Are Donors Watching? Nonprofit Rating Availability and Pay-to-Performance Sensitivity

Abstract

CEO compensation by nonprofit organizations is controversial. Higher-qualified CEOs should be compensated more than lesser-qualified individuals because of better performance regarding organizational goals and missions. Alternatively, an ethical issue may exist if CEOs are overcompensated resulting in a negative impact on the operations of their organizations. Donors have the incentive to monitor nonprofit organizations, but their role is limited to their ability to acquire nonprofit organization information. However, charity rating agencies make information more accessible and understandable, thus reducing information asymmetry between donors and nonprofit organizations. This study examines whether charity rating availability is associated with negative pay-to-performance sensitivity. Using a sample derived from the IRS Form 990 s and Charity Navigator ratings, this study provides evidence that rating availability is negatively related to pay-to-performance sensitivity in nonprofit organizations. Additional tests provide evidence that the overall rating score and its financial rating component are negatively associated with pay-to-performance sensitivity.

Appendices

Appendix A: Charity Navigator’s Measures and Component for Ratings

From A Guide to Charity Navigator’s Ratings (Charity Navigator, 2020).

Financial Health Measures (computed from financial information on Form 990):

• Financial efficiency performance metrics

• Program expense ratio

• Administrative expense ratio

• Fundraising expense ratio

• Fundraising Efficiency Ratio

• Financial capacity performance metrics

• Program expense ratio growth

• Working capital ratio

• Liabilities to assets ratio.

Financial rating calculation: Each of the seven performance metrics was calculated, and the raw scores were converted to numerical scores ranging from 0 to 10. Subsequently, 30 points were added to the sum of these scores to provide a rating score on a 100-point scale.

Accountability and Transparency Measures:

• From Form 990:

• Board composition (15 points)

• A material diversion of assets (15 points)

• Audited financial statements/Audit committee (15 points)

• Loans to or from related parties (4 points)

• Documents board meetings minutes (4 points)

• A conflict of interest policy (4 points)

• A whistleblower policy (4 points)

• A records retention and destruction policy (4 points)

• The CEO and their salary (4 points)

• The process of determining CEO compensation (4 points)

• The board members that are not compensated (4 points)

• 990 was provided to the board prior to filing (4 points)

• Included or available from nonprofit organization’s website(s):

• Board members listed (4 points)

• Key staff listed (4 points)

• Most recently filed Form 990 (4 points)

• Published audited financial statements on website (4 points)

• Published privacy policy for donors (4 points)

Accountability rating calculation: Subtract any points for missing items from 100.

Appendix B: How to Obtain Historical Ratings Data from Charity Navigator API

Current rating information is readily available from Charity Navigator, but historical data are only available through the Charity Navigator API. The API is provided in an interactive window, as shown in the following figure.

The URL was generated using the Charity Navigator API. Once the URLs are entered into the internet browser, a JSON file, which can be copied and saved as a txt file, is generated. A total of 8960 URLs were generated using the Employer Identification Number (EIN) for historical rating scores and ranks. These ratings were used only for the overall ratings. A unique Rating ID was provided for each rating record (a combination of EIN and rating data). The Charity Navigator API requires both the Rating ID and the EIN to generate URLs for the two dimensions of rating (financial and accountability). A total of 107,000 combinations were generated for the two dimensions, and obtained about 7300 records. Python codes were developed to open the URLs and extract data from the JSON files because of the high number of URLs and irregular format of the JSON file. The Charity Navigator API has a limit of 25,000 hits per day; therefore, the extraction of the data takes approximately 5 days, consistently running Python code. Python code then generates an Excel file with the overall as well as financial and accountability rating scores and ranks.

Appendix C: Variable definitions

COMP/REV	CEO compensation adjusted by total revenue in year t
RATED	A dummy variable that indicates whether the organization year is rated by Charity navigator, and RATED = 1 if the organization year is rated, and 0 otherwise in the overall sample
Pspending/Rev	Total program spending in year t deflated by total revenue
%ΔCOMP	Percentage change in CEO compensation from year t—1 to year t
%ΔREV	Percentage change in total revenue from year t—1 to year t
ΔYIELD	Fund usage performance
BOARD	Board size of the organization year
Ln(ASSETS)	Natural log of total assets
RatingRank	Rating ranks by Charity Navigator
FinRank	Financial rating rank by Charity Navigator
AccRank	Accountability rating rank by Charity Navigator
RATEDYR	A dummy variable that indicates whether the organization year is rated by Charity navigator, and RATEDYR = 1 if the organization year is rated, and 0 otherwise
RATE	Rated organization in the 1–4 matched sample; and
RATED_A	Rated organization in the sample where TM > 500,000 and TC > 1,000,000