November 01, 2013

The Overhead Debate: Charities Risk Widening Rift With Donors Over Administrative Costs

It’s rare that nonprofit accounting makes headlines, but it certainly has had its share of time in the spotlight in recent months. Most recently, an investigation by The Washington Post into substantial “diversions” of assets among nonprofit organizations highlighted issues of financial accountability. The report examined embezzlement, fraud, and other irregularities at more than 1,000 nonprofits.

While these financial troubles do not necessarily indicate poor intent of the nonprofits’ leaders, they do indicate poor internal controls over finances.

That report follows the “America’s Worst Charities” investigation by the Center for Investigative Reporting (in conjunction with the Tampa Bay Times and CNN). Their articles focused on charities that put alarmingly small amounts of donor money to use in achieving their mission. They also brought the use of for-profit telemarketers into the mainstream public view and highlighted the legal and public-relations efforts some in the nonprofit world have taken to keep such information from influencing donors’ decisions.

It may be tempting to dismiss these reports of poor financial management in the popular press as an unfair focus on outliers. However, doing so runs the risk of widening a rift that has opened up between charities and donors who have strong concerns about how their money will be spent, concerns that are known to reduce giving.

A recent survey by U.S. Trust and Phoenix Marketing International found that the top reason wealthy donors do not give more is fear their money “won’t be used wisely.” Charities rely heavily on public trust. This makes it all the more important that nonprofit leaders assuage donor fears when it comes to financial stewardship.

With this in mind, consider the nonprofit world’s primary message to donors when it comes to accountability. The most notable development in this realm is the introduction of the “overhead myth” campaign, an effort by three prominent charity-evaluation organizations—the BBB Wise Giving Alliance, Charity Navigator, and GuideStar. In a “letter to the donors of America,” they urged potential contributors to put less emphasis on what percentage of a charity’s expenses is spent on fundraising and administration, or “overhead,” when they choose where to give.

This effort comes on the heels of a highly popular TED talk by Dan Pallotta arguing that donors’ preference for lower salaries and less marketing by nonprofits (again, to keep overhead low) is counterproductive. This broad message that donors should pay less attention to accounting measures of financial efficiency has been greeted with unbridled enthusiasm in the nonprofit world.

Trying to look through the eyes of a donor, however, I cannot help but view these concurrent developments as signs of a growing rift in the perspectives of charities and their donors. While donors cringe at the thought that their donations may not be going toward their intended target, nonprofit leaders are seemingly telling them, “Look away. There’s nothing to see here.”

Granted, while the “overhead myth” letter asserted that many nonprofits need more, not less, overhead, it also noted that “at the extreme” overhead expenses can tip off donors to fraud or financial mismanagement.

I have no doubt that the motives behind this campaign are to introduce nuance into donors’ assessments, not to eliminate financial scrutiny.

Yet I also wonder whether that is the message that has been received.

Telling people to pay less attention to where their money goes, even if in a thoughtful way, runs the risk of seeming tone deaf in light of well-publicized cases of poor financial management. It doesn’t help that the new response to every allegation of charity misdeeds is for the charity, its advocates, or its telemarketers to point to the “overhead myth” letter or Dan Pallotta’s TED talk as a defense.

Don’t get me wrong. I realize that accounting measures of efficiency have their weaknesses and even nonprofits with stellar internal controls can find themselves victims of malfeasance. But I also fear the nonprofit world may be unwittingly losing public support by dismissing stories of financial imprudence among its members, even if they are atypical.

Rather than bemoaning the flaws of basic accounting metrics and asking (even telling) donors to pay less attention to them, nonprofits may be better served by providing and promoting additional financial information. This could entail offering more details on Web sites or annual reports about the specific components of program and overhead costs (for example, advertising, salaries, legal expenses, postage, consulting). Since accounting standards already require compiling such information, making it a more prominent part of donor communication is not costly. Further, rather than lamenting the tendency of the popular press to focus on extreme examples of financial fraud, the nonprofit world should redouble efforts to ensure and credibly communicate the importance of good financial stewardship. This could entail developing an industry-wide culture of routine external review and certification of internal controls, a common practice among for-profit counterparts.

Failure to change the current tack could solidify the gulf between nonprofit insiders and their donors.

Brian Mittendorf is a professor of accounting at Ohio State University who specializes in nonprofit issues.