Do operating reserves stabilize spending by nonprofit organizations?

Abstract

The public budgeting literature has a long and rich tradition that examines the role of budget stabilization funds as fiscal stabilizers for state and local governments during periods of declining revenues and deteriorating economic conditions. Similarly, nonprofit organizations may accumulate operating reserves that allow them to smooth out annual imbalances between revenues and expenses, especially when facing a fiscal shock. Agency theory, on the other hand, indicates that managers might use these reserves to enrich themselves at the expense of the organization. This article is a step toward addressing a gap in our knowledge by analyzing the implications of reserves on nonprofit spending in general and also on particular functions (program versus overhead spending). Using a long panel of data from 1995 to 2011 and controlling for sample selection bias, the empirical results suggest that operating reserves held by nonprofit organizations do reduce expense gaps during downturns, but the effect is small. The results also suggest that nonprofit managers value current spending more than reserving funds for the future. Further, operating reserves are not associated with agency problems as predicted by theory. The empirical results suggest that the current rule of thumb—that nonprofits ought to hold up to 6 months of operating reserves—is inadequate if these pools of savings are intended to maintain all spending at trend during poor fiscal times. If, however, reserves are intended to only offset trend deviations partially while alternative strategies are sought, then the current rule of thumb may be sufficient.

Toward a valid approach to nonprofit efficiency measurement

“…Statistical inference with DEA scores computed from nonprofit tax data should consider the smaller sample when making theoretical efficiency claims. Example of design approaches with solutions for the nonprofit size sampling constraint can be seen in Calabrese () and Searing ().…”

Cash is not king for fund‐raising: Gifts of noncash assets predict current and future contributions growth

“…Finally, a measurement of operational activity is revenue such as fees for services or the sale of goods, which is reported as “Program service revenue” on Form 990 Part I line 9, again excluding any negative values (Searing, ). For the following analysis, an organization's subsector is defined by the first letter of the National Taxonomy of Exempt Entities (NTEE) Classification System as developed by the National Center for Charitable Statistics assigned to its employer identification number (see similar usage of NTEE codes in, e.g., Calabrese, ).…”

Nonprofit cash holdings and spending: The missing role of government funding

“…In corporate finance, “cash holdings” refer to cash‐on‐hand and savings, including temporary or short‐term investments that can easily be converted to cash. Previous research in nonprofit finance has defined the term similarly: “cash holdings” are cash, savings, and temporary cash investments held by nonprofit organizations (Calabrese, ; Core et al, ; Fisman & Hubbard, ; Ramirez, ).…”

“…Organizations also accumulate cash to use as a buffer against revenue shortfalls and may seek growth opportunities by increasing program expenses to provide more goods and services (Core et al, ). Studies have also suggested the presence of agency problems as an alternative explanation for organizations' cash holdings (Jensen, ); however, some studies have rejected this idea (e.g., Calabrese, ). Unlike debt and equity that entail formal monitoring by external constituencies, cash gives discretion to managers so that they can expropriate cash for private gain (Ramirez, ).…”

“…Nevertheless, previous literature examining nonprofits' use of cash has several limitations. First, except for a few (e.g., Calabrese, ), studies of nonprofit cash holdings often use data with an overrepresentation of large nonprofit organizations in the sample (e.g., Core et al, ; Fisman & Hubbard, ; Ramirez, ). Second, studies have failed to consider the influence of environmental factors on nonprofit financial behavior (Prentice, ).…”