Playing the Numbers Game

Abstract

Nonprofit organizations are often evaluated using the program ratio: the proportion of mission-related program expenses to total expenses. Nonprofit managers have incentives to manipulate the reporting of financial information to enhance the program ratio. This article reviews the scholarly literature on program ratio management in nonprofit organizations. Prior research has identified several motivations for and methods of program ratio management and provided limited evidence that it occurs. Researchers have explored the consequences of program ratio management and provided a list of factors mitigating such behaviors. The emerging consensus is that the program ratio is of limited usefulness in evaluating nonprofit performance. Keywords: program ratio; program ratio management; nonprofit organizations; earnings management; nonprofit performance measures EXTANT LITERATURE PROVIDES CONSIDERABLE EVIDENCE of many publicly traded, profi t-seeking corporations manipulating reported numbers to infl uence the perceptions and decisions of fi nancial statement users (Dechow and Skinner 2000;Graham, Harvey, and Rajgopal 2005;Habib and Hansen 2008;Healy and Wahlen 1999;Schipper 1989). However, for-profi t corporations are not alone in the practice of intervening in the fi nancial reporting process to present more favorable results. Nonprofi t managers also face pressures to manipulate fi nancial results. Although their success is not measured by profi t margins or rates of return, nonprofi t organizations are evaluated using fi nancial reports.Recently, the nonprofi t sector has grown substantially and has begun to attract more attention. Advances in technology, coupled with broader disclosure requirements by regulators, have increased access to nonprofit financial information. Internal Revenue Service (IRS) Form 990 annual reports are now publicly available through various websites. Th is increased access has resulted in heightened scrutiny of how nonprofi ts spend their money, especially in light of several high-profi le scandals in recent decades (Dimsdale 2009;Shepard and Miller 1994;Simross 1992). Th e role of charity "watchdog" agencies has grown, and donors have become more discriminating when disbursing their scarce resources. Competing with thousands of other nonprofi ts for resources and knowing they are commonly judged on their Nonprofi t Management & Leadership DOI: 10.1002/nml 402 GARVEN, HOFMANN, MCSWAINfi nancial results, some nonprofi t managers may resort to playing a numbers game to make the organization look as favorable as possible. Figure 1 describes the elements of this game.Although management of fi nancial results by profi t-seeking corporations tends to focus on net income, management of fi nancial results by nonprofi ts is more likely to focus on the program ratio (Khumawala, Parsons, and Gordon 2005)-the proportion of total expenses dedicated to providing programs that fulfi ll an organization's mission. Th e program ratio is typically computed as program expenses divided by total expenses. An alt...

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