Boards, Executive Excess Compensation, and Shared Power: Evidence from Nonprofit Firms

• Published date: 01 November 2013
• Date: 01 November 2013
• Author: Teresa D. Harrison,Jacqueline L. Garner
• DOI: http://doi.org/10.1111/fire.12018

The Financial Review 48 (2013) 617–643

Boards, Executive Excess Compensation,

and Shared Power: Evidence from

Nonprofit Firms

Jacqueline L. Garner∗

Mississippi State University

Teresa D. Harrison

Drexel University

Abstract

We investigatehow executives, the board, and excess compensation jointly affect the per-

formance of nonprofits. Since the common measure of nonprofit performance often includes

salaries, we also use expenses that directly benefit the targeted population. Our results suggest

that above average compensation for executives is associated with poor firm performance.

However, the negative relation of CEO pay to performance occurs for firms with only one

executive, the CEO. We conclude that a powerful CEO with autonomy can harm firm perfor-

mance, but other executives can mitigate these agency problems. The board also appears to

monitor direct community benefits more than indirect benefits.

Keywords: nonprofit, governance, firm performance, excess compensation

JEL Classifications: G34, L31

∗Corresponding author: John Nutie and Edie Dowdle Associate Professor of Finance, Department of

Finance and Economics, Mississippi State University,316-A McCool Hall, Mississippi State, MS 39762;

Phone: (662) 325-6716; Fax: (662) 325-1977; E-mail: Jacqueline.Garner@msstate.edu.

We thank Ralph Walkling, Francie Ostrower, Elizabeth Boris, two anonymous referees and the Editor for

helpful comments as well as seminar participants at VillanovaUniversity and Drexel University. Wethank

Luciana Costa, Won Yong Kim, Farhad Omeyr, and Jason Varghese for helpful research assistance. We

also thank the Urban Institute for data. A good portion of the research was done while Harrison was a

visiting scholar at The Urban Institute.

C2013 The Eastern Finance Association 617

618 J. L. Garner and T. D. Harrison/The Financial Review48 (2013) 617–643

1. Introduction

Governance literature has placed a great deal of attention on the relation be-

tween firm performance and either board composition or executive power, particu-

larly in the for-profit arena (Yermack,1996; Shivdasani and Yermack,1999; Bebchuk,

Cremers and Peyer, 2007). Nonprofitliterature has placed much of the focus on board

composition as measured by size, percentage of donors, or demographic characteris-

tics (Callen and Falk, 1993; Callen, Klein and Tinkelman, 2003; O’Regan and Oster,

2005). Although evidence suggests that many nonprofits are led by powerful, influ-

ential executives (Miller, 2002; O’Regan and Oster, 2005), there is little empirical

work on the impact of such power on nonprofit firm performance. Withan increasing

role of and dependence on nonprofits in the United States, such findings are critical

to our understanding of the effective governance and managerial incentives for non-

profit firms. Wecontribute to the literature by not only investigating the power of the

executives but also examining the interaction between the board and the executives

and their simultaneous relation to nonprofit firm performance.

Further understanding of the joint influence of nonprofit boards and executives

on firm performance is crucial due to some unique features of the nonprofit firm and

the board’s role. First, nonprofits, like those in our sample, are generally tax exempt

and do not have any residual claimants. This lack of clearly defined stakeholders

makes the monitoring duties of a nonprofit board and the interaction between the

board and executive bodies more complex. As Fama and Jensen (1983a,b) discuss,

the donative nature of nonprofits avoids agency problems between donors and resid-

ual claimants, but other internal agents, such as executives, still have an incentive

to expropriate cash flows. However, nonprofit board members have more roles; they

are not only monitoring operations and financial decisions as in for-profit firms but

are also often expected to assist in donation generation and fundraising promotion

(O’Regan and Oster, 2005). As a result, nonprofit boards might not alleviate agency

problems as effectively as for-profit boards since their tasks are multidimensional. In

addition, Chait, Holland and Taylor (1996) demonstrate that university board mem-

bers have trouble determining appropriate measures of nonprofit firm performance.

This difficulty perhaps occurs because the objective for a nonprofit is less clear than

in for-profits (see examples in Newhouse, 1970; Pauly and Redisch, 1973; Steinberg,

1986; Deneffe and Masson, 2002) where the goal of shareholder wealth maximization

is unambiguous.

In addition to the lack of clear objectives and multiple tasks that nonprofit

board members face, they appear to place more implicit trust in executives.Evidence

suggests that nonprofit board members tend to rely heavily on financial advice and

input from the executive body, even when the financial performance is poor (Miller,

2002). According to Miller (2002), board members rarely question executivedecision

making, suggesting some decreased monitoring by the board and increased agency

issues between the executives and other stakeholders.