Management compensation disclosures in private colleges' and universities' forms 990: reporting strategies and donor reaction.

ABSTRACT

The Internet presence of private colleges' and universities' Forms 990 and their disclosure of top management's compensation amounts have led to fears of declines in donor contributions to these institutions. This paper explores donor reaction to two possible reporting strategies to counter negative perceptions: a high measure of management's financial efficiency, and a high level of management's non-financial success. The study finds that while each measurement type may succeed in countering some negative donor reaction, high non-financial success levels may offset greater amounts, a potentially important discovery since many institutions fail to highlight significant non-financial achievements in Form 990.

1. INTRODUCTION

The reporting of top management compensation amounts in nonprofit organizations' Form 990, the comprehensive yearly informational return filed with the Internal Revenue Service (IRS) and now available on the Internet, has raised concerns that such disclosures may lead to declines in donor contributions (Evangelical Council for Financial Accountability, 1999). This fear may be especially great among private colleges and universities, since their presidential compensation amounts have recently come under the scrutiny of the popular media (See for example Lockman (2002)). Recognizing that all nonprofit organizations, including colleges and universities, may now need to justify their management compensation amounts (Evangelical Council for Financial Accountability, 1999), this paper explores, in an experimental setting, the potential success of two Form 990 reporting strategies in countering negative donor reaction: a high measure of management's financial efficiency; and a high level of non-financial success achieved under management's leadership. The paper's results, although couched in the context of private educational institutions, should interest all nonprofit organizations competing for donations in an increasingly skeptical donor environment.

2. LITERATURE REVIEW

Form 990 is the informational return that most tax-exempt organizations (501(c)(3) organizations) file with the IRS to provide evidence that they have not violated their tax-exempt status. The return, a voluminous report often spanning as many as 30 pages or more, consists of nine parts and one set of schedules. Part I, the Revenue, Expenses, and Changes in Net Assets or Fund Balances statement, reports the organization's revenue sources and total expenses. This section of the report classifies total expenses in one of three categories: program services (amounts spent on activities related to the organization's mission); management and general (amounts devoted to administrative functions); and fundraising. The individual expense composition of these three totals is disclosed in Part II, the Statement of Functional Expenses. Part III, the Statement of Program Service Accomplishments, presents non-financial measures of an organization's success in achieving its mission. Currently, most organizations, including colleges and universities, do not utilize this statement to highlight significant non-financial success, a deficiency that may be due to the IRS's lack of specifications as to the exact measures to report (The Urban Institute, 2004; Moore & Williams, 1998). Part IV, the Balance Sheets, presents an organization's beginning and ending year financial position, while Part V, the List of Officers, Directors, Trustees, and Key Employees, reports top management's compensation amounts, data typically absent from most annual reports. The remaining sections of the return disclose miscellaneous information ranging from an analysis of income producing activities to compensation amounts of the five highest paid independent contractors.

Because of the wealth of data it contains, Form 990 can serve as an invaluable informational source for donors contemplating contributions to nonprofit organizations. When evaluating such entities, donors and public service agencies rank the ratio of total program service expenses to total organizational expenses, the program expenditure percentage, high in importance (Baber et al., 2002; Baber et al., 2001). This ratio, which can be directly calculated from data appearing in the Revenue, Expenses, and Changes in Net Assets or Fund Balances statement, provides an indication of the financial efficiency of the organization. Research findings suggest that donors increase their levels of contributions as program expenditure percentages rise (Baber et al., 2002; Khumawala and Gordon, 1997). Nonprofit experts also contend that non-financial achievement disclosures are equally important in gauging the success of an organization (The Urban Institute, 2004; Evangelical Council for Financial Accountability, 1999). These measures, if reported, may be disclosed in Form 990's Statement of Program Service Accomplishments. As with financial metrics, empirical research also suggest that donors may value non-financial measures of an organization's success (Khumawala and Gordon, 1997).

3. HYPOTHESIS AND RESEARCH QUESTIONS

This paper tests the following hypothesis, stated in alternative form:

H1: High management compensation disclosures negatively affect donors' perceptions of a private college or university.

Since high compensation disclosures are expected to lead to negative donor reaction, the paper also investigates the following two questions:

1. Can the reporting of a high program service expenditure percentage, a measure of management's financial efficiency, offset negative donor reaction to high management compensation amounts?

2. Can the disclosure of a high level of non-financial program service success achieved under management's leadership offset negative donor reaction to high management compensation amounts?

Because these questions are exploratory in nature, no a priori hypotheses regarding them are offered.

4. EXPERIMENTAL MATERIALS AND METHOD

To investigate the above research issues, 50 donors were recruited for an experimental study. All donors were evening MBA students enrolled in a management accounting course; all had completed at least one, three-semester-credit-hour undergraduate financial accounting class prior to the course. Donors' average age was 34, and all were employed on a full-time basis. Average household income for the majority of donors fell in the $50,000 to $75,000 range.

Following Gordon and Khumawala's research design (1999), experimental materials instructed participants to assume that their employer had recently authorized substantial, unrestricted contributions to one or more of eight comparably sized private liberal arts colleges. Donors were told that they had no ties to any of the institutions and that they had not attended or visited any of them. Participants' superiors requested them to review Form 990 data from the eight institutions and to rate, on a ten point scale, their level of recommendation for a separate contribution to each college.

To perform their evaluations, donors received the following Form 990 sections for each college: a Revenue, Expenses, and Changes in Net Assets or Fund Balances statement (Part I); a Statement of Program Service Accomplishments (Part III); and the List of Officers, Directors, Trustees, and Key Employees (Part V). Three independent variables, each manipulated at high and low levels, were explored: the program expenditure percentage (the ratio of program service expenses to total organizational expenses), calculated from data in the Revenue, Expenses, and Changes in Net Assets or Fund Balances statement; the degree of non-financial program service success based on the Governmental Accounting Standard Board's (GASB) suggested outcomes measures of service accomplishments for state sponsored colleges and universities (Hatry et al., 1990) and reported in the Statement of Program Service Accomplishments; and the compensation levels of the top executives disclosed in the List of Officers, Directors, Trustees, and Key Employees.

Each college's Revenue, Expenses, and Changes in Net Assets or Fund Balances statement reported a program expenditure percentage of 60 or 85 percent. Its Statement of Program Service Accomplishments disclosed three GASB suggested outcome measures of educational success, collectively manipulated at either low (59th-60th percentile or percent) or high (84th-85th percentile or percent) levels: an average percentile score on a national, general education examination; an overall average percentile score on national, major field examinations; and student satisfaction. Each institution's List of Officers, Directors, Trustees, and Key Employees reported one of the following compensation levels, or slight variation thereof, for the president and vice presidents of academic affairs, administration, student affairs, enrollment, and institutional advancement: $142,000, $93,000, $92,000, $90,550, $91,250, and $98,667, respectively; or $245,000, $192,000, $199,000, $194,500, $186,250, and $198,250, respectively.

Each of the eight colleges represented a different combination of the two levels (low and high) of the three independent variables (program expenditure percentage, non-financial program success and management compensation level). The resulting 2x2x2 within repeated measures design allowed all donors to evaluate each of the eight institutions (variable combinations).

5. ANALYSIS OF RESULTS AND DISCUSSION

Table 1 presents mean (standard deviation) donor recommendation ratings of the eight combinations of variables (institutions), partitioned according to compensation level:

A 2x2x2 within repeated measures ANOVA, with recommendation ratings as the dependent variable and management compensation, program expenditure percentage and non-financial program success as the three independent variables, was used to test the hypothesis and to study the two research questions. Tests of within subjects effects from the ANOVA are shown in Table 2:

The combined results of Table 1 and Table 2 indicate that high management compensation disclosures negatively affected donors' recommendation ratings, evidence supportive of the study's hypothesis, H1. In addition, the program expenditure percentage, the level of non-financial program success and two interactions, compensation by program expenditure percentage and compensation by non-financial program success, also significantly influenced results.

A closer inspection of the data from Table 1 and Table 2 reveals that while high program expenditure percentages and high levels of non-financial program (educational) success each succeeded in countering some of the negative donor reaction to high management compensation amounts, high non-financial program success levels offset greater shares. For example, at the high management compensation level (Table 1, Panel A), donors rated the combination of a high degree of non-financial success and a low program expenditure percentage (6.10) significantly higher (p=.000) than the combination of a low degree of non-financial success and a high program expenditure percentage (4.24). Further, the Table 1, Panel A college reporting high compensation, a low program expenditure percentage, but high non-financial success received a greater, although not statistically greater, recommendation rating (6.10) than the Table 1, Panel B college disclosing low compensation, a high program expenditure percentage, but low non-financial performance (5.62). At both management compensation levels, in fact, donors weighed the non-financial performance level more heavily. At the high compensation amount (Panel A, Table 1), the difference between the mean high and mean low levels of the non-financial success variable was 2.29; at the low compensation amount (Panel B) this difference was 2.80. In contrast, the same mean difference for the program expenditure percentage at the high compensation level was .43 and at the low level .88. Taken as a whole, these results suggest that reporting a high level of non-financial program (educational) success may hold greater promise in offsetting more negative donor reaction to high management compensation amounts than a high program expenditure percentage, a potentially noteworthy finding since many private colleges and universities do not currently use the Statement of Program Service Accomplishments to highlight significant non-financial success (The Urban Institute, 2004; Moore & Williams, 1998).

6. LIMITATIONS AND CONCLUSION

The results of the experimental findings are limited by two factors. First, participants, although active donors, were not randomly selected from the general population of donors. Second, the study focused only on the relationship between accounting information and donors' preferences. Despite these limitations, the findings of this study suggest that private colleges and universities awarding high management compensation may be able to partially alleviate some negative donor reaction through specific Form 990 reporting strategies.

TABLE 1

DONOR RECOMMENDATION RATINGS (STANDARD DEVIATIONS)

PANEL A. HIGH MANAGEMENT COMPENSATION AMOUNTS

                                                Level of
                                 Non-financial Program Service Success

Program Expenditure Percentage                 Low     High

             Low                              3.94     6.10
                                             (1.81)   (1.90)
             High                             4.24     6.66
                                             (2.16)   (2.08)

PANEL B: LOW MANAGEMENT COMPENSATION AMOUNTS

                                                 Level of
                                 Non-financial Program Service Success

                                               Low     High

Program Expenditure Percentage
             Low                              4.86     7.54
                                             (1.86)   (1.95)
             High                             5.62     8.54
                                             (2.15)   (1.40)

TABLE 2

ANOVA TESTS OF WITHIN SUBJECTS EFFECTS

Variable                                          F-Statistic   p-value

Management Compensation                             33.044        .000
Program Expenditure Percentage                      11.022        .002
Non-financial Program Success                       92.415        .000
Compensation by Program Expenditure Percentage       4.272        .044
Compensation by Non-financial Program Success        6.908        .011
Program Expenditure Percentage by Non-financial
Program Success                                      1.758        .191
Compensation by Program Expenditure Percentage
by Non-financial Program Success                      .004        .951

7. REFERENCES

Baber, W.R., Daniel, P.L., and Roberts, A.A., "Compensation to Managers of Charitable Organizations: An Empirical Study of the Role of Accounting Measures of Program Activities," The Accounting Review, 77(4), 2002, 679-693.

Baber, W. R., Roberts, A.A., and Visvanathan, G., "Charitable Organizations' Strategies and Program-Spending Ratios," Accounting Horizons, 15 (3), 2001, 329-343.

Evangelical Council for Financial Accountability, "Use the Form 990 to Showcase Your Ministry," Focus on Accountability, 1999; The Urban Institute, www.qua1990.org/showcase.

Gordon, T. P., and Khumawala, S.B., "The Impact of Joint Cost Allocation Disclosures in the Decision to Support Not-for-Profit Organizations," delivered at the 1999 American Accounting Association Annual Meeting, August 1999, San Diego, California.

Hatry, H.P., Fountain, J. R., Jr., Sullivan, J. M., and Kremer, L., Service Efforts and Accomplishments Reporting. Its Time Has Come, GASB, Norwalk, CT, 1990.

Khumawala, S. B., and Gordon, T P., "Bridging the Credibility of GAAP: Individual Donors and the New Accounting Standards for Nonprofit Organizations," Accounting Horizons, Vol. 11(3), 1997, 45-68.

Lockman, Norman A., "College Pay: Halls of Ivy Hung with Green," November 29, 2002, The Cincinnati Enquirer.

Moore, J., and Williams, G., "Return of the Future: Disclosure Laws and Internet Access Spur New Focus on Charity Tax Forms," The Chronicle of Philanthropy, December 17, 1998; The Urban Institute, www.qua1990.org/return_of_the_future.

The Urban Institute, Form 990 Accounting and Reporting Issues, 2004; The Urban Institute, www.qua1990.org/issues.

R. Steven Flynn, Thomas More College, Crestview Hills, Kentucky, USA

Author Profile

Dr. R. Steven Flynn received his Ph.D. from the University of Cincinnati in 1987. Currently he is an associate professor of accountancy and chair of the Department of Accountancy at Thomas More College, Crestview Hills, Kentucky, USA. Dr. Flynn is also a Certified Public Accountant (CPA).