas for two different time horizons: a period covering the next three months (using a three-month projection of operating cash flows and uncertainty calculated on past quarters of operating cash flows) and a period covering the upcoming year (using a year-ahead projection of operating cash flows and uncertainty calculated on past annual values of operating cash flows). Scenario analysis would also provide helpful insights here. *

**

that may be built up, measured, and managed. I suggest the following three elements of core liquidity and one element of augmented liquid­ ity. I label the Level 1 measure as CORE-1 (“Core of the Core,” as this is the only amount that could be spent at a moment’s notice), the Level 2 measure as CORE-2 (other liquidity resources), and the Level 3 measure as CORE-3 (net incoming cash from operations). All of these are measurable and manageable for managers and the board. Outsid­ ers may calculate some of these directly and derive proximate meas­ ures of several others but would have difficulty estimating all but the first three components of financial flexibility. Nonprofit managers can assess their organizations’ liquidity composite by calculating the target liquidity level lambda (also called relative liquidity index and lambda), based on the sum of the three elements of core liquidity (CORE-1 + CORE-2 + CORE-3), as informed by augmented liquidity. If the sum of the three elements of core liquidity appears insufficient, managers determine if augmented liquidity (financial flexibility) is ample. If not, they may determine whether and how to build augmented liquidity, perhaps through having several major donors establish a formal back­ up liquidity donation letter of intention. If augmented liquidity is not and will not be sufficient, managers may review and manage the three core liquidity elements, perhaps deciding to contract for or request an increased amount for a line of credit.

Call for Additional Research One might suggest three directions for further research. First, the com­ posite liquidity tool offered here can be refined and improved. Second, insights from the closely related and developing field of risk management

Treasury, Cash, and Liquidity Management

143

should be integrated with our understanding of cash and liquidity man­ agement. Researchers might also add value for managers by moving away from financial vulnerability as a binary measure (vulnerable-not vulnerable) to a continuum of financial health. An initial contribution in this direction with gradations of vulnerability (highly or not highly vul­ nerable) and with short-term and long-term factors is made by AndresAlonso, Garcia-Rodriguez, and Romero-Merino (2016).

References Andres-Alonso, P., Garcia-Rodriguez, I., & Romero-Merino, M. E. (2016). Dis­ entangling the financial vulnerability of nonprofits. Voluntas: International Journal of Voluntary and Nonprofit Organizations, 27(6), 2539–2560. Ang, J. S. (1991). The corporate-slack controversy. In Y. H. Kim & V. Srinivasan (Eds.), Advances in working capital management (Vol. 2, pp. 3–14). Green­ wich, CT: JAI Press. Association for Financial Professionals. (2013). Essentials of treasury manage­ ment (4th ed.). Bethesda, MD: Association for Financial Professionals. Barr, K. (2019). Analyzing financial information using ratios. Retrieved from www.propelnonprofits.org/wp-content/uploads/2017/10/analyzing_financial_ information_using_ratios.pdf Boileau, M., & Moyen, N. (2016). Corporate cash holdings and credit line usage. International Economic Review, 57(4), 1481–1506. Center on Philanthropy. (Ed.). (2012). Financial literacy and knowledge in the nonprofit sector. Indianapolis: Indiana University. Retrieved from https://phi­ lanthropy.iupui.edu/files/research/2012financialliteracy.pdf Chorafas, D. N. (2002). Liabilities, liquidity, and cash management: Balancing financial risks. New York, NY: John Wiley & Sons. Financial Accounting Standards Board. (1993). Statement of financial account­ ing standards no. 117. Financial statements of not-for-profit organizations. Retrieved from www.fasb.org/pdf/fas117.pdf Gallinger, G. W., & Healey, P. B. (1987). Liquidity analysis and management. Reading, MA: Addison-Wesley. Graham, J. R., & Leary, M. T. (2018). The evolution of corporate cash. Journal of Applied Corporate Finance, 30(4), 36–60. Hankin, J. A., Seidner, A., & Zietlow, J. (1998). Financial management for non­ profit organizations. Hoboken, NJ: John Wiley. Harford, J., Klasa, S., & Maxwell, W. F. (2014). Refinancing risk and cash hold­ ings. Journal of Finance, 69(3), 975–1012. Kim, C., Mauer, D. C., & Sherman, A. (1998). The determinants of corporate liquidity: Theory and evidence. Journal of Financial and Quantitative Analysis, 33(3), 335–359. Kramer, P. (2018, March 26). Top indicators of nonprofit financial health. Nonprofit Finance Fund. Retrieved from https://nff.org/blog/top-indicators­ nonprofit-financial-health Lins, K. V., Servaes, H., & Tufano, P. (2010). What drives corporate liquidity? An international survey of cash holdings in lines of credit. Journal of Financial Economics, 98(1), 160–176.

144

Zietlow

Lopez-Gracia, J., & Sogorb-Mira, F. (2015). Financial constraints and cash-cash flow sensitivity. Applied Economics, 47(10), 1037–1049. Marwell, N. P., & Calabrese, T. D. (2015). A deficit model of collaborative gov­ ernance: Government—Nonprofit fiscal relations in the provision of child wel­ fare services. Journal of Public Administration Research and Theory, 25(4), 1031–1058. Morris, J. R. (1991). Discussion. In Y. H. Kim & V. Srinivasan (Eds.), Advances in working capital management (Vol. 2, pp. 15–19). Greenwich, CT: JAI Press. Neamtiu, M., Shroff, N., White, H. D., & Williams, C. D. (2014). The impact of ambiguity on managerial investment and cash holdings. Journal of Business Finance & Accounting, 41(7–8), 1071–1099. Opler, T., Pinkowitz, L., Stulz, R., & Williamson, R. (1999). The determinants and implications of corporate cash holdings. Journal of Financial Economics, 52(1), 3–46. Paarlberg, L., An, S., Nesbit, R., Christensen, R., & Bullock, J. (2018). A field too crowded? How measures of market structure shape nonprofit fiscal health. Nonprofit and Voluntary Sector Quarterly, 47(3), 453–473. Ramirez, A. (2011). Nonprofit cash holdings: Determinants and implications. Public Finance Review, 39(5), 653–681. Simutin, M. (2010). Excess cash and stock returns. Financial Management, 39(3), 1197–1222. Sloan, M. F., Charles, C., & Kim, M. (2016). Nonprofit leader perceptions of operating reserves and their substitutes. Nonprofit Management & Leader­ ship, 26(4), 417–433. Zietlow, J. (1994). Organizational goals and financial management and donative nonprofit organizations. Terre Haute: Indiana State University. Zietlow, J. (1997, December). Liquidity management in donative nonprofit organizations. Paper presented at the 1997 Annual Meeting of the Association for Research on Nonprofit Organizations and Voluntary Action (ARNOVA), Indianapolis, IN. Zietlow, J. (2012). A financial health index for achieving nonprofit financial sus­ tainability. Retrieved from SSRN website https://ssrn.com/abstract=2049022. Zietlow, J., & Chisholm, R. (1988). Useful cash management techniques for ser­ vice and nonprofit organizations. Journal of Cash Management, 8(6), 79–82. Zietlow, J., Hankin, J. A., Seidner, A., & O’Brien, T. (2018). Financial manage­ ment for nonprofit organizations: Policies and practices (3rd ed.). Hoboken, NJ: John Wiley & Sons. Zietlow, J., Hill, M., & Maness, T. (2020). Short-term financial management (Revised 5th ed.). San Diego, CA: Cognella Academic Publishing.

11 Capital Structure and

Financial Health

Marcus Lam, Elizabeth Searing, Christopher Prentice, and Nathan Grasse1

Introduction The simplicity with which capital structure may be defined—that is the relative mix of an organization’s assets and liabilities—calls into ques­ tion the complexity and importance of the concept in regard to non­ profit operations and survival. More than just an accounting exercise, concerned with tracking “the distribution, nature, and magnitude of an organization’s assets, liabilities, and net assets” (Miller, 2003, p. 1), the capital structure of an NPO dictates how successful it will be in achiev­ ing its mission. A suboptimal capital structure, where an NPO has an unbalanced proportion of debt to equity, increases the cost of capital and decreases financial health (Andres-Alonso, Garcia-Rodriguez, & Romero-Merino, 2016; Jegers, 2018; Lin & Wang, 2016; Miller, 2003; Trussel, 2002, 2012; Wedig, Hassan, & Morrisey, 1996). The amount and sources of debt that a nonprofit organization (NPO) uses to finance its projects and programs is a critical management issue (Trussel, 2012). Nonprofit practitioners would benefit from a more pro­ found insight into the capital structure decisions they have to make, and the possible consequences that those decisions may have for organiza­ tional operations and financial health (Jegers, 2018). As Bowman, Cala­ brese, and Searing (2018) note, capital structure should not be considered in isolation. Just as a balance sheet should be viewed alongside an income statement, capital structure must be considered alongside the current business operations and future operational goals of an NPO (Bowman et al., 2018; Miller, 2003). After all, nonprofit operations—documented in the income statement—are financed by resources in the balance sheet. Jegers (2018) argues that much more theoretical and empirical research is needed to understand nonprofit capital structure, and he spe­ cifically calls for replication studies in different countries. In response to Jegers’s (2018) call, this empirical research analyzes the capital struc­ ture of Canadian charities with panel data over an eight-year period and seeks to contribute to a greater understanding of how NPOs finance their operations. Specifically, we explore whether Canadian charities finance

146

Lam, Searing, Prentice, and Grasse

operations by using net assets or leverage their assets and pursue financ­ ing by issuing debt. The chapter begins with a brief review of the ‘uniqueness of nonprofit finance’ (Bowman, 2002). In this section we discuss the structural, legal, and normative elements that make borrowing decisions in NPOs different than in for-profit organizations. Next, we present the two dominant com­ peting theories of capital structures—pecking order and static trade-off— and offer a literature review of studies that examine the capital structure of NPOs. The following sections offer a brief discussion of the Canadian nonprofit sector for context and a review of our methodology, including the operationalization of our variables and the analysis procedure. We then present the results of our analysis and conclude with a discussion of the implications of our findings for future research.

Capital Structure: The Nonprofit Difference Much of what we know about capital structures emerges from the cor­ porate finance literature, building upon influential works by Donaldson (1961), Fama and Jensen (1985), Jensen and Meckling (1976), Miller and Modigliani (1961), and others (see surveys by Harris & Raviv, 1991; Zingales, 2000). Some observers suggest that NPOs may not approach capital structure and debt decisions differently than for-profits (Brody, 1996; Trussel, 2012). They argue that in certain service areas (e.g., health care) NPOs and for-profits face similar challenges when deciding how to finance operations. In their view, business operations and institutional isomorphism are more influential than legal status and tax benefits in deciding whether and how much to borrow. Indeed, Trussel’s (2012) results support this theory of institutional convergence on capital struc­ ture. Although this argument regarding the similarity in capital structures between NPOs and for-profits operating in the same space is compelling, it is unlikely that the majority of NPOs operating in uniquely charitable domains approach debt similarly. Bowman (2002) offers that four legal distinctions between nonprofit and for-profit firms are relevant to financing behavior. First, NPOs do not have owners and thus cannot issue stock or engage in equity financing. Second, incentives in the tax code allow NPOs to raise money via dona­ tions. Relatedly, however, these donations may come with donor restric­ tions and may not be used for financing certain operations. Third, NPOs are not subject to involuntary bankruptcy and cannot be legally forced into liquidation or reorganization. The consequence of this protection is a certain insulation from creditors for nonprofit firms. Finally, unlike forprofit organizations, many NPOs are eligible to sell tax-exempt bonds. According to Calabrese and Ely (2016), the importance of tax-exempt borrowing to the nonprofit sector has grown significantly over time, with an 8% compound annual growth rate in their use from 1993 to 2010.

Capital Structure and Financial Health

147

Nonprofit Debt: To Borrow, or Not To Borrow? “Borrowing money—whether short-term (in the form of trade credits, notes, etc.) or long-term (in the form of mortgages, bonds, etc.)—is nei­ ther inherently a good nor a bad decision for any organization” (Mitch­ ell & Calabrese, 2019, p. 655). And yet, normative and legal boundaries disincentivize nonprofit borrowing. To some stakeholders, nonprofit debt service represents an unacceptable diversion of resources away from cur­ rent programs, calling into question the organization’s legitimacy. Char­ ity Navigator—an online ‘evaluator’ that rates NPOs across various financial criteria to produce a rank-ordered list of the ‘most responsible’ organizations—uses as a key component to their ratings whether an NPO has a high level of liabilities relative to assets. To obtain their highest rat­ ing, NPOs must maintain a ratio as low as 5% in some service domains (e.g., animal welfare, food banks, libraries). Whether Charity Navigator or other online information intermediar­ ies influence nonprofit stakeholders is not clear, but the research sug­ gests their preference for lower levels of indebtedness is mirrored by donors. Prior research indicates that organizations with higher levels of debt service receive lower levels of donations (Calabrese & Grizzle, 2012; Charles, 2018). Mitchell and Calabrese (2019) refer to the widely accepted notion that NPOs should avoid debt as one of four enduring proverbs of nonprofit financial management. In addition to the norma­ tive bias against nonprofit debt, legal and policy implications exist in the U.S. context. “When elite universities issued significant debt during the 1980s, public policy limited debt issuances for the entire sector from 1987 to 1997” (Mitchell & Calabrese, 2019, p. 655). Despite these normative and legal boundaries, debt has several poten­ tial advantages for NPOs. Resource acquisition, in any form, comes at a cost. Individual donor development, grant writing, capital campaigns, etc. require significant investment in time and human capital and yield uneven returns. “Debt can capitalize an organization relatively quickly and at a relatively low cost” (Mitchell & Calabrese, 2019, p. 655), and such capitalization can support programmatic expansion, fund new programs, deliver capital investment to initiate growth, and provide unrestricted cash reserves (Bowman, 2002; Jegers, 2003; Mitchell & Calabrese, 2019). Cash reserves are particularly useful to organizations that contract with government, which is often slow to provide reimburse­ ment (Pettijohn & Boris, 2013), and thus are subject to uneven revenue flows. Debt capacity also “represents an important (if imperfect) vehicle for maintaining program continuity during economic downturns. Mak­ ing recourse to debt, rather than to spending cuts, can help organizations reduce staff turnover, maintain program capacity and scale, and cope with other sectoral norms that limit access to other forms of fiscal slack” (Mitchell & Calabrese, 2019, p. 655).

148

Lam, Searing, Prentice, and Grasse

Thus, NPOs face competing challenges in whether to pursue exter­ nal financing, and may prefer to exhaust internal financing before issu­ ing debt given normative and legal pressures. In the next section, we turn explicitly to this question and present the two dominant theories of capital structures: pecking order and static trade-off. We briefly review empirical studies that test these theories in the nonprofit context, discuss the mixed results emerging from these studies, and propose our model for examining the capital structure of Canadian NPOs.

Literature Review We follow nonprofit finance researchers such as Bowman (2002) and Garcia-Rodriguez and Jegers (2017) in defining capital structure as the combination of debt and equity that allows for the financing of an organ­ ization’s operations or growth. On the practitioner side, capital structure is defined in a similar way but with a focus on organizational assets, i.e., cash, investments, receivables, buildings and equipment, etc. (Miller, 2003). NPOs may use their capital structure for a number of reasons: to smooth out cash flow due to delays in third-party payer reimbursements; expand services by hiring new staff; invest in new programs; or make capital purchases such as equipment, land, or a building. The decision about how to finance operational or growth activities is at the crux of nonprofit capital structure research. In short, NPOs can either use exist­ ing reserves (aka net assets or equity) or leverage their assets and borrow, thus incurring more debt, to finance these activities. More formally, the two major competing theories about nonprofit financing behavior are ‘pecking order’ and ‘static trade-off.’ The ‘pecking order’ theory posits that nonprofit managers are debt averse and thus prefer to use net assets or reserves to finance new activities or capital purchases over taking on new debt, thus implying a ‘pecking order’ with respect to financing activities (Bowman, 2002; Garcia-Rodriguez & Jegers, 2017). Only when NPOs lack reserves will they turn to debt instruments. Further, Jegers (2018) makes the distinc­ tion between ‘market debt’ and ‘non-market debt.’ Market debt consists of common debt instruments provided by traditional financing institu­ tions (i.e., banks, credit unions, etc.) whereas non-market debt consists of debt instruments with fewer conditions attached for borrowing and issued by ‘individuals or institutions with sympathy for the organiza­ tion’s mission’ (Jegers, 2018, p. 90). This implies that the pecking order is expanded, in order of preference, to include: equity, non-market debt, and market debt. As for hypothesis, the ‘pecking order’ theory suggests a negative relationship between measures of equity or net assets and capital structure, for example, commonly measured as total liabilities divided by total assets.

Capital Structure and Financial Health

149

Alternatively, ‘static trade-off’ theory posits that nonprofit managers prefer to maintain a sustainable balance between net reserves and debt as long as the cost of incurring debt does not exceed its benefits (Bowman, 2002; Garcia-Rodriguez & Jegers, 2017). As such, by maintaining an opti­ mal level of debt, NPOs are truly ‘leveraging’ their assets while maintain­ ing reserves for other uses. Further, allocating a portion of expenses for debt payments also curbs potential principal-agent problems emerging from nonprofit managers’ preferences to use net assets for their personal projects, rather than to further the organization’s mission (Bowman, 2002; Jegers, 2018). Thus, the static trade-off theory hypothesizes a positive relationship between measures of net assets and capital structure. Evidence from the literature has been mixed with studies finding support for both theories. For example, Garcia-Rodriguez and Jegers (2017), in examining the capital structure of nongovernmental develop­ ment organizations across three countries (Spain, United Kingdom, and Belgium) and using three measures of capital structure (i.e., short-term, long-term debt, and overall debt,), find support for the pecking order explanation of capital structure for measures of overall or total debt. Garcia-Rodriguez and Jegers (2017) ran country specific models (i.e., one separate model for each country) as well as a country interaction model and found significant negative coefficients between their measure of equity (i.e., return on assets) and capital structure (i.e., leverage) for the U.K. and Belgium but not for Spain. Calabrese (2011), in his test of the competing capital structure theories, finds NPOs “reveal behavior consistent with the pecking order theory,” regardless of whether capital structure is defined as total leverage or financial debt (p. 139). On the other hand, Bowman (2002), in analyzing nonprofit data from the United States, points to the importance of endowments in decisions to borrow. He hypothesizes that endowments allow for collateral and thus nonprofit managers have more confidence in their ability to take on debt in the presence of endowments and lenders also have more confidence in lending to NPOs with endowed net assets. Indeed, Bowman (2002) finds support for the static trade-off theory for NPOs with endowments, that is, a significant positive coefficient between earnings (return on assets) and capital structure, as well as a significant positive coefficient between explicit measure of endowment assets and leverage. From a practitioner’s perspective, Miller (2003) reminds us that an NPO’s capital structure should reflect its core business. For example, whereas a nonprofit theater and a for-profit commercial airline may both have vastly divergent missions, “they have in common the busi­ ness of filling seats” (p. 3). As such, a nonprofit theater house may have a capital structure more similar to a commercial airline company than to a nonprofit human service agency. What this suggests for research is that capital structure should vary across nonprofit sub-sectors depending

150

Lam, Searing, Prentice, and Grasse

on its core business. Nonprofit hospitals and educational institutions, for example, are in the business of ‘filling beds and seats’ and are thus expected to have more long-term assets and (potentially) more long-term debt to finance these assets compared to a nonprofit advocacy organiza­ tion, or a nonprofit human service agency that provides ‘meals on wheels’ as its core business. Evidence from existing studies does suggest that there are indeed sub-sector differences with respect to capital structure. For example, Bowman’s (2002) analysis tested for subsector differences (hos­ pitals, higher education institutions, human service organizations that provide housing, and arts and cultural organizations) and found that, when considering the presence of endowment assets, there is no signifi­ cant difference between human service housing organizations and hospi­ tals with respect to leverage but that higher education institutions have less leverage compared to housing organizations. This may not be sur­ prising given that the core business of housing service organizations, like hospitals, is to ‘fill beds’ and thus may require similar capital structures. Higher education institutions, on the other hand, may have more sophis­ ticated capital fundraising campaigns and as a result require less debt to finance their activities. On the other hand, Calabrese and Ely (2016) in their analysis of taxexempt bonds as a capital source of NPOs found that hospitals with larger endowments had increased usage of tax-exempt bonds. This find­ ing is consistent with Gentry’s (2002) findings that endowment assets and tax-exempt bonds are concentrated in a minority of hospitals. He further notes that “over half of tax-exempt debt could be retired by hospitals reducing their endowments” (Gentry, 2002, p. 871), a finding consist­ ent with static trade-off theory. Although just one form of borrowing, these findings are noteworthy because tax-exempt borrowing comprises 45% of all financial liabilities outstanding in the U.S. nonprofit sector, dwarfing the next largest liability category of mortgages at 24% (Cala­ brese & Ely, 2016). Unsurprisingly, these figures are driven by hospitals and higher education institutions that hold roughly 75% of the U.S. non­ profit sector’s tax-exempt debt. Another sectoral difference of note is Calabrese and Ely’s (2016) find­ ing that arts organizations “prefer internal financial resources for capital expansion—consistent with the pecking order theory of capital struc­ ture” (p. 473). In summary, the review of existing studies suggests that nonprofit financing behavior is not one dimensional and that there is var­ iation by country and sub-sector. As Garcia-Rodriguez and Jegers (2017) point out, there may be key macroeconomic variables at the country level that may explain differences in financing behavior, such as differences in legal-systems, political stability, and government effectiveness, among others. In this chapter, we further our understanding of nonprofit capital structure by examining data from the Canadian nonprofit sector. Canada offers a unique case study as it is similar politically and economically to

Capital Structure and Financial Health

151

the United States but differs in governmental support of its nonprofit sector. There are also relatively few studies in the nonprofit finance lit­ erature that focus on Canada and none that focus on capital structure, as far as we know. Thus, this chapter makes an important contribution to the nonprofit finance literature. In the next section, we briefly review the scale and scope of the nonprofit sector in Canada.

Canadian Nonprofit Sector Canada’s nonprofit sector is the second largest in the world, measured as a share of its respective economically active population (Hall, Barr, Easwaramoorthy, Sokolowski, & Salamon, 2005). Similar to other developed countries, the Canadian nonprofit sector provides vital health, cultural, and social services to residents of its most underserved com­ munities. Canadian NPOs also operate with a business model similar to other NPOs in developed countries—generating revenue prior to service provision and providing services to clients regardless of ability to pay. Often, services are provided at no-cost to the client or at prices below the cost of production (Walker & Osterhaus, 2010). Thus, Canadian NPOs must generate revenue through multiple streams of income to cover the cost of production, to build reserve funds, or simply to grow and expand services. The Canadian nonprofit sector is unique, however, in that it receives a larger share of revenue from the government compared to its North American counterparts, including funding for civic and advocacy organizations. Specifically, on average, nonprofit and voluntary organiza­ tions in Canada generate 51% of revenue from government sources, fol­ lowed by 39% from fees for service, and 9% from philanthropic sources (Hall et al., 2005). Canadian NPOs also have a high reliance on volun­ teers (Hall et al., 2005). A distinction needs to be made between ‘registered charities’ and ‘non­ profit organizations’ in Canada. Whereas both types of organizations are mission-driven rather than profit-driven, and exist for the benefit of the larger society or for specific members, registered charities are more for­ mal, offer more tax benefits, and serve a boarder clientele compared to NPOs (Government of Canada, 2016). For example, registered charities must formally register and apply to the Canadian Revenue Agency (CRA) for approval to operate as a charity whereas NPOs are not required to go through this process. As such, registered charities also have more for­ mal annual reporting requirements and file a more extensive tax form (T3010) compared to NPOs (T2). In addition, as already mentioned, reg­ istered charities serve a broader clientele and operate with a broader mis­ sion whereas NPOs, in general, work in more specific areas such as sports recreation or civic improvement.2 Finally, forms of income generation also differ as registered charities can issue donation receipts for income tax purposes whereas NPOs cannot do so (see endnote 2 of this chapter).

152

Lam, Searing, Prentice, and Grasse

Given that the data for this chapter are drawn primarily from tax form T3010, the analysis, discussion, and implications are for the population of registered charities only rather than for the population of NPOs.

Methods Data To illustrate and test our hypotheses, we use archived data from the Canadian T3010 form. This form, similar to the Form 990 in the United States, is required for all Canadian charities. However, unlike the U.S., the Canadian data capture organizations that are not required to file in the U.S., such as congregations. We compiled and cleaned data from 2009 to 2016 into a well-balanced panel of 676,721 observations. One important step in our data cleaning process is to exclude charities with less than $100K in revenue. Charities which have over $100K in revenues supply more granular information than smaller charities. This is similar to the difference in filing the 990 and the 990EZ in the United States, except that Canadian charities are filling out a different portion of a single form that is primarily common across all sizes. Because charities under $100K do not supply much detailed information on their finances, this study restricts the sample to those receiving over $100K in revenues (329,946 observations). The removal of observations with missing or potentially misreported necessary data and the use of lags in the inde­ pendent variables produce a final sample of 229,970 observations over seven years, or 39,574 charities per year. Finally, we exclude extreme outlying observations by ‘winsorizing’ all ratio variables at the 1st and 99th percentiles. Variables Dependent Variable To measure capital structure, we follow Bowman (2002) as well as Garcia-Rodriguez and Jegers (2017) and use the debt ratio, or LTA (Lia­ bilities to Assets). This is operationalized as total liabilities divided by total assets, with a ratio of one reflecting a balance of liabilities and assets. The higher the ratio, the more debt the charity sustains per dollar of asset. Independent Variables We include four primary predictors in our model, each measured as a oneyear lag of the dependent variable. The first is return on assets (ROA), which is a measure of profitability (here operationalized by revenue minus expenses or net income) divided by total assets. The second is a measure

Capital Structure and Financial Health

153

of the liquidity of existing assets (liquidity). This is calculated as cash and amounts receivable over total assets. Liquidity is important for organiza­ tions because it can be useful as a protection against funding disruption, and this will be a factor considered by management in debt structure. The third measure is a capture of the impact of an endowment or quasiendowment (endow), which other scholars have found important (Bow­ man, 2002; Calabrese, 2011). Unlike in the U.S., there is no box to check signaling an endowment, nor is there a required disclosure of permanently restricted net assets. However, charities are required to disclose the dollar value of their assets which are not involved in charitable activities. This means that these assets are used to produce another stream of income, either unrelated market income or investment. Our endowment variable therefore includes the monetary value for these assets, normalized by total assets. So, although this variable includes both possibilities, capturing the existence of such a revenue stream is important to debt structure. Finally, we include a variable for size (beyond the total asset figure used as the denominator in our ratios) in order to capture size effects (size). Our measure of size relies on the natural log of a charity’s total revenue. Descriptive statistics of all these variables can be seen in Table 11.1. Analysis Procedure This analysis relies on fixed effects models. Our models account for fixed effects on two dimensions, firm and subsector, in order to identify asso­ ciations between lagged values of our independent variables and lever­ age. We rely on STATA package reghdfe, developed by Correia (2016), in which the estimator efficiently accounts for these fixed effects by demean­ ing each variable and identifying their joint convergence. This method is more efficient than using dummy variables when the number of catego­ ries represented by a variable is large (Correia, 2016).

Results ROA: In the initial model (Model 1, Table 11.2) for all charities, only the ROA variable was statistically significant. More net income per dollar Table 11.1 Descriptive Statistics (Total Revenue $100K+) (2016) Variable

n

Mean

SD

Leverage ROA Liquidity Endow Size

35,987 40,803 43,111 43,111 41,729

0.45 0.19 0.45 0.02 13.20

0.79 1.13 0.39 0.13 1.44

154

Lam, Searing, Prentice, and Grasse

Table 11.2 Leverage of Canadian Charities (Revenue $100K+)

ROA Liquidity Endow Size Cons R-Squared Groups n ***

(Model 1) All Charities b (S.E.)

(Model 2) Holding Land b (S.E.)

(Model 3) Without Land b (S.E.)

–0.044*** (0.01) 0.006 (0.02) –0.007 (0.01) –0.002 (0.00) 0.461*** (0.06) 0.74 38,291 195,801

–0.051*** (0.01) –0.051** (0.02) –0.001 (0.01) 0.01** (0.00) 0.244*** (0.05) 0.799 17,337 86,789

–0.046*** (0.01) 0.006 (0.03) –0.006 (0.02) –0.008 (0.01) 0.591*** (0.07) 0.752 22,417 105,910

and ** indicate that coefficients are statistically significant with a confidence level of 99% and 95%, respectively.

of asset is associated with a 4.4% reduction in liabilities per asset in the following year. This is an encouraging sign, consistent with higher ROA charities using their net income to either a) pay down their liabilities or b) acquire more assets without the accumulation of more debt. The role of ROA is also statistically significant, whether examining those charities that hold land and buildings (Model 2) or those who do not (Model 3). We find no evidence that the association between leverage and ROA is contingent upon holding land or buildings. Liquidity: The liquidity of the asset portfolio is not statistically sig­ nificant when examining all charities (Model 1). However, this changes when charities that own land are analyzed independently (Model 2). Here, we see evidence of a negative and statistically significant relation­ ship between liquidity and LEV. This could be due to organizations flush with cash paying down their liabilities in ensuing years, but could also be that the existence of more liquid assets in the asset portfolio indicates the ability to shield against revenue disruption. Further, the negative coef­ ficient between liquidity and LTA for land holders further suggests that charities are using liquid reserves primarily to ‘smooth’ out cash flow, rather than for new land acquisition. Also notable is the insignificant coefficient for liquidity among chari­ ties which do not own land (Model 3). As noted earlier in the chapter, access to capital is a concern among charities because of their business models, size, and inability to offer equity stakes. Debt is often secured through collateral such as large fixed assets. Organizations without land

Capital Structure and Financial Health

155

or buildings may not be able to fully utilize their debt capacity. This would indicate that the composition of the other elements of the asset portfolio is irrelevant to the ability to use debt. Endow: The existence of a quasi-endowment was not significant in our models. Whereas we believe it to be a potentially important control varia­ ble, our models do not suggest that non-mission assets impact leverage. In future work, we hope that scholars gain the ability to separate investment assets from those used in the production of non-mission market income in order to further examine these assets and identify any direct effects. Size: Like liquidity, the role of size in debt structure is dependent on the presence of land or buildings. In Model 1 for all charities, the role of size is practically irrelevant; however, this changes when the analysis is limited to those organizations with land or buildings. For those charities which own land or buildings, larger organizations are more likely to have higher levels of debt per dollar of asset. As suggested in the literature, this is likely because size increases a charity’s debt capacity, or the ability to take on debt. However, we find this is limited to land or building owning charities, sug­ gesting that land may be a precondition necessary to access debt capacity.

Discussion and Conclusion Using panel data over an eight-year period we explored the capital struc­ ture of Canadian charities. Consistent with previous research on the drivers of nonprofit capital structure, our analysis yielded mixed results. Whereas some previous research suggests organizations with larger endowments hold more debt (Bowman, 2002; Calabrese & Ely, 2016; Gentry, 2002), our findings indicate that the presence of an endowment does not positively influence external financing relative to assets. Even endowed organizations holding land were no more likely than others to take on higher levels of leverage, suggesting a more cautious approach to financing activities. This interpretation is supported by the finding that highly liquid organizations holding land had significantly lower levels of leverage. It seems likely that organizations are using their cash to finance activities and, possibly, to pay down outstanding debt. Our most notable and consistent finding is the negative relationship between profitability (return on assets) and leverage (debt ratio). Whether or not an organization holds land, higher levels of profitability in these charities were associated with lower levels of debt relative to assets. This result is consistent with pecking order theory and suggests NPOs are turn­ ing to internal sources of funding before incurring debt. What is not clear from our findings is whether these organizations are holding lower levels of debt and using internal financing, as opposed to external financing, in response to normative and legal pressures to maintain a low debt ratio. The literature on capital structure warns that organizations with a suboptimal mix of debt and assets incur higher costs of capital and risk

156

Lam, Searing, Prentice, and Grasse

having worse financial health. It is possible that by holding lower levels of debt, NPOs in our sample have suboptimal capital structures. According to corporate literature, this unbalanced proportion of debt to assets could be inhibiting organizational growth and financial well-being. However, it is also possible that by relying on internal sources of financing these NPOs are strategically forgoing a balanced capital structure in favor of optimiz­ ing their overall organizational performance. Nonprofit borrowing is not a judgement-free activity, and NPOs may suffer consequences by holding higher levels of debt than normative boundaries suggest is appropriate. Although an optimal capital structure may yield various associated financial benefits to an organization, it is possible that having an ‘opti­ mal’ capital structure comes at the cost of organizational trustworthi­ ness, thus jeopardizing future donative revenue flows. Therefore, in the nonprofit context, prioritizing internal financing and avoiding external financing may signal to donors and other external stakeholders that nonprofit directors are conservative and attentive financial stewards. Overall, organizational performance—i.e., balancing an organization’s financial position, current operations, and future programmatic goals— may require a different conception of capital structure. Further, accord­ ing to pecking order theory, no optimal mix of capital structure exists (Jegers, 2018). From this view, organizations turn to the cheapest source of funds, typically internal ones. Once those funds are depleted, then managers turn to the next cheapest source, issuing debt. In the Canadian context, there may be broader institutional or cultural explanations for debt issuance. Maintaining an ‘optimal mix’ between debt and assets may not be a common business practice, for example, in coun­ tries with cultural norms that view debt negatively at both the individual and organizational level, or if public policy and business practices do not incentivize borrowing. The significant and negative relationship between liquidity and leverage for charities that hold land may be a clue that suggests a broader society aversion to debt and a propensity to use liquid reserves to reduce debt. Finally, further comparative work may reveal that in socie­ ties with robust social and health safety nets, NPOs may feel less pressured to grow and expand services through leveraging assets with debt. At the practitioner level, additional research is needed to determine how nonprofit practitioners manage capital structure decisions. As with other matters of nonprofit management, these consequential decisions are not likely to be made in isolation and should be viewed in a broader systems context.

Notes 1. Equal contribution by each author. 2. Canadian government website (www.canada.ca/en/revenue-agency/services/ charities-giving/giving-charity-information-donors/about-registered-charities/ what-difference-between-a-registered-charity-a-non-profit-organization.html).

Capital Structure and Financial Health

157

References Andres-Alonso, P., Garcia-Rodriguez, I., & Romero-Merino, M. E. (2016). Dis­ entangling the financial vulnerability of nonprofits. Voluntas: International Journal of Voluntary and Nonprofit Organizations, 27(6), 2539–2560. Bowman, W. (2002). The uniqueness of nonprofit finance and the decision to bor­ row. Nonprofit Management & Leadership, 12(3), 293–311. Bowman, W., Calabrese, T., & Searing, E. (2018). Asset composition. In B. A. Seaman & D. R. Young (Eds.), Handbook of research on nonprofit economics and management (pp. 97–117). Northampton, MA: Edward Elgar Publishing. Brody, E. (1996). Agents without principles: The economics convergence of the nonprofit and for-profit organizational forms. New York Law School Law Review, 40, 457–535. Calabrese, T. D. (2011). Testing competing capital structure theories of nonprofit organizations. Public Budgeting & Finance, 31(3), 119–143. Calabrese, T. D., & Ely, T. L. (2016). Borrowing for the public good: The grow­ ing importance of tax-exempt bonds for public charities. Nonprofit and Volun­ tary Sector Quarterly, 45(3), 458–477. Calabrese, T. D., & Grizzle, C. (2012). Debt, donors, and the decision to give. Journal of Public Budgeting, Accounting & Financial Management, 24(2), 221–254. Charles, C. (2018). Nonprofit arts organizations: Debt ratio does not influence donations—Interest expense ratio does. American Review of Public Adminis­ tration, 48(7), 659–667. Correia, S. (2016). A feasible estimator for linear models with multi-way fixed effects (Working Paper). Retrieved from http://scorreia.com/research/hdfe.pdf Donaldson, G. (1961). Corporate debt capacity: A study of corporate debt policy and the determination of corporate debt capacity. Boston, MA: Harvard Busi­ ness School. Fama, E. F., & Jensen, M. C. (1985). Organizational forms and investment deci­ sion. Journal of Financial Economics, 14(1), 101–119. Garcia-Rodriguez, I., & Jegers, M. (2017). Capital structure of nongovernmen­ tal development organizations. Nonprofit Management & Leadership, 28(2), 175–194. Gentry, W. M. (2002). Debt, investment and endowment accumulation: The case of not-for-profit hospitals. Journal of Health Economics, 21, 845–872. Government of Canada. (2016). What is the difference between a registered charity and a non-profit organization? Retrieved from www.canada.ca/en/ revenue-agency/services/charities-giving/giving-charity-information-donors/ about-registered-charities/what-difference-between-a-registered-charity-a-non­ profit-organization.html Hall, M. H., Barr, C. W., Easwaramoorthy, M., Sokolowski, S. W., & Salamon, L. M. (2005). The Canadian nonprofit and voluntary sector in comparative perspective. Toronto, Canada: Imagine Canada. Harris, M., & Raviv, A. (1991). The theory of capital structure. Journal of Finance, 46(1), 297–355. Jegers, M. (2003). The sustainable growth rate of nonprofit organizations: The effect of efficiency, profitability and capital structure. Financial Accountabil­ ity & Management, 19, 309–314.

158

Lam, Searing, Prentice, and Grasse

Jegers, M. (2018). Capital structure. In B. A. Seaman & D. R. Young (Eds.), Handbook of research on nonprofit economics and management (pp. 87–96). Northampton, MA: Edward Elgar Publishing. Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behav­ ior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305–360. Lin, W., & Wang, Q. (2016). What helped nonprofits weather the great reces­ sion? Evidence from human services and community improvement organiza­ tions. Nonprofit Management & Leadership, 26(3), 257–276. Miller, C. (2003). Hidden in plain sight: Understanding nonprofit capital struc­ ture. The Nonprofit Quarterly, 10(1), 1–8. Miller, M. H., & Modigliani, F. (1961). Dividend policy, growth, and the valua­ tion of shares. Journal of Business, 34(4), 411–432. Mitchell, G. E., & Calabrese, T. D. (2019). Proverbs of nonprofit financial man­ agement. American Review of Public Administration, 49(6), 649–661. Pettijohn, S. L., & Boris, E. T. (2013). Contracts and grants between nonprof­ its and government (Government-Nonprofit Contracting Relationships Series, Brief #3). Washington, DC: Urban Institute. Retrieved from www.urban. org/sites/default/files/brief_contracts-and-grants-between-nonprofits-and­ governments_12-5.pdf Trussel, J. (2002). Revisiting the prediction of financial vulnerability. Nonprofit Management & Leadership, 13(1), 17–31. Trussel, J. (2012). A comparison of the capital structures of nonprofit and propri­ etary health care organizations. Journal of Health Care Finance, 39(1), 1–11. Walker, M. A., & Osterhaus, J. E. (2010). Medicaid fee for service reimburse­ ment and the delivery of human services for individuals with developmental disabilities or severe mental illness: Negotiating cost. Journal of Health and Human Services Administration, 32(4), 380–404. Wedig, G. J., Hassan, M., & Morrisey, M. A. (1996). Tax-exempt debt and the capital structure of nonprofit organizations: An application to hospitals. Jour­ nal of Finance, 51(4), 1247–1283. Zingales, L. (2000). In search of new foundations. Journal of Finance, 55(4), 1623–1653.

Part III

New Ways of Financing and an Approach to the Business Practices

12 Business Practices in Nonprofit Funding Gabriela Vaceková, Mária Murray

Svidroňová, Michal Plaček,

and Juraj Nemec

Introduction In this chapter we delve into other ways of nonprofit funding that come from the business world (among them, Chapter 13 will focus on crowdfunding specifically). “Research on NPOs becoming business-like has increased continuously since the 1980s, and, in view of recent develop­ ments, is more relevant than ever” (Maier, Meyer, & Steinbereithner, 2016, p. 78). On the one hand, there is an effort to achieve nonprofit organization (NPOs) financial independence, which supports the idea of NPOs becoming business-like. On the other hand, there is the frequently stressed ‘non-commercial’ mission and purpose of NPOs, which might seem in contrast to becoming business-like. For a deeper look at this issue, in this chapter we aim to answer the following research questions: • •

Are NPOs becoming business-like? If so, why? What are the effects of NPOs becoming business-like?

Literature on this issue is fragmented, and scholarly attitude towards this phenomenon is diverse (see Maier et al., 2016 for a systematic litera­ ture review on NPOs becoming business-like). Hence, we aim to review the international definitional and theoretical approaches to the business practices in nonprofit funding originating in the Western environment with a view to assessing their applicability in the (post-)transitional con­ text of the Czech Republic and Slovakia, when identifying the elements of their conceptual core.

Phenomenon of NPOs Becoming Business-Like All over the world, NPOs are experiencing the challenging implications of austerity and financial uncertainty and are turning to commercial activi­ ties in order to meet the emerging survival challenges (Vaceková, Valenti­ nov, & Nemec, 2017). The Johns Hopkins Comparative Nonprofit Sector Project documents commercial revenue as the most important funding

162

Vaceková, Svidroňová, Plaček, and Nemec

source of the global nonprofit sector (Salamon, Sokolowski, Haddock, & Tice, 2013). Becoming business-like can assume many faces. It may involve the increasing market orientation and entrepreneurial activism of NPOs (Nicholls & Cho, 2006; Sharir & Lerner, 2006; Weerawardena, McDonald, & Sullivan Mort, 2010) as well as their growing innovative­ ness (Jaskyte, 2004; McDonald, 2007; Weerawardena & Sullivan Mort, 2006). It may also generate an overly competitive stance as well as an increased interest in outcomes targeted by public policies (Weerawardena et al., 2010). The importance of commercial income has not gone unnoticed in the nonprofit research literature (Vaceková et al., 2017). Serious concerns about the potentially distracting effects of becoming business-like in fulfilling nonprofit missions have been influentially voiced by Weisbrod (2004), who recommended that “nonprofit organizations should get out of commercial ventures” (p. 40) unless they want to “lose their souls” (p. 46). It is difficult to resist the impression of at least an implicit moral disapprobation when commercialization is understood as the ‘marketi­ zation of welfare’ (Salamon, 1993) and is associated “with the explicit intent of earning a profit” (Tuckman, 1998, p. 177) or with a business­ like character (McKay, Moro, Teasdale, & Clifford, 2015). Eikenberry and Kluver (2004, p. 135) contend that the benefits of nonprofit com­ mercialization or marketization exact a price in the form of undermining “the nonprofit sector’s role in creating and maintaining a strong civil society—as value guardians, service providers and advocates, and build­ ers of social capital.” All this “may be too high a price to pay” (Eiken­ berry & Kluver, 2004, p. 135). The list of critical moral concerns about NPOs becoming business-like can be extended, even when the com­ mercialization is driven by commendable social and financial intentions (Guo, 2006). These concerns can be summarized by admitting that the ability of NPOs to succeed in their mission and improve the social quality of life is “limited by the corrupting effects of the embedding pecuniary culture” (Valentinov, 2011, p. 901). At the same time, the existing literature includes many arguments for accepting or even promoting NPOs becoming business-like. For one, it may well be the case that nonprofit commercialization as such is a much too abstract and broad concept to enable a meaningful moral judgment. As a starting point, it makes good sense to follow Enjolras’s (2002) dis­ tinction between the two paths of commercialization: commercializa­ tion may be the result of activities intended to finance the production of mission-related outputs or it may be the result of the transformation of the relationship between the organization and its members from participation to consumption. Moral concerns seem more appropriate in the latter case than in the former. Froelich (1999, p. 246) suggests that these concerns originate from “our casual, naïve, or maybe wishful thinking” about NPOs that are assumed to be “travelling an unfettered path in pursuit of

Business Practices in Nonprofit Funding

163

(their) goals, free of mundane concerns associated with resource acquisi­ tion.” Indeed, given that “many nonprofit organizations are located in hostile environments” it follows that “commercial activities provide a self-regulatory mechanism that enables, rather than hinders, nonprofit organizations to perform their missions in environments where the supply of critical resources is insecure” (Moeller & Valentinov, 2012, p. 366). More generally, it seems that the phenomenon of NPOs becoming business-like is another illustration of the well-known heterogeneity of the nonprofit sector. Traditional approaches to the nonprofit sector, including those of Salamon and Anheier (1998), illustrate the insuf­ ficiency of single-factor explanations. It is becoming increasingly clear that different NPOs have different goals and subsequently different struc­ tures, both organizational and financial. The ‘governance’ theories (e.g., Peters, 2000) in particular underscore the spread of partnerships (not only political ones) in modern Western societies. Furthermore, econo­ mists have long recognized that public service delivery can be organized through many mechanisms. Cullis and Jones (1992) document the trend toward the pluralization of public service delivery, i.e., a shift away from the classic public delivery system toward the increasing involvement of private (for-profit and nonprofit) organizations. Pollitt and Bouckaert (2000) likewise note that the traditional delivery systems are giving way to multi-tiered systems exhibiting clear borders between financing, pro­ curing, and producing functions. Various key concepts describe the phenomenon of NPOs becoming business-like (see Maier et al., 2016). NPOs can become business-like in any dimension (organization, goals, rhetoric) in more or less comprehen­ sive ways, maintaining alternative orientations to varying degrees (Maier et al., 2016). This is embraced in the concept of hybrid organizations (e.g., Evers, 2005), which emphasizes the merging of logics from different fields. It has been argued that hybridity has long been, and will remain, a characteristic of NPOs (e.g., Brandsen, Van de Donk, & Putters, 2005). Even in the early years of the field of nonprofit studies, some voices were already calling for recognition of the blurred boundaries between the sec­ tors (Billis, 2010). DiMaggio (1987), Langton (1987), Salamon (1987), Van Til (1988), Ware (1989), and Wuthnow (1991) all agreed that the tri­ partite distinction between public, private, and nonprofit could be prob­ lematic because this distinction conceals the interrelationships between sectors. More recently, theoretical frameworks have emerged that are characterized by a blurry sectoral boundary view. These frameworks rec­ ognize that the sectors can overlap or mix. However, Nobel Laureate M. Yunus, founder of the Grameen Bank, warns against putting too much faith in hybrid organizations (see also Pestoff, 2012). In the real world it will be difficult to operate a business with two conflicting goals of profit maximizing and social benefits. The

164

Vaceková, Svidroňová, Plaček, and Nemec executives of these hybrid businesses will gradually inch toward the profit-maximization goal, no matter how the company’s mission is designed. (Pestoff, 2007, p. 33)

Hence, hybridization is being examined carefully (Donnelly-Cox, 2015) and with some concern for its positive effects (e.g., Dees & Anderson, 2003; Hwang & Powell, 2009; Jones, 2007). There is evidence that the benefits outweigh the risks (Brandsen & Karré, 2011) and that hybrids will come to represent the ‘new normal’ of civil society organizations (Brandsen et al., 2005; Donnelly-Cox, 2015; Evers, 2005).

Causes of NPOs Becoming Business-Like Since the 1970s, neoclassical economists have been considering an appar­ ent paradox: “The presence of nonprofit organizations inside markets driven by the quest for profit” (Laville, Young, & Eynaud, 2015, p. 3). Economics literature on the nonprofit sector has continued in the neoclas­ sical tradition, which examines the reasons of entering NPOs in the market economy (Laville et al., 2015). NPOs are chiefly explained in terms of their ability to address market failure (Jegers, 2008; Steinberg, 2006). The limi­ tations of this explanation are, however, widely recognized (see Steinberg, 2006). Specifically, the market failure explanation does little to include the motivational phenomena, such as ideological commitment, altruism, social values, and mission-drivenness, that are critical for the effective operation of the nonprofit sector (Rose-Ackerman, 1996). Valentinov (2011) argues that it is for this reason that the market failure explanation for this sec­ tor is supplemented with the ideological entrepreneurship theory, which is centrally concerned with the motivational phenomena. The services that NPOs are expected to provide are those that involve some ‘public’ or collective character. Such goods and services are typi­ cally difficult to supply through the private market because they are available to everyone regardless of whether they have been paid for, because those in need of them lack resources, or because the services require some special element of trust (Hansmann, 1980; Salamon, 1987; Weisbrod, 1975). Salamon, Hems, and Chinnock (2000) showed that “in situations where trusted economic institutions to provide credit or assist with marketing and related roles are unavailable, moreover, nonprofits can also be expected to provide such economic services (e.g., in many developing countries and transition economies)” (p. 5). Moreover, “in a number of places, the nonprofit service role is not distinguished sharply from that of government, although in some places, such as Central and Eastern Europe (CEE), nonprofit organizations are now expected to be the primary service providers (e.g., Hungary, Romania, Slovakia)” (Sala­ mon et al., 2000, p. 15).

Business Practices in Nonprofit Funding

165

The relation to the public sector presents a crucial contrast with the institutional embedding of nonprofit commercialization in the Western world, where this phenomenon is taken to be an integral part of neolib­ eral governance (Evans, Richmond, & Shields, 2005). Far from promot­ ing autonomy from the public sector, commercialization in the neoliberal governance system “hides a steeply hierarchical and centralized relation­ ship of power embedded in a contractual arrangement between the state and those agencies increasingly responsible for the delivery of public goods and services” (Evans et al., 2005, p. 78). This hierarchical rela­ tionship is most visibly demonstrated in the reorientation of nonprofit accountability from a broad range of civil society actors toward the state (McCambridge, 2005).

Effects of NPOs Becoming Business-Like Based on an extensive systematic literature review Maier et al. (2016) came to the findings that “causes [of nonprofits becoming business-like] have been researched extensively and appear to lie in the organization’s environment, within the organization, and on the interface between the organization and its environment, that is, in the way the organization responds to environmental conditions” (p. 72). Researching into this direc­ tion brought also interesting findings about the effects of NPOs becoming business-like, as they seem to occur in “four areas: organizational per­ formance; NPOs’ fulfillment of societal functions; power, knowledge and subjectivities; and NPOs’ legitimacy” (Maier et al., 2016, p. 75). “If not for profit, for what?” This question is also the title of Dennis Young’s pioneering work (1983) exploring a behavioral theory of the nonprofit sector based on entrepreneurship. More than 30 years ago, long before widespread research into entrepreneurship in the nonprofit sector was popular, this work “catalyzed a research stream that also forms the basis for an entire academic discipline” (Frank, 2013, p. xxix). The current challenge for nonprofit scholars is to continue to cultivate this rich field of inquiry in the quest for a better understanding of “how society can encourage, support and engage entrepreneurial energies for the public good” (Young, 2013, p. xvi). However, the field remains dif­ ficult to grasp in its entirety, as researchers use a multitude of similar, yet distinct, key concepts. The considerable range and complexity of these overlapping notions create major challenges: “Scholars struggle to posi­ tion their work in a larger context; it is not easy to build on previous find­ ings and methodological developments; and research gaps are difficult to identify” (Maier et al., 2016, p. 64). Hybridity is of both theoretical relevance and practical importance around the world, including in the post-Communist economies. The trend towards emerging hybridization in the transitional economies of CEE has increased significantly in recent years, taking into account the

166

Vaceková, Svidroňová, Plaček, and Nemec

considerable heterogeneity of transitional economies. Even in the early years after the transition, public services were being delivered by hybrid organizations operating in the intersections of the market, the civil soci­ ety, and the public sector.

The Case of the Czech Republic and Slovakia Some scholars may see NPOs becoming business-like as a moral dilemma because commercial activities may secure the survival of the organiza­ tion at the expense of undermining the mission orientation. This moral framing of the commercialization debate is insufficient for describing the Czech and Slovak nonprofit sectors, which are still struggling to develop their own distinct institutional identities (see Vaceková et al., 2017). Financial independence is part of this identity, and commercial activi­ ties might be able to assist NPOs in emancipating themselves from the previously paternalistic state. The institutional nature of the commer­ cialization phenomenon in the Czech Republic and Slovakia has been emphasized on this basis (Vaceková et al., 2017). The decisions favoring commercialization by nonprofit managers in the (post-)transitive context of CEE are shown to be heavily influenced by the current institutional and regulatory environment, which explicitly promotes nonprofit selffinancing initiatives. If nonprofit commercialization is understood as an institutional phenomenon, then its moral significance is best captured in terms of institutional ethics rather than in terms of the individual ethics of nonprofit managers, an approach that seems to be predominant in the Western literature (Vaceková et al., 2017). At this point, it is useful to step back and reconsider the influential understanding of NPOs becoming business-like put forward by Weisbrod (1998, p. 12): “Nonprofit organizations confront a dilemma, as does public policy toward them: how to balance pursuit of their social mis­ sions with financial constraints when additional resources may be avail­ able from sources that might distort the mission.” This understanding takes for granted that NPOs hold a distinct institutional identity defined, among other things, by autonomy from the public sector. Whereas this assumption is perfectly sensible for the Western and especially AngloSaxon institutional environment, it is less applicable to the transitional context of the Czech Republic, where the nonprofit sector still “remains in statu nascendi” (Pospíšil, Navrátil, & Pejcal, 2014, p. 49). Accord­ ingly, in the Czech and Slovak context, commercialization is not some­ thing that needs to be balanced, or traded off, against the pursuit of the NPO’s mission. Rather, it presents a tool for NPOs to gain autonomy from the public sector and thus to become empowered to independently define their missions in the first place. Under these circumstances, nonprofit scholars and practitioners alike need to be aware of the markedly different moral connotations of

Business Practices in Nonprofit Funding

167

nonprofit commercialization in the (post-)transitive context of the Czech Republic and Slovakia and the Western world. Thus, compared with the situation in Western countries, the causal nexus of nonprofit commercialization in the Czech Republic and Slova­ kia is shifted from the level of individual managerial decision-making to the level of institutional environment. An indication of this argument is that the legal and institutional definition of commercialization is quite ambiguous, especially against the backdrop of a seemingly harmonious relationship between commercialization and mission attainment. Insti­ tutional ambiguities are certainly acknowledged in the Western litera­ ture, which is sensitive to the existence of ‘for-profits-in-disguise’ that are attracted into the nonprofit sector by the tax and subsidy advantages they can get there (James, 1998, p. 273). Western scholars acknowledge that commercialization and ‘for-profits­ in-disguise’ may be similarly driven by cross-subsidization, which aligns well with the assumption of the mission-drivenness of individual non­ profit decision makers. In the Czech and Slovak context of peaceful coexistence between commercialization and mission attainment, these institutional ambiguities are amplified. Finally, as an institutional and legal phenomenon, nonprofit commer­ cialization in the Czech Republic and Slovakia has to be seen in the con­ text of the ongoing evolutionary trends of the (post-)transitive welfare state (see Vaceková et al., 2017). Horák, Horáková, and Sirovátka (2013) contend that the nature of the public-private mix of social service deliv­ ery is being affected by the centralization of decision-making, the mar­ ketization and contractualization of service delivery, the increasing use of new public management methods, organizational innovation, and the increasing networking between state and non-state organizations. These trends reflect the increasing involvement of the nonprofit sector in service delivery processes, as well as its closer entanglement and coordination with the public and private for-profit sectors (Bode & Brandsen, 2014). In the Czech and Slovak institutional context (see also Nemec, Špaček, Suwaj, & Modrzejewski, 2014), it is plausible to speculate that nonprofit commercialization constitutes a part of the evolutionary dynamics of the welfare state, a dynamic that is likely to be accepted by individual nonprofit decision makers, and unlikely to be seen by them as a moral dilemma in Weisbrod’s (1998) sense. If there are discrepancies between social structure and semantics, then such discrepancies are probably well exemplified by the precarious fitting of the Western semantics of NPOs becoming business-like into the insti­ tutional context of the Czech Republic and Slovakia. Whereas there are few reasons to doubt that commercial pressures may indeed potentially erode the mission orientation of certain NPOs in the Western world, more generally, the (post-)transitive nonprofit sector still faces the challenge of developing its own independent and distinct institutional identity, an

168

Vaceková, Svidroňová, Plaček, and Nemec

integral part of which is financial independence from the state. It is true that in Western semantics, the attempts of Czech and Slovak NPOs to secure their financial independence qualify as commercialization. In the (post-)transitive context, however, this commercialization seems to be an integral step in the difficult and lengthy evolution of a nonprofit sector that would be worthy of the name. The (post-)transitive context defies Weisbrod’s (1998) vision of commercialization as a moral dilemma of individual nonprofit decision makers. Taking into account the definition of hybrid organizations as those that combine the characteristics of at least two of the public/private/third sectors, the organizations in the Czech Republic and Slovakia that are considered to possess significant characteristics of more than one sector are usually social enterprises that can be defined as private and third sec­ tor hybrids. To emphasize this central advancement and discuss both its strengths and limitations, it is first necessary to return to the very roots of the social economy concept and underline how its base differs from the core feature of the nonprofit sector. Against this background, it will be easier to discuss the relevance of the extended boundaries (Defourny & Nyssens, 2016).

Conclusions Perspectives on the future of NPOs are dependent on the observers’ worldviews and their interpretation of past and present dynamics (Casey, 2016). Recently, nonprofit scholars took note of a possible paradigm shift in the field of nonprofit sector studies prompted by debates on its commercialization. Most researchers distinguished “an America-led, non-distribution, constraint-based positivist non-profit ‘sector’ paradigm from a ‘new’ paradigm, emphasizing the blurry sectoral boundary, volun­ tariness, and normative values” (Knutsen, 2016, p. 1563). This chapter adds to the definitional clarification of the conceptual foundations of the business practices in nonprofit funding. The emphasis of the scientific discourse on NPOs becoming business-like in (post-)transitional coun­ tries provides a basis for investigating the generally positive, normative, and heuristic analysis of the nonprofit sector associated with insights that consider the challenging socio-economic and political environments of the Czech Republic and Slovakia.

References Billis, D. (Ed.). (2010). Hybrid organizations and the third sector: Challenges for practice, theory and policy. London, England: Palgrave Macmillan. Bode, I., & Brandsen, T. (2014). State—Third sector partnerships: A short over­ view of key issues in the debate. Public Management Review, 16(8), 1055–1066. Brandsen, T., & Karré, P. M. (2011). Hybrid organizations: No cause for con­ cern? International Journal of Public Administration, 34(13), 827–836.

Business Practices in Nonprofit Funding

169

Brandsen, T., Van de Donk, W., & Putters, K. (2005). Griffins or chameleons? Hybridity as a permanent and inevitable characteristic of the third sector. International Journal of Public Administration, 28(9–10), 749–765. Casey, J. (2016). Comparing nonprofit sectors around the world: What do we know and how do we know it? The Journal of Nonprofit Education and Lead­ ership, 6(3), 187–223. Cullis, J. G., & Jones, P. R. (1992). Public choice and public finance: Analytical perspectives. Oxford, England: Oxford University Press. Dees, J. G., & Anderson, B. B. (2003). Sector-bending: Blurring lines between nonprofit and for-profit. Society, 40(4), 16–27. Defourny, J., & Nyssens, M. (2016). How to bring the centres of gravity of the non-profit sector and the social economy closer to each other? Volun­ tas: International Journal of Voluntary and Nonprofit Organizations, 27(4), 1547–1552. DiMaggio, P. (1987). Nonprofit organizations in the production and distribu­ tion of culture. In E. James (Ed.), The nonprofit sector: A research handbook (pp. 195–220). New Haven, CT: Yale University Press. Donnelly-Cox, G. (2015). Civil society governance: Hybridization within thirdsector and social enterprise domains. In Civil society, the third sector and social enterprise (pp. 52–66). New York, NY: Routledge. Eikenberry, A. M., & Kluver, J. D. (2004). The marketization of the nonprofit sector: Civil society at risk? Public Administration Review, 64(2), 132–140. Enjolras, B. (2002). The commercialization of voluntary sport organizations in Norway. Nonprofit and Voluntary Sector Quarterly, 31(3), 352–376. Evans, B., Richmond, T., & Shields, J. (2005). Structuring neoliberal governance: The nonprofit sector, emerging new modes of control and the marketisation of service delivery. Policy and Society, 24(1), 73–97. Evers, A. (2005). Mixed welfare systems and hybrid organizations: Changes in the governance and provision of social services. International Journal of Public Administration, 28(9–10), 737–748. Frank, P. M. (2013). Entrepreneurship in a multi-sector world. In D. R. Young (Ed.), If not for profit, for what? Lexington, MA: Lexington Books. Froelich, K. A. (1999). Diversification of revenue strategies: Evolving resource dependence in nonprofit organizations. Nonprofit and Voluntary Sector Quar­ terly, 28(3), 246–268. Guo, B. (2006). Charity for profit? Exploring factors associated with the com­ mercialization of human service nonprofits. Nonprofit and Voluntary Sector Quarterly, 35(1), 123–138. Hansmann, H. (1980). The role of nonprofit enterprise. Yale Law Journal, 89, 835–901. Horák, P., Horáková, M., & Sirovátka, T. (2013). Recent trends and changes in Czech social services in the European context: The case of childcare and elderly care. Czech & Slovak Social Work, 13(5), 5–19. Hwang, H., & Powell, W. W. (2009). The rationalization of charity: The influ­ ences of professionalism in the nonprofit sector. Administrative Science Quar­ terly, 54(2), 268–298. James, E. (1998). Commercialism among nonprofits: Objectives, opportunities, and constraints. In B. A. Weisbrod (Ed.), To profit or not to profit: The com­ mercial transformation of the nonprofit sector (pp. 271–286). Cambridge, NY: Cambridge University Press.

170

Vaceková, Svidroňová, Plaček, and Nemec

Jaskyte, K. (2004). Transformational leadership, organizational culture, and innovativeness in nonprofit organizations. Nonprofit Management and Lead­ ership, 15(2), 153–168. Jegers, M. (2008). Managerial economics of non-profit organizations. London, England: Routledge. Jones, M. B. (2007). The multiple sources of mission drift. Nonprofit and Volun­ tary Sector Quarterly, 36(2), 299–307. Knutsen, W. (2016). The non-profit sector is dead, long live the non-profit sector! Voluntas: International Journal of Voluntary and Nonprofit Organizations, 27(4), 1562–1584. Langton, S. (1987). Envoi: Developing nonprofit theory. Nonprofit and Volun­ tary Sector Quarterly, 16(1–2), 134–148. Laville, J. L., Young, D. R., & Eynaud, P. (Eds.). (2015). Civil society, the third sector and social enterprise: Governance and democracy (Vol. 200). New York, NY: Routledge. Maier, F., Meyer, M., & Steinbereithner, M. (2016). Nonprofit organizations becoming business-like: A systematic review. Nonprofit and Voluntary Sector Quarterly, 45(1), 64–86. McCambridge, R. (2005). Is accountability the same as regulation? Not exactly. The Nonprofit Quarterly, 12(4), 6–9. McDonald, R. E. (2007). An investigation of innovation in nonprofit organi­ zations: The role of organizational mission. Nonprofit and Voluntary Sector Quarterly, 36(2), 256–281. McKay, S., Moro, D., Teasdale, S., & Clifford, D. (2015). The marketisation of charities in England and Wales. Voluntas: International Journal of Voluntary and Nonprofit Organizations, 26(1), 336–354. Moeller, L., & Valentinov, V. (2012). The commercialization of the nonprofit sector: A general systems theory perspective. Systemic Practice and Action Research, 25(4), 365–370. Nemec, J., Špaček, D., Suwaj, P., & Modrzejewski, A. (2014). Public manage­ ment as a university discipline in New European Union member states. Public Management Review, 14(8), 1087–1108. Nicholls, A., & Cho, A. H. (2006). Social entrepreneurship: The structuration of a field. Social entrepreneurship: New models of sustainable social change. Oxford: Oxford University Press. Pestoff, V. (2007). Democratic governance: Citizen participation and co-production in the provision of personal social services in Sweden. Paper presented at the Third Sector Study Group of the European Group for Public Administration. Pestoff, V. (2012). Co-production and third sector social services in Europe: Some concepts and evidence. Voluntas: International Journal of Voluntary and Non­ profit Organizations, 23(4), 1102–1118. Peters, G. (2000). Globalization, institutions, and governance. In B. G. Peters & D. J. Savoie (Eds.), Governance in the twenty-first century: Revitalizing the public service (pp. 29–57). Montreal, Quebec: McGill University Press. Pollitt, C., & Bouckaert, G. (2000). Public management reform: A comparative perspective (Vol. 13). Supporting the International Conference on Moderniza­ tion and State Reform, Rio de Janeiro. Pospíšil, M., Navrátil, J., & Pejcal, J. (2014). Czech Republic. In Maecenata Institute. (Ed.), Civil society in the ‘Visegrád Four’: Data and literature in the

Business Practices in Nonprofit Funding

171

Czech Republic, Hungary, Poland and Slovakia (pp. 48–93). Berlin, Germany: Maecenata Institute. Rose-Ackerman, S. (1996). Altruism, nonprofits, and economic theory. Journal of Economic Literature, 34(2), 701–728. Salamon, L. M. (1987). Of market failure, voluntary failure, and third-party government: Toward a theory of government-nonprofit relations in the modern welfare state. Nonprofit and Voluntary Sector Quarterly, 16(1–2), 29–49. Salamon, L. M. (1993). The marketization of welfare: Changing nonprofit and for-profit roles in the American welfare state. The Social Service Review, 67(1), 16–39. Salamon, L. M., & Anheier, H. K. (1998). Nonprofit institutions and the 1993 system of national accounts (Working Paper of the Johns Hopkins Comparative Nonprofit Sector Project No. 25). Retrieved from http://ccss.jhu.edu/wp­ content/uploads/downloads/2011/09/CNP_WP25_1998.pdf Salamon, L. M., Hems, L. C., & Chinnock, K. (2000). The nonprofit sector: For what and for whom? Baltimore, MD: Johns Hopkins University Institute for Policy Studies. Salamon, L. M., Sokolowski, S. W., Haddock, M. A., & Tice, H. S. (2013). The state of global civil society and volunteering: Latest findings from the imple­ mentation of the UN nonprofit handbook (Working Papers of the Johns Hop­ kins Comparative Nonprofit Sector Project, No. 49). Retrieved from http:// ccss.jhu.edu/wp-content/uploads/downloads/2013/04/JHU_Global-Civil­ Society-Volunteering_FINAL_3.2013.pdf Sharir, M., & Lerner, M. (2006). Gauging the success of social ventures initiated by individual social entrepreneurs. Journal of World Business, 41(1), 6–20. Steinberg, R. (2006). Economic theories of nonprofit organization. In W. Pow­ ell & R. Steinberg (Eds.), The nonprofit sector: A research handbook (2nd ed., pp. 117–139). New Haven, CT: Yale University Press. Tuckman, H. P. (1998). Competition, commercialization, and the evolution of nonprofit organizational structures. Journal of Policy Analysis and Manage­ ment, 17(2), 175–194. Vaceková, G., Valentinov, V., & Nemec, J. (2017). Rethinking nonprofit com­ mercialization: The case of the Czech Republic. Voluntas: International Jour­ nal of Voluntary and Nonprofit Organizations, 28(5), 2103–2123. Valentinov, V. (2011). The meaning of nonprofit organization: Insights from clas­ sical institutionalism. Journal of Economic Issues, 45(4), 901–916. Van Til, J. (1988). Mapping the third sector: Voluntarism in a changing social economy. New York, NY: Foundation Center. Ware, A. (1989). Between profit and state: Intermediate organizations in Britain and the United States. Princeton, NJ: Princeton University Press. Weerawardena, J., McDonald, R. E., & Sullivan Mort, G. (2010). Sustainability of nonprofit organizations: An empirical investigation. Journal of World Busi­ ness, 45(4), 346–356. Weerawardena, J., & Sullivan Mort, G. (2006). Investigating social entrepreneur­ ship: A multidimensional model. Journal of World Business, 41(1), 21–35. Weisbrod, B. A. (1975). Toward a theory of the voluntary nonprofit sector in a three-sector Economy. In E. Phelps (Ed.), Altruism, morality, and economic theory (pp. 171–196). New York, NY: Russell Sage Foundation.

172

Vaceková, Svidroňová, Plaček, and Nemec

Weisbrod, B. A. (1998). The nonprofit mission and its funding: Growing links between nonprofits and the rest of the economy. In B. A. Weisbrod (Ed.), To profit or not to profit: The commercial transformation of the nonprofit sector (pp. 1–24). Cambridge, England: Cambridge University Press. Weisbrod, B. A. (2004). The pitfalls of profits. Stanford Social Innovation Review, 2(3), 40–47. Wuthnow, R. (1991). The voluntary sector: Legacy of the past, hope for the future? In R. Wuthnow (Ed.), Between states and markets. The voluntary sec­ tor in comparative perspective (pp. 3–29). Princeton, NJ: Princeton University Press. Young, D. R. (1983). If not for profit, for what? A behavioral theory of the nonprofit sector based on entrepreneurship. Lexington, MA: Lexington Books. Young, D. R. (2013). Preface. In D. R. Young (Ed.), If not for profit, for what? A behavioral theory of the nonprofit sector based on entrepreneurship (1983 Print ed., pp. xi–xviii). Lexington, MA: Lexington Books; Atlanta, GA: Geor­ gia State University Library. Retrieved from http://scholarworks.gsu.edu/ facbooks2013/1/

13 Crowdfunding as a New Model of Nonprofit Funding Dita Hommerová

Introduction Every year nonprofit organizations (NPOs) are faced with instability in funding their activities. In their case, it is about the constant daily strug­ gle to raise sufficient financial resources to ensure their operation. The non-conceptual nature of this effort cannot usually be blamed on the organization’s internal factors, but rather can be attributed to a phenom­ enon of a macroeconomic, legislative, and societal character. This chapter focuses on the modern phenomenon arising in the world of project financing (crowdfunding) and its meaning for the development of NPOs. Crowdfunding can be described as the process of raising finan­ cial resources for commercial and non-commercial projects. It is based on the concept of crowdsourcing, which uses a group of individuals to get ideas, feedback, or solutions for specific tasks (Mack, 2012). There are many different definitions of crowdfunding, such as: “Crowdfunding involves an open call, mostly through the Internet, for the provision of financial resources either in the form of donation or in exchange for the future product or voting right to support initiatives for specific purposes” (Belleflamme, Lambert, & Schwienbacher, 2014, p. 585; Steinberg & DeMaria, 2012). According to Hainzer (2017) and Helmig and Boenigk (2012), crowdfunding is an innovative and flexible instrument for financ­ ing that can be used in many different facets regardless of the respective organizational purpose. Crowdfunding is one of the latest and most powerful methods to finance projects, products, or even businesses. It is a trend with the goal of expanding the possibilities of effective multisource funding for NPOs (Hommerová & Severová, 2019). Investors are individuals who con­ tribute a relatively small amount of money in a short time (Younkin & Kashkooli, 2016). This method of financing is carried out via the Inter­ net and is closely linked to social media (Banhatti, 2016; Ondráčková & Černý, 2015). Crowdfunding keeps growing globally and so does the development of specialized platforms that focus on raising funds, the socalled crowdfunding campaigns.

174

Hommerová

Development of Crowdfunding and Reasons for Its Success Among the very first crowdfunding campaigns was that of Alexander Pope, who in 1713 wanted to translate Greek poetry into English. His subscribers pledged two gold guineas and were listed in an early edition of the book. In 1783, Mozart took a similar path. He wanted to perform three recently composed piano concertos in a Viennese concert hall. Like many of today’s projects, Mozart’s first campaign was not successful. He succeeded one year later. But, the most famous crowdfunding campaign is probably the one organized by Joseph Pulitzer, who launched a fun­ draising campaign to support the construction of the Statue of Liberty. In just five months the world raised $101,091 from more than 160,000 donors (Clarkson, 2015). Crowdfunding gained traction in the United States when Brian Came­ lio, a Boston musician and computer programmer, launched ArtistShare in 2003. It started as a website where musicians could seek donations from their fans to produce digital recordings and has evolved into a fundraising platform for film/video and photography projects as well as music. ArtistShare’s first crowdfunding project was Maria Schneider’s jazz album “Concert in a Garden.” Schneider offered a tiered system of rewards (Freedman & Nutting, 2015). Since then, crowdfunding has been constantly evolving; it has many new forms, and there are many entrepreneurs and non-entrepreneurs who use this reliable alternative source of funding. During the first ten years of its existence, it has been estimated that crowdfunding encouraged investments to the amount of $5.1 billion worldwide (Ondráčková & Černý, 2015). According to Howe (2008), there are four reasons leading to the suc­ cess of crowdfunding: 1) as a result of the specialization of jobs, pri­ vate individuals are interested in contributing to economic production in their spare time, they want to do something different, or they are willing to share their knowledge; 2) the division of an overwhelming task into small enough chunks makes it not only feasible, but fun; 3) the increasing accessibility of information thanks to the Internet; and 4) the emergence of online communities in which the online population is organized. The Internet allows for communication between amateurs and professionals. Where once professionals were in power, now a self-organizing commu­ nity of amateurs takes on a large extent of the labor. The main idea behind crowdfunding is very simple. A visitor to a crowdfunding portal can be both investor and author of a new project. The basic terms are defined as follows (Belleflamme, Omrani, & Peitz, 2016; Young, 2013): • Investor is a person who financially supports a crowdfunding project and receives various forms of compensations. The higher his/her con­ tribution, the higher the reward.

Crowdfunding as New Nonprofit Funding Model

175

• Author of a project is a person who created a project which can be part of a crowdfunding campaign. • Crowdfunding portal is used for the implementation of projects. Por­ tals must meet several requirements, such as: a detailed description of a project, methods applied for the use of the financial investment obtained, preparation of the necessary documents, video recording, description of the project budget (i.e., of the target amount), defini­ tion of rewards including their delivery dates. • Crowdfunding campaign is a procedure during which the exist­ ing project is published on the crowdfunding portal. The duration of a campaign may vary, but the recommended length is 30 days. During this period, investors can financially support the project. If the author of the project reaches a predetermined financial tar­ get, the entire amount belongs to him/her. Otherwise, the funds are returned to investors (Eisenmann, Parker, & Van Alstyne, 2011; Young, 2013). In his book, Bruhn (2012) introduces the tools of classic fundraising, which are a personal discussion, mailing, telemarketing, media fundrais­ ing, events, online fundraising, mobile fundraising, and heritage fund­ raising. It can be expected that future scientific literature on the subject will include crowdfunding with a focus on the above-mentioned tools.

Crowdfunding Regulations in Europe One of the first significant attempts at determining the intensity of utiliza­ tion, the relevant legislation, the saturation of markets, and the analysis of best practice examples, including an international comparison, is the study published by the Visegrad Group (2014).1 The study describes the legal and tax regulations in the V4 countries concerning the application of crowdfunding, and also the legislative measures at the EU level and expected legislative changes. The very first study on the subject conducted by the European Com­ mission was one presented in Brussels in April 2014 under the name “Startup Europe Crowdfunding Network (30-CE-0557296/00–95).” The study examined and evaluated a total of 230 crowdfunding plat­ forms throughout the European Union. This study is based on the results of a questionnaire survey, whose aim was to identify the reasons why project owners used this new tool for funding start-ups, what their expec­ tations were, what the requested amount was, why they have not used this way of funding before, the possibilities of stimulating crowdfunding servers in the future, the introduction of a kind of quality label (a year later discussed as transparency label), the possibility of support by the European Commission, and others (Startup Europe Crowdfunding Net­ work, 2015).

176

Hommerová

In response to the growing significance of start-ups for the economy, the European Commission decided to support this way of raising the initial capital to develop business plans for both small and mediumsized companies as well as the nonprofit sector. In its communication on crowdfunding, the European Commission (2014) committed to creating targeted support for this significant tool for funding starter projects and refraining from introducing additional legislative obstacles. On April 1, 2015, the European Commission published its own study on the state and intensity of crowdfunding use in individual EU member states. Apart from that, the study also presents successful examples of crowdfunding application in start-ups. Finally, in 2017, the European Commission (2017) published a review of interpretations of existing regulation concerning crowdfunding in Europe, North America, and Israel. Furthermore, the study also presents the latest statistics on the use of crowdfunding.

Advantages, Disadvantages, and Possible Risks Related to Crowdfunding in NPOs Wymer, Knowles, and Gomes (2006) present the significance of the Internet for NPOs. It is through the Internet that NPOs communi­ cate with external groups. When the earlier-mentioned book was pub­ lished, crowdfunding, i.e., community funding, had not yet become a well-known concept. Belleflamme, Lambert, and Schwienbacher (2013, p. 315) also confirm that this new fundraising tool has not been addressed in scientific literature and that we are only now beginning to gain knowledge of it. By using crowdfunding, NPOs have the opportunity to solve a short­ age of financial resources, especially during the initial phase of their business activities. It provides funding and support for unusual and inno­ vative projects which would not otherwise be supported by investors. Small local projects get the chance to be funded by local resources. As mentioned above, crowdfunding is not only about raising funds. Thanks to crowdfunding, the author of a project carries out market research, receives helpful information about customers’ interest and launches a marketing campaign. One indisputable advantage of crowdfunding is the fact that right from the start each project gets some kind of feedback from potential customers and the idea behind the project is promoted from the very beginning. Moreover, crowdfunding offers the opportunity to enter into cooperation with the public sector (e.g., public funds) and thus create common platforms. It unites the motivation of contributors to fund various high-quality projects. But despite its many positive aspects, crowdfunding also has many dis­ advantages and risks. The presentation of a project to the public might be very risky, because an innovative project can be copied or imitated. The

Crowdfunding as New Nonprofit Funding Model

177

biggest risk is the financing of new businesses because a large number of small investors get the opportunity to influence the operation of a newly established company. Moreover, investors may force the author of a pro­ ject to focus on organization in the community, which can negatively influence the finalization of the project. There are also some risks and disadvantages for the contributors, such as fraud. A trusting contributor may be deceived by a swindler who cre­ ated a presentation of a project on a crowdfunding platform. Once the swindler receives a set amount of money, he/she stops communicating and refuses to meet his/her obligations. The lack of user evaluation of a project could also lead to possible frauds. Reviews are the best tool to support the reputation of a crowdfunding platform. Another problem is the failure to comply with deadlines set by the author of a project. Successfully funded projects are very often delivered with delays. New projects are highly risky. Moreover, there are some situations the author cannot control. These cru­ cial situations can have a fatal impact on the project and could cause its termination. Information asymmetry between the creator and funder plays an important role, because of the distribution of risk, which is greater on the side of the funder (Agrawal, Catalini, & Goldfarb, 2014).

Basic Crowdfunding Models According to Young (2013) there are the following crowdfunding models: donation-based crowdfunding; reward-based crowdfunding; debt-based crowdfunding; equity-based crowdfunding. Černý (2015) also adds the Royalty crowdfunding. As can be seen in Figure 13.1, crowdfunding is based on investment or non-investment models of financing. Non-Investment Models Non-investment models are suitable for the financing of one-time pro­ jects when the funder does not expect the return of his/her investment. These models are often used in the nonprofit sector. The most popular non-investment models include donor- and rewardbased models. Donation-Based Model Donation-based crowdfunding is based on the fact that investors donate their funds to a project without receiving any compensation in return. Usually, this model is used for charitable or community projects (e.g., dog shelters). The donation-based model is considered a subset of classical fundraising and is typical for nonprofit projects (Černý, 2015; Young, 2013). Funders are satisfied as they do a good deed and contribute to a useful project.

178

Hommerová

Crowdfunding

Noninvestment

Investment

Donationbased

Lending-based

Reward-based

Equity-based

Royalty Figure 13.1 Crowdfunding Models Source: Own processing according to Černý (2015) and Ondráčková and Černý (2015)

Donors are often engaged in the NPO’s activities rather than being only in the position of financial supporters. Apart from dealing with crowdfunding as a new source of funding, it would be advisable to deal with managing relationships with donors and apply the calculation of the indicator based on their assessment of the particular NPO. Khodakarami, Petersen, and Venkatesan (2015) presented the princi­ ple of building long-term relations with donors, taking into consideration their life values. Hladká and Hyánek (2017) created a model of donor behavior in the Czech Republic based on the results obtained from a regression analysis of variables. The authors conclude that the variables which statistically significantly affect the willingness to donate and may be referred to as altruistic, are completely different from the variables which affect the donation amount (Hladká & Hyánek, 2017, p. 26). The donation amount is positively influenced by economic incentives (e.g., the possibility of deducting the donation amount from the tax base) rather than by altruistic sentiments. Reward-Based Crowdfunding Reward-based crowdfunding is based on remuneration. This model is often used in the world of music, art, or culture, and it results in the

Crowdfunding as New Nonprofit Funding Model

179

provision of the content to the funder. Very often, the funder is personally involved in the creation of the project, which positively influences his/her motivation to provide financial support. In this case, the investor does not receive a financial reward, but a thank you, discounts, a product or service. The main advantage for the author of the project is the fact that he/she is not obliged to return the donated financial means but provides non-financial rewards. Another significant advantage of this model is the fact that the author is able, dur­ ing the course of fund-raising, to create a strong fan and customer base. Investment Models Investment-based crowdfunding focuses on a future benefit or income for the investor. This model includes lending- and equity-based and royalty crowdfunding. These models are particularly applicable for profitable projects. Lending-Based Crowdfunding The lending-based model is based on micro loans (i.e., peer-to-peer, P2P). This concept focuses on raising money from a large group of indi­ viduals in exchange for repayment of the investment with interests. The interest rates are very often higher than those provided by monetary institutions. Lending-based crowdfunding connects lenders and borrowers, and its principle is different from other crowdfunding methods as it is based on lending money between individuals, not on the support of a project or idea. Financial transactions are carried out without an intermedi­ ary involved. This process is called crowdfunding because individuals are lent money from a large group of people. These loans are based on P2P and can be divided into: direct, indirect, secured, and unsecured (Young, 2013). Equity-Based Crowdfunding This model is unique because the investor acquires an ownership inter­ est in the company or business with the expectation that the company will be prosperous. At a chosen moment, he/she can decide to sell his/ her share when under favorable conditions. The investor also has the possibility to keep his/her share in order to benefit from profitable com­ pany dividends. In this case, the investor becomes a shareholder in the company. This concept is particularly useful for start-ups and entrepreneurs who are starting a business and need the initial capital in exchange for com­ pany shares.

180

Hommerová

Royalty Crowdfunding Royalty crowdfunding offers investors a percentage of revenue generated from a project or company. Before the investment, the entrepreneur and investor agree via a portal how much of the funds will be awarded to the investor and what amount will be designated for the entrepreneur. The yield depends primarily on the investment size. The advantage of this model is based on the fact that the entrepreneur does not have to return the funds until his/her project or company becomes profitable. Moreover, he/ she sells the share of potential success, and thus prevents the influence of investors on his/her business. A disadvantage of this model may be based on the fact that the company returns a substantial part of its profits back into the development, production, and distribution of the product, and therefore it should keep a sufficient proportion of its income. As a precau­ tion, most portals provide the so-called buy-back guarantee which allows entrepreneurs to repurchase the right to a share of income, respectively limiting the duration of the entire contract. This model is useful for start­ ups, whose owners want to keep the entire ownership of the company (Černý, 2015).

Comparison of Successful Crowdfunding Platforms This section presents the results of a comparison of successful crowdfunding platforms. The lending-based model was not included in this comparison, because it is based on lending money to individuals and does not support creative projects (Young, 2013). Comparison parameters are as follows: focus of the platform, year of launch, users, special services, funding method, fees, number of successful projects, the most successful project, the amount of invested funds since the launch of the company, and the number of fans on social networks. For the purpose of the comparison, the following successful platforms were selected: Kickstarter, Indiegogo, Crowdrise, Seedrs, Crowdcube, and GoFundMe. These individual platforms were compared on the basis of the above-mentioned parameters. The number of fans on social net­ works is a factor that greatly reflects on marketing and communication activities of a company, and the number of successful projects together with the total investment is clearly a factor indicating success and popu­ larity of a crowdfunding platform. Donation-Based Crowdfunding In Table 13.1 we compare two of the most successful platforms of the donation-based model. Based on the fact that some data have not been published, the platforms are compared only in terms of the number of fans on social networks and the number of successful projects.

Crowdfunding as New Nonprofit Funding Model

181

Table 13.1 Comparison of Successful Platforms of the Donation-Based Model Crowdrise Focus

Year of launch Users Special services

Funding method

Fees

Successful projects Most successful project

GoFundMe

Raises charitable donations.

Raises donations for important life events and challenging life situations. 2010. 2010. Any legal or natural Any legal or natural person who is 18 years person who is 18 years or older. or older. Website perfectly Website perfectly optimized. optimized. Clear connection to social Main page divides the projects that can be networks. Opportunity financially supported. to purchase promotional Clear description of clothing. the crowdfunding Celebrity section where process and methods of celebrities express their financing. personal opinions. Link to the section Decent Links to company news, its successful projects, Humans or to the Chaos blog, popular articles, Blog dedicated to the fundraising tips, etc. publication of news of the company. Do not follow the concept The author of a project of “all-or-nothing is not obliged to fulfil funding.” The author the financial objective; of a project receives the therefore he/she is final amount collected. entitled to whatever amount he/she receives from donors. Commission of 3% of the Commission of 5% of each investor’s donation total donations. plus the payment of transfer fees. > 2 million. > 1.5 million. Support Victims of No data. Pulse Shooting ($7.85 million). > $3 billion. No data.

Invested funds since launch Fans on social networks Twitter: 26,100. Facebook: 47,471. Instagram: 4,930.

Twitter: 536,000. Facebook: 814,071. Instagram: 13,800.

It is clear that the platform GoFundMe dominates on all social net­ works. Both platforms were established in 2010 and have perfectly opti­ mized websites. Funding methods are identical. It can be concluded that GoFundMe is probably much more competent in the field of marketing activities and user attraction.

182

Hommerová

The number of successful projects launched by GoFundMe exceeds Crowdrise by about 500,000 projects. The reason may be a greater awareness of the platform and the fact that it is considered a global leader in donation-based crowdfunding. Reward-Based Crowdfunding Table 13.2 contains a comparison of two reward-based crowdfunding platforms. Two such platforms have been operating in the market for approximately the same length of time and they both rank among the most successful crowdfunding platforms in the world. However, they dif­ fer significantly in their funding principles. As it is noticed, both companies use Twitter and Facebook to com­ municate with followers. Instagram is not so popular because this application was primarily designed for photo sharing and not for com­ munication. It is clear that Kickstarter has much more active users on all analyzed social networks than Indiegogo. The reason for this success can be a wide offer of special services or better communication with users. In terms of project success, the platform Indiegogo exceeds Kickstarter by nearly 40,000 projects. The reason may be the possibility of both fixed and flexible financing. Also, in terms of total sums invested in projects Kickstarter clearly dominates Indiegogo. The reasons may be similar to those used to explain the difference in the number of social networks users, which is a greater offer of special services, better communication, and certainly greater popularity of the platform. Equity-Based Crowdfunding Two examples of successful equity-based crowdfunding platforms are Seedrs and Crowdcube. These platforms are comparable in terms of their length of operation and other characteristics, substantially differing only in terms of the geographical territory where they operate. As shown in Table 13.3, Crowdcube is more active on the social net­ work Twitter. However, Seedrs has more users on Facebook and Insta­ gram who follow its marketing activities. It can be concluded that the company Seedrs pays less attention to Facebook than Crowdcube does. Regarding the successful projects, Crowdcube has more of them, spe­ cifically 42 more. There may be several reasons for this: Crowdcube has been on the market one year longer than Seedrs, the website is more attractive (see the most successful projects of the Crowdcube platform), and the commission fees are lower. Conclusion of Comparison of Selected Crowdfunding Platforms The most profitable donation-based platform is the platform GoFundMe as it has reached the best figures. The company has thousands of fans on social networks, and the most successful project reached the amount of nearly $8 million.

Table 13.2 Comparison of Successful Platforms of the Reward-Based Model Kickstarter Focus

Creative projects launched in the world of music, film, games, arts, and technological innovation. Year of launch 2009. Users Any legal or natural person who is 18 years or older and has a permanent residence in the U.S. or a tax registration number (tax ID). Special services Technical support throughout the entire campaign. Perfect interconnection with social networks. Regularly published statistics, live video of the project author. Overview of previous successful projects. Funding The concept of ‘all­ method or-nothing funding,’ i.e., funds are provided to the project’s author only if the project reaches a predetermined amount, otherwise the money is returned to the investors.

Fees

5% commission plus transfer fees. Fees are not charged if a project does not succeed.

Successful projects Most successful project Invested funds since launch Fans on social networks

> 122 million.

Indiegogo Supports creative projects.

2008. Anyone older than 18 years of age.

Perfectly optimized and interconnected with social networks (Facebook, Twitter, Instagram, YouTube, and LinkedIn). Offers interesting links, consulting and analytical services, and a comparison with the Kickstarter platform. Two forms of financing— flexible and fixed. Flexible financing (the more expensive option) means the author can keep all contributions even if the campaign goal was not met. The fixed model (the cheaper option) is similar to Kickstarter’s concept of ‘all-or-nothing funding.’ Fixed model: 5% of the total amount collected. No fees charged if a project does not succeed. Flexible financing: a fee of 5% is charged even if the target amount was not reached. Obligatory transfer fees. Personal cause crowdfunding called Generosity provided free of charge. > 175,000.

Pebble watch ($20,338,986).

Flow Hive ($12,174,187).

$2.9 billion.

> $1 billion.

Twitter: 1.1 million. Facebook: 1,508,491. Instagram: 154,000.

Twitter: 321,000. Facebook: 491,671. Instagram: 31,000.

184

Hommerová

Table 13.3 Comparison of Successful Platforms of the Equity-Based Model Seedrs

Crowdcube

Focused on equity-based An equity-based crowdfunding. crowdfunding company focusing on start-ups, new projects, and companies. 2011. Year of launch 2012. Users Anyone at the age of 18 or Authors of projects must be at least 18 years older residing in the EU, old and meet the EEA, or Switzerland. legal requirements for starting a business in the UK. Perfectly optimized and Special services Perfectly optimized interconnected with and interconnected social networks. News with social networks. about the company and Complete information a link to a company about the company and magazine available its team on the website, on the main page. including a blog, case A description of all studies, and a glossary. necessary activities and obligations related to the platform as well as a download link for the company app in the App Store. The concept of ‘all­ Funding method The concept of ‘all­ or-nothing funding.’ or-nothing funding.’ A 7% fee from the total A 7.5% fee from the Fees amount collected plus total amount collected project and transfer fees. plus transfer fees. Administrative and legal costs included. 512.

470. Successful projects JustPark ($3,620,000).

Most successful project Den—new sockets and switches ($1,747,283). $212,742,324.

> $213 million. Invested funds since launch Twitter: 39,700.

Fans on social networks Twitter: 27,800. Facebook: 11,528.

Facebook: 15,065. Instagram: 286.

Instagram: 580. Focus

The most successful reward-based crowdfunding platform is Kickstarter. Indiegogo has more successful projects, but much more money has been invested in Kickstarter and the platform has a well-established name across many countries, as evidenced by the high number of followers.

Crowdfunding as New Nonprofit Funding Model

185

The best equity-based crowdfunding platform is Crowdcube; the sec­ ond one is the company Seedrs. Crowdcube is, therefore, the best plat­ form for those who want to run a campaign dedicated to equity-based crowdfunding. Each server uses a different way of acquiring new projects. The most successful ones must actively engage in marketing activities in the market and communicate, i.e., not only offer the possibility of posting projects on their websites, but also search for prospective projects and communi­ cate with them. Less successful servers make do with offering applicants the possibility to submit a project synopsis on their website. Advertis­ ing, advisory, and consulting agencies are slowly beginning to realize that there is a new phenomenon on the market and that in the near future there will be demand for services such as creating a crowdfunding campaign.

Conclusions The literature review declares important facts. To realize and offer—in the long run—their services to the required quantitative and qualitative extent, it is imperative that organizations of all different sectors need to have access to financing. Fundraising as a set of methods aimed at raising the funds necessary for the execution of activities of an NPO is only an important means to an end. One of these options not only for the non­ profit sector is crowdfunding. Crowdfunding is a trend with the goal of expanding the possibilities of effective multisource funding. Crowdfunding can be successful only on condition that the activities the NPO offers are beneficial for the community and thus contribute to society’s sustainable development. NPOs will profit if they embrace and adopt it as not just another means for fundraising but as a tool that empowers individual funders to actively participate in actualizing the creator’s project. The significance of fundraising in NPOs has been rising as the com­ petition is getting tougher and there is an increasing number of organi­ zations applying for both private and corporate donations, resources from other budgets, and other forms of subsidies. Specialized publica­ tions (particularly those from abroad) have offered various mechanisms by the combination of which success can be achieved. The most fre­ quently stated ones are, according to Helmig and Boenigk (2012), the desire to help, altruism, psychological virtues, reputation, and the use of donations. As a conclusion it can be confirmed that crowdfunding as a new fun­ draising tool has not been addressed enough in scientific literature yet and that we are just beginning to gain knowledge of it. Now it also should be the center of attention for science and research to secure sus­ tainability; unfortunately, only little research exists in this area, even internationally.

186

Hommerová

Note 1. It was conducted in cooperation between institutions from the four countries of the so-called Visegrad Four (V4): Aspen Institute Prague (The Czech Repub­ lic), Res Publica Foundation (Poland), The Budapest Observatory (Hungary), and Creative Industry Forum (Slovakia).

References Agrawal, A., Catalini, C., & Goldfarb, A. (2014). Some simple economics of crowdfunding. Innovation Policy and the Economy, 14(1), 63–97. Banhatti, R. D. (2016). Crowdfunding—The phenomenon and its potential in the context of civil society and fundraising. In A. Zimmer & T. Hallmann (Eds.), Nonprofit-Organisationen vor neuen Herausforderungen (pp. 373–398). Wiesbaden, Germany: Springer VS. Belleflamme, P., Lambert, T., & Schwienbacher, A. (2013). Individual crowdfunding practices. Venture Capital, 15(4), 313–333. Belleflamme, P., Lambert, T., & Schwienbacher, A. (2014). Crowdfunding: Tap­ ping the right crowd. Journal of Business Venturing, 29(5), 585–609. Belleflamme, P., Omrani, N., & Peitz, M. (2016). Understanding the strategies of crowdfunding platforms. CESifo DICE Report, 14(2), 6–10. Bruhn, M. (2012). Marketing für Nonproft-Organisationen. Stuttgart, Germany: W. Kohlhammer GmbH. Černý, D. (2015). Crowdfunding: Investiční modely financování [Crowdfund­ ing: Investment financing models]. Retrieved from http://finexpert.e15.cz/ crowdfunding-investicni-modely-financovani Clarkson, N. (2015). A brief history of crowdfunding. Retrieved from www. virgin.com/entrepreneur/a-brief-history-of-crowdfunding Eisenmann, T., Parker, G., & Van Alstyne, M. (2011). Platform envelopment. Strategic Management Journal, 32(12), 1270–1285. European Commission. (2014). Communication from the Commission to the European Parliament, the Council, the European Economic and Social Com­ mittee and the Committee of the Regions. Unleashing the potential of crowdfunding in the European Union. Retrieved from https://eur-lex.europa.eu/ resource.html?uri=cellar:3e0b89b3-b6eb-11e3-86f9-01aa75ed71a1.0002.01/ DOC_1&format=PDF European Commission. (2017). Review of crowdfunding regulation 2017. Inter­ pretations of existing regulation concerning crowdfunding in Europe, North America and Israel. Retrieved from https://eurocrowd.org/wp-content/blogs. dir/sites/85/2017/10/ECN_Review_of_Crowdfunding_Regulation_2017.pdf Freedman, M., & Nutting, M. R. (2015.) Equity crowdfunding for investors: A guide to risks, returns, regulations, funding portals, due diligence, and deal terms. Hoboken, NJ: John Wiley & Sons. Hainzer, M. (2017). Finanzierung von nachhaltigen und gemeinnützigen Projek­ ten mit Hilfe der Crowd [Financing sustainable and charitable projects with the help of the crowd]. In L. Theuvsen, R. Andeßner, M. Gmür, & D. Greiling (Eds.), Nonprofit-Organisationen und Nachhaltigkeit [Nonprofit organiza­ tions and sustainability] (pp. 265–276). Wiesbaden, Germany: Springer Gabler.

Crowdfunding as New Nonprofit Funding Model

187

Helmig, B., & Boenigk, S. (2012). Nonprofit management. München, Germany: Verlag Franz Vahlen GmbH. Hladká, M., & Hyánek, V. (2017). Model dárcovského chování v České repub­ lice [Model of donor behavior in the Czech Republic]. Acta Oeconomica Pra­ gensia, 25(2), 17–33. Hommerová, D., & Severová, L. (2019). Fundraising of nonprofit organiza­ tions: Specifics and new possibilities. Journal of Social Service Research, 45(2), 181–192. Howe, J. (2008). Crowdsourcing: Why the power of the crowd is driving the future of business. New York, NY: Crown Publishing Group. Khodakarami, F., Petersen, J. A., & Venkatesan, R. (2015). Developing donor relationships: The role of the breadth of giving. Journal of Marketing, 79(4), 77–93. Mack, E. (2012). A brief history of crowdsourcing. Retrieved from www. crowdsourcing.org/editorial/a-brief-history-of-crowdsourcinginfographic/12532 Ondráčková, K., & Černý, D. (2015). Crowdfunding: Investiční modely [Crowdfunding: Investment models]. Retrieved from http://finexpert.e15.cz/ crowdfunding-investicni-modely Startup Europe Crowdfunding Network. (2015). Final report. Retrieved from https://eurocrowd.org/2014/05/23/startup-europe-crowdfunding-network­ final-report/ Steinberg, S., & DeMaria, R. (2012). The crowdfunding Bible: How to raise money for any startup, video game, or project. (Ed. J. Kimmich). Cincinnati, OH: ReadMe. Visegrad Group. (2014). Crowdfunding Visegrad. A study. Retrieved from www. visegradgroup.eu/crowdfunding-visegrad Wymer, W., Knowles, P. A., & Gomes, R. (2006). Nonprofit marketing: Market­ ing management for charitable and nongovernmental organizations. Thousand Oaks, CA: Sage. Young, T. E. (2013). The everything guide to crowdfunding: Learn how to use social media for small business funding. Avon, MA: Adams Media. Younkin, P., & Kashkooli, K. (2016). What problems does crowdfunding solve? California Management Review, 58(2), 20–43.

Contributor Bios

René Bekkers is Professor of Philanthropy and Director of the Center for Philanthropic Studies at the Department of Sociology at Vrije Univer­ siteit Amsterdam, the Netherlands. Ignacio Bretos is Assistant Professor of Management at Zaragoza Uni­ versity, Spain. María del Carmen Caba-Pérez is Full Professor in the Public Manage­ ment Sector and General Manager at the University of Almería, Spain. Thad D. Calabrese is Associate Professor at the Robert F. Wagner Gradu­ ate School of Public Service at New York University, USA, where he heads the finance specialization. Grace L. Chikoto-Schultz is Associate Professor of Nonprofit Manage­ ment in the Mark O. Hatfield School of Government in the College of Urban and Public Affairs at Portland State University, USA. Esther de Quevedo-Puente is Associate Professor of Management at Burgos University, Spain. Arjen de Wit is Assistant Professor at the Center for Philanthropic Studies at Vrije Universiteit Amsterdam, the Netherlands. Millán Díaz-Foncea is Associate Professor of Management at Zaragoza University, Spain. Todd L. Ely is Associate Professor in the University of Colorado Denver’s School of Public Affairs, USA, where he directs the Center for Local Government Research and Training. María del Mar Gálvez-Rodríguez is Associate Professor of Management in the Department of Economics and Business at the University of Almería, Spain. Inigo Garcia-Rodriguez is Assistant Professor of Finance at the Univer­ sity of Burgos, Spain.

Contributor Bios

189

Nathan Grasse is Associate Professor in the School of Public Policy and Administration at Carleton University in Ottawa, Canada. Dita Hommerová is Assistant Professor of the Department of Market­ ing, Trade and Services of the Faculty of Economics, University of West Bohemia in Pilsen (Czech Republic), and works at the Institute for Sustainability in Technics and Economics of OTH Amberg-Weiden (Germany). Marc Jegers is Professor of Managerial Economics at the Vrije Univer­ siteit Brussel, Belgium. Marcus Lam is Assistant Professor in the School of Leadership and Edu­ cation Sciences at the University of San Diego, USA. Manuel López-Godoy is Assistant Professor in Financial Market and Financial Management at the Department of Economics and Business at the University of Almería, Spain. Carmen Marcuello is Full Professor of Management at Zaragoza Univer­ sity, Spain. Natalia Martín-Cruz is Full Professor of Corporate Strategy and the Chair of the Business Department at the University of Valladolid, Spain. Víctor Martín-Pérez is Associate Professor of Management in the Business Department at the University of Valladolid, Spain. Juraj Nemec is full-time Professor of Public Finance and Public Manage­ ment at the Faculty of Economics and Administration at Masaryk University in Brno, Czech Republic, and part-time Professor at the Fac­ ulty of Economics at Matej Bel University in Banska Bystrica, Slovakia. Clara Pérez-Cornejo is Assistant Professor of Management at Burgos University, Spain. Michal Plaček is Associate Professor at the Faculty of Social Sciences at Charles University in Prague, Czech Republic. Christopher Prentice is Associate Professor of Nonprofit Management at the University of North Carolina Wilmington, USA. M. Elena Romero-Merino is Associate Professor of Finance at the Uni­ versity of Burgos, Spain. Narttana Sakolvittayanon is a Ph.D. candidate in Public Affairs and Pol­ icy in the Mark O. Hatfield School of Government, College of Urban and Public Affairs at Portland State University, USA. Elizabeth Searing is Assistant Professor in the Rockefeller School of Public Affairs and Policy at the University at Albany (SUNY), New York, USA.

190

Contributor Bios

Mária Murray Svidroňová is Associate Professor at the Department of Public Economics and Regional Development at Matej Bel University in Banska Bystrica, Slovakia. Gabriela Vaceková is Associate Professor at the Faculty of Social Sciences at Charles University in Prague, Czech Republic, and Associate Profes­ sor at the Department of Public Economics at Masaryk University in Brno, Czech Republic. Pamala Wiepking is Visiting Stead Family Chair in International Philan­ thropy and Visiting Associate Professor at the Lilly Family School of Philanthropy at Indiana University, USA, and Professor of Societal Sig­ nificance of Charitable Lotteries at the Center for Philanthropic Studies at Vrije Universiteit Amsterdam, the Netherlands. John Zietlow is Associate Faculty at IUPUI, Indiana, USA; Associate Faculty at Indiana University, Indiana, USA; and Professor of Business Administration at Southwest Baptist University, Missouri, USA. John is also a Certified Treasury Professional (CTP).

Index

Note: Page numbers in italics indicate figures, and those in bold indicate tables. accountability 3, 5–6, 18, 43, 49–53,

56–57, 77–78, 104

accounting 2, 25–28, 33, 43, 115,

117, 125–126, 137–138, 145 agency problems 121, 127 alliance 7, 54, 75–76 altruism 11, 13, 18, 84, 90, 164, 178, 185 audit 43, 46n3, 55, 78, 121, 125 board 16, 40–42, 45, 46n3, 54–55, 68–69, 107, 114–116, 120, 125, 129, 133–134, 136, 139, 142 borrow 4, 114, 132–134, 140, 146, 147–150, 156 business practices 2, 5, 77, 120, 156, 161 Canada 64, 69, 87, 145–146, 148, 150–152, 154, 155–156 capital structure 4–5, 145–146, 148–152, 155–156 cash flow 1, 4, 114, 129–133, 137, 140–142, 148, 154 cash management 1, 126n1, 129 causality 5, 45, 87 charity 46n22, 64–67, 86–87, 104, 116, 145, 151–153, 154, 155–156 Charity Navigator 46, 63, 147 commercial activities 5, 163, 166 commercialization 162, 165–168 compensation 12–13, 42, 46n3, 46n7, 54, 121, 174, 177 corporate social responsibility 75–76 crowdfunding 1, 5, 15, 173–177, 178, 180, 181, 182, 183–184, 185, 190; donation-based 177, 178, 180, 181,

182; equity-based 177, 178, 179, 182, 184, 185; lending-based 178, 179–180; model 177, 178; platform 177, 180, 184–185; reward-based 177, 178, 182, 183, 184; royalty 177, 178, 179–180 crowding-in 4, 15, 45, 90 crowding-out 4, 15, 45, 83, 87–92 Data Envelopment Analysis (DEA) 27–29, 31–34 debt 7, 121, 126n4, 131–132, 134, 138, 140, 145–150, 152–156 decision-making 14, 16, 19, 88, 167 decision-making units (DMU) 27–28 disclosure 43, 45, 50, 52–53, 56, 125, 153 donation: charitable 75, 181; corporate 16, 185; individual 1, 3, 5, 84, 90, 102; private 1, 4–5, 13–14, 17–18, 83, 87, 89–90 donor: corporate 12, 18, 40; individual 4, 11, 18–19, 51, 55–56, 90, 92, 147; motivations 12, 108; private 2, 13, 40, 76, 84; restrictions 116, 121, 126n2 efficiency 2, 4–5, 17–19, 23–29, 32–34, 34n2, 100, 104, 125; allocative 26, 29, 34n3; technical 26, 29, 34n3 empirical evidence 6, 84–87, 92, 100 endowment 84, 115–116, 134, 140–141, 149–150, 153, 155 environment 3, 6, 13, 15–17, 51, 55, 66, 76, 92, 99–100, 103, 106–107, 132, 161, 163, 165–168

192

Index

Europe 11–12, 18, 85, 175–176 expense: administrative 24, 26–27, 32, 34n3, 104, 132; program 43, 103–104 external financing 4, 129, 131–132, 156 financial distress 108 financial growth 100, 108 financial health 2, 4–5, 83, 88, 100, 103, 105, 107, 109, 118, 120, 129–130, 139, 143, 145, 156 financial vulnerability 103, 143 flexibility 108, 135–140, 141, 142 Form 990 104, 106, 116–117, 119, 121–122, 126n2, 152 funders 40, 43, 72, 83, 87, 90–92, 99, 101, 104, 108, 120, 136, 177, 179, 185 funding sources 89, 90, 101, 103–105, 108–110, 134 fundraising 1, 2, 4, 18–19, 26, 32, 41–43, 53, 67, 75, 87, 91, 104, 107–108, 141, 150, 174–177, 181, 185 giving 15–16, 66, 83–84, 86–88, 91; charitable 91, 100; corporate 16–17; individual 87, 92; private 2, 15, 83, 89–90 governance 2–3, 5, 40–42, 44–46, 46n3, 46n18, 53, 54, 56, 69, 76–78, 83, 115, 125, 136, 163, 165 government failure theory 85 government funding 45, 83–84, 86, 88–89, 91 government grants 62, 100, 102, 107, 118, 119, 122, 124 Hirschman-Herfindahl Index 101–102, 105, 107 hybrid organizations 163, 166, 168 independence 4, 17, 46n3, 116, 161, 166, 168 information asymmetry 43–44, 50, 77, 177 internal financing 4, 115, 148, 155–156 Internet 1, 5–6, 51, 173–174, 176 legitimacy 50, 53, 62, 75, 103, 108–109, 147, 165 leverage 108, 146, 148–150, 153–154, 155–156

liability 126n4, 134, 137, 139–140, 145, 147–148, 150, 152, 154 liquidity 88, 103, 114, 116, 120, 125, 129–140, 140–142; management 4, 129–131, 135, 137–139; target 135–139 loan 125, 126n4, 139, 179 manager 16, 40, 44, 46n7, 64, 69, 71–72, 77, 105, 114–116, 120, 125–126, 129–140, 142, 143, 148–149 margin 5, 103, 114, 116–118, 119, 122, 125, 126n3 market failure 1, 164 meta-analysis 91, 100, 102, 105, 107, 109 modern portfolio theory 102, 104–106, 108 non-distribution constraint 114, 121 nongovernmental development organization 32, 149 organizational institutionalism theory 102–103 pecking order theory 146, 148–150, 155–156 practitioner 63, 78, 120, 130, 145, 148–149, 156, 166 price 2, 14, 19, 26–27, 29, 33, 34n1, 126n1, 151, 162 profit 16, 19, 33, 114–116, 118, 119, 125, 131, 133–134, 162–164, 180, 185 profitability 25, 33, 152, 155 public funding 4, 17, 19, 89 public good 1, 11, 13, 15, 17–19, 84–85, 88, 91–92, 165 public sector 1, 13, 15, 19, 23, 165–166, 176 public subsidy 2 ranking 20n4, 33, 44, 63 ratio 26–27, 31, 33, 34n3, 101, 118, 119, 121–122, 123–124, 126nn2–4, 131–132, 134, 137–138, 147, 152–153, 155 remuneration 42, 178 reputation 2–3, 5–6, 62–63, 64–73, 74–78, 84, 177, 185 reserves 1, 3–5, 116, 118, 120–122, 125, 130, 134–136, 138, 140, 142, 147–149, 151, 154, 156; operating

Index 115–116, 120–122, 123–124,

126n2, 126n4, 133, 135

resource dependence theory 53, 102–103 revenue: commercial 161; concentration 99–101, 104, 107; diversification 2, 4–5, 90, 99–109; sources 7, 83, 101–102, 104–108, 118 risk 3–5, 17, 34, 44, 76, 99, 103, 105–106, 109–110, 120, 129, 131–132, 136, 138, 142, 155, 164, 176–177 sales 40, 106 scandal 6, 44, 47, 56–57, 62, 75–76 self-regulation 54 slack 4, 17, 114–117, 121, 131, 134–135, 147 social networks 51, 57 solvency 109, 137–140 stability 4, 99, 103, 105–108, 150 stakeholder 3, 5–6, 40, 42–44, 49–53, 54, 55–57, 62, 71, 74, 76–78, 107, 120, 147, 156 surplus 103, 114–118, 119, 120, 122, 125, 126n3, 133–136, 141 sustainability 23, 55, 57, 65, 100, 107, 109, 120, 130, 139

193

tax 1, 14, 18, 26, 51, 69, 84, 88–90, 116, 126n2, 151–152, 157, 175, 178, 183; benefit 3, 146, 151; exempt bonds 122, 126n4, 146, 150; incentive 11, 13–14 technology 2, 5, 7, 16, 28–29, 52, 57, 183; informational 12, 15–18 trade-off theory 149–150 transaction costs theory 104 transparency 2–3, 18, 27, 34, 45, 46n3, 49–51, 53–57, 54, 175 treasury 129, 131, 134, 140, 141; management 1, 129–130, 133 trust 15, 26, 41–42, 49, 57, 67, 71, 73, 75, 77, 164 United States (U.S.) 6, 18, 41, 44, 46, 68, 72, 87, 90–91, 99, 107, 117, 125, 131, 147, 149–152, 174, 183 volatility 103, 105–106, 121, 131–132, 137 volunteer 11–12, 22, 49, 51–54, 64, 67–69, 71, 74, 77, 100, 107, 133 warm glow 11, 84 watchdog 19, 20n4, 44–45, 46n17 website 15, 44–46, 50–53, 57, 67, 174, 181, 182, 184, 185

Taylor & Francis eBooks www.taylorfrancis.com A single destination for eBooks from Taylor & Francis with increased functionality and an improved user experience to meet the needs of our customers. 90,000+ eBooks of award-winning academic content in Humanities, Social Science, Science, Technology, Engineering, and Medical written by a global network of editors and authors.

TA YLOR & FRANCIS EBOOKS OFFERS: A streamlined experience for our library customers

A single point of discovery for all of our eBook content

Improved search and discovery of content at both book and chapter level

REQUEST A FREE TRIAL [email protected]