CEO compensation and performance in US private foundations

• Published date: 01 May 2018
• Date: 01 May 2018
• DOI: http://doi.org/10.1111/faam.12150

Received: 5 April 2015 Revised: 2 September 2016 Accepted: 3 October 2016

DOI: 10.1111/faam.12150

ORIGINAL ARTICLE

CEO compensation and performance in US

private foundations

Arthur Allen1Brian McAllister2

1Collegeof Business, University of Nebraska-

Lincoln,Lincoln, NE, 68588-0488, USA

2Collegeof Business and Administration, Uni-

versityof Colorado Colorado Springs, Colorado

Springs,CO, 80918, USA

Correspondence

BrianMcAllister, College of Business and Admin-

istration,University of Colorado Colorado

Springs,Colorado Springs, CO 80918.

Email:bmcallis@uccs.edu

Dataare available from public sources identified

inthe text.

Thispaper has benefited from the research assis-

tanceof Tom Kubick and Xiaoyan Cheng and from

commentsby Patricia Derrick, research work-

shopparticipants at the University of Colorado

ColoradoSprings and the University of Nebraska-

Lincoln,and session participants at the AAA GNP

MidyearMeeting. The first author would like to

thankthe College of Business Administration at

theUniversity of Nebraska-Lincoln for research

funding.

Abstract

In a large sample of US private foundations, we examine the associa-

tion between CEO compensation and an accounting-based measure

of performance, administrative efficiency. We document a positive

pay–performance association across time within foundations, but a

negative association across foundations. We interpret our evidence

as follows: some foundation boards reward CEOs for high admin-

istrative efficiency, which results in a positive pay–performance

association. However, some foundations are poorly monitored rel-

ative than others, resulting in higher CEO compensation and lower

efficiency.

KEYWORDS

compensation, efficiency, nonprofit, performance, private founda-

tion

1INTRODUCTION

Private foundations are typically created with a substantial contribution from a single set of donors for the purpose

of generating investment returns and then distributing them to public charities. Public charities use these funds to

carry out their philanthropic missions. In 2012, there were 86,192 US private foundations controlling $715 billion of

assets and distributing $52 billion in grants (FoundationCenter, 2014).1Given the economic significance of US private

foundations, their performance has a significant impact on the funds available to public charities and their executive

compensation is subject to scrutiny by important stakeholders.

Weexamine the association between private foundation CEO compensation and an accounting-based performance

measure, administrative efficiency. The unique features of private foundations suggest that the findings from other

organizational forms, in particular public charities, cannot be generalized to foundations. Prior research on public

charities has generally found a positive association between CEO compensation and accounting measures of perfor-

mance (Baber, Daniel, & Roberts, 2002; Bertrand, Hallock, & Arnould, 2005; Brickley & VanHorn, 2002; Frumkin &

Keating, 2010; Hallock, 2002; Preyra & Pink, 2001, and Sedatole, Swaney, Yetman, & Yetman, 2015), providing

evidence that public charities use extrinsic incentives to reward CEOs for good performance. Additionally, because

Financial Acc & Man. 2018;34:117–132. wileyonlinelibrary.com/journal/faam c

2018 John Wiley & Sons Ltd 117

118 ALLEN ANDMCALLISTER

public charity donors want to maximize the public benefits of their private contributions, they are likely to monitor

their CEO activities. The perpetual need to obtain donations appears to discipline public charity managers into promot-

ing efficient operations (Baber et al., 2002). In support of this, prior academic research consistently indicates a positive

associationbetween donation levels and accounting-based efficiency measures for public charities (Okten & Weisbrod,

2000; Parsons, 2007; Posnett & Sandler, 1989; Tinkelman, 1999; Weisbrod& Dominguez, 1986; Yetman & Yetman,

2013).

Private foundations are distinctive in that there are fewer monitors, relative to public charities, to oversee their

operations. Founders of private foundations, who are typically the only donors available to monitor foundation man-

agers, eventually cease to monitor because of poor health, death, or the pursuit of other interests. Additionally, the

endowments of private foundations are sufficient to eliminate the need for funding from nonfounder donors. Specifi-

cally,foundations spend less than their investment income, so they exist in perpetuity even in the absence of additional

donations. As a result, the contemporaneous link between the donations made to a foundation and their distribution

for charitable purposes is broken (Sansing & Yetman,2006). At this point, the only remaining nonregulatory monitors

of foundation managers are foundation trustees, who are potentially “self-perpetuating and fundamentally unaccount-

able to anyone else” (Fleishman, 2009, p. 220). Because of this, some foundation boards are likely to be less effective

than others. Therefore, the positive association between accounting-based measures of performance (administrative

efficiency) and CEO compensation found in the public charity setting is likely to be weaker in the private foundation

setting.

Despite the lack of monitors, most foundations boards and managers are driven by the intrinsic rewards of

accomplishing the philanthropic goals of their foundation. In these foundations, we expectmodest CEO compensation,

strong performance, and a positive pay–performance association. However, relative to more effective foundation

boards, ineffective boards will likely result in excessiveCEO compensation, poor performance, and little association

between pay and performance. Therefore, holding board effectiveness constant, we expect that a comparison across

time within foundations is likely to indicate a positive association between pay and performance. We also expect

the association to be relatively modest. However,to the extent that some foundations have relatively low CEO com-

pensation and strong performance, whereas other foundations have excessivecompensation and poor performance,

a comparison across foundations is likely to indicate either no association or a negative association between CEO

compensation and performance.

Our final sample consists of 12,897 foundation-years for the period 1998-2012. Our primary analysis consists of

two main tests. In our first test, we make comparisons across foundations (across foundations model) and find a strong

negative association between CEO compensation and administrative efficiency. We estimate that foundations with

10% points lower administrative efficiency have an estimated 5.6% higher CEO compensation. These across founda-

tion model results are inconsistent with public charity research (Frumkin & Keating,2010; Hallock, 2002), which finds

a positive association between CEO compensation and accounting-based efficiency measures.

In our second test, we make comparisons across time, but within foundations (across time model), and find a mod-

est positive association between CEO compensation and administrativeefficiency. For this test, a 10% point increase in

administrativeefficiency is associated with about 2.5% increase in CEO compensation. These across time model results

are consistent with public charity research (Frumkin & Keating, 2010), which finds a positive association between

accounting-based efficiency measures and CEO compensation. We propose that the conflicting results are indica-

tive of unobservable board governance mechanisms that impact CEO compensation. We believe that the negative

pay–performance association for the cross-sectional sample is likely driven byhigher variation in board effectiveness

between foundations than in year-to-year variation within each foundation.

We also provide support that private foundations predominantly use compensation benchmarks based on founda-

tionsize to determine CEO compensation. We estimate that private foundations that are twice as large have about 50%

more CEO compensation. This positive association is consistent with past public charity research (Dhole, Khumawala,

Mishra,& Ranasinghe, 2015; Frumkin & Keating, 2010), although the magnitude of the effect size is much larger for our

sample of private foundations.