Abstract:The principles of normative nonprofit financial management instruct organizations to minimize overhead and to remain fiscally lean. Although prior scholarship has addressed many of the unintended negative consequences of normative managerial practices, research has not yet explored the impact of the norm of fiscal leanness on the ability of nonprofits to respond efficiently to their economic environments. This research seeks to address this gap and finds that fiscal leanness appears inhibit fiscal responsivene… Show more
“…Managing for efficiency is often categorized by such tension because external stakeholders perceive low overhead ratios as a signal of efficient nonprofit management. Meeting external notions of efficiency means scrambling to report low financial ratios and spending to appease external expectations of fiscal and administrative leanness, even as managers realize that doing so can have low limited instrumental value in that low spending can be inconsistent with pursuit of efficient management (Calabrese, ; Mitchell, ).…”
“…Service organizations can manage for different kinds of efficiency: transactional efficiency , where organizations behave in a way that minimizes the frictions inherent in economic activity (Coupet & McWilliams, ; Valentinov, ); distributive efficiency , concerned with maximizing the equitable distribution of social benefits (Zerbe, ); allocative efficiency, concerned with expenditure of resources in vectors that maximize their productivity (Callen & Falk, ); and technical (or productive) efficiency, concerned with maximizing outputs relative to inputs (Miragaia, Brito, & Ferreira, ). Transactional and distributive notions of efficiency typically are less concerned with the direct relationships of inputs and outputs, and scholarship in nonprofit management where financial ratios are used has typically been concerned with technical or allocative efficiency (Mitchell, ). Financial ratios are themselves good measurements of neither.…”
Past literature in nonprofit management uses the overhead ratio of nonprofits as a measure of efficiency. Although the overhead ratio might measure top-heaviness, we argue that it does not measure nonprofit efficiency. To investigate this, we use financial and operational data to rank the efficiency of Habitat for Humanity affiliates with the overhead and administrative ratio, as well as data envelopment analysis (DEA) and stochastic frontier analysis (SFA), two of the most popular efficiency measures. While the DEA and SFA rankings are statistically correlated, overhead ratio rankings are negatively correlated with both SFA and DEA rankings. We argue that nonprofit scholars, managers, and donors should move away from concepts and measures of efficiency based on financial ratios, and toward ones that embrace maximizing what nonprofits are able to make and do.
“…Managing for efficiency is often categorized by such tension because external stakeholders perceive low overhead ratios as a signal of efficient nonprofit management. Meeting external notions of efficiency means scrambling to report low financial ratios and spending to appease external expectations of fiscal and administrative leanness, even as managers realize that doing so can have low limited instrumental value in that low spending can be inconsistent with pursuit of efficient management (Calabrese, ; Mitchell, ).…”
“…Service organizations can manage for different kinds of efficiency: transactional efficiency , where organizations behave in a way that minimizes the frictions inherent in economic activity (Coupet & McWilliams, ; Valentinov, ); distributive efficiency , concerned with maximizing the equitable distribution of social benefits (Zerbe, ); allocative efficiency, concerned with expenditure of resources in vectors that maximize their productivity (Callen & Falk, ); and technical (or productive) efficiency, concerned with maximizing outputs relative to inputs (Miragaia, Brito, & Ferreira, ). Transactional and distributive notions of efficiency typically are less concerned with the direct relationships of inputs and outputs, and scholarship in nonprofit management where financial ratios are used has typically been concerned with technical or allocative efficiency (Mitchell, ). Financial ratios are themselves good measurements of neither.…”
Past literature in nonprofit management uses the overhead ratio of nonprofits as a measure of efficiency. Although the overhead ratio might measure top-heaviness, we argue that it does not measure nonprofit efficiency. To investigate this, we use financial and operational data to rank the efficiency of Habitat for Humanity affiliates with the overhead and administrative ratio, as well as data envelopment analysis (DEA) and stochastic frontier analysis (SFA), two of the most popular efficiency measures. While the DEA and SFA rankings are statistically correlated, overhead ratio rankings are negatively correlated with both SFA and DEA rankings. We argue that nonprofit scholars, managers, and donors should move away from concepts and measures of efficiency based on financial ratios, and toward ones that embrace maximizing what nonprofits are able to make and do.
“…While corporations can scale back investment and dividends when short of cash, nonprofits often can only reduce administrative overhead (“recoverable” slack, as termed by Bowman, ), or reduce programmatic output; the reduction in output, though, can reduce revenues (through fewer clients or donors reached), meaning overhead is often the victim of expense reductions for nonprofits with no reserves to fall back upon. Tuckman and Chang () hypothesized that nonprofits with more administrative spending could reduce spending when revenues unexpectedly did not materialize, and Mitchell () finds that nonprofits with little overhead are less able to respond efficiently to fiscal shocks. Therefore, nonprofits may choose to use reserves strategically to stabilize program and overhead expenses differently. Hypothesis 2: Using or accumulating operating reserves stabilizes nonprofit program and overhead spending differently.…”
Section: Literature Review and Testable Hypothesesmentioning
confidence: 99%
“…Nonprofits, though, are hesitant to appear “too wealthy” because stakeholders take a negative view of charities that appear to hoard wealth (Calabrese, ). Further, nonprofits are expected to appear “lean” by devoting most spending directly toward programs (Mitchell, ). As a result, nonprofits face difficulty in accumulating reserves in the first place, and reserves might come with significant costs that are unique to nonprofits.…”
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.
“…In contrast to total spending, how a nonprofit directs its spending might also influence meaningful endowment building. The program expense ratio is commonly used by donors considering contributions (see Mitchell, ), although the approach is not without its critics (Coupet & Berrett, ). As a proxy for attractiveness to donors, organizations with higher program expense ratios may have an easier time attracting endowment dollars.…”
Section: Related Literature Research Questions and Hypothesesmentioning
Most nonprofits lack a true endowment and endowment wealth is concentrated in a relatively small number of organizations and subsectors. This study supports an operational definition of material endowment, equal to or greater than annual expenses, and investigates how common it is for a nonprofit to establish a meaningful endowment over time. Specifically, we address whether the sector's enthusiasm over the potential of endowment building is reflected in charitable organizations' experiences. Using financial data, we find that building a meaningful permanent endowment is a rare achievement among public charities over a period of two decades. Meaningful endowment creation, achieved by less than 2% of the sample, is more common for organizations with donor attachments, the need for subsidization of mission services, those with more fundraising costs, and those with more donative revenue portfolios.
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