Charity Ratings

• Published date: 01 March 2016
• Date: 01 March 2016
• Author: Barış K. Yörük
• DOI: http://doi.org/10.1111/jems.12139

Charity Ratings

BARIS¸K.Y

¨

OR ¨

UK

Department of Economics

University at Albany

State University of New York

Albany NY 12222

byoruk@albany.edu

How do charitable donors respond to the third-party ratings that signal the quality of charities?

I investigate this question using a novel data set from Charity Navigator, which provides quality

ratings for 5,400 charities. Because Charity Navigator prominently displays a charity’s star

rating which is assigned based on its overall rating, one can identify the causal impact of a one

star increase in ratings on charitable contributions with a regression discontinuity framework

that exploits the threshold values of the overall ratings. I find that in general, the third-party

ratings have a minor and often insignificant impact on charitable contributions received by

charities. However, for relativelysmall charities, a higher rating leads to an increase in charitable

contributions received. In particular, for these charities, I find that a one star increase in ratings

is associated with a 19.5% increase in the amount of charitable contributions received. This result

is robust under alternative model specifications and highlights the role of the third-party ratings

in not-for-profit markets.

Key words: charitable contributions; charity ratings

1. Introduction

Many markets are characterized by incomplete information. When consumers cannot

observe the true qualities of products or services that they intend to purchase, they

cannot make informed decisions. In recent years, this classic market failure led to the

proliferation of online consumer review and product rating web sites that provide

information about the quality of products and services. The effect of the third-party

ratings or consumer reviews on markets and consumers’ decisions is ambiguous. On

the one hand, they may complement or substitute for existing information sources such

as advertising and help consumers to make informed decisions. On the other hand,

reviews or ratings may be subjective or hard to interpret and cover only a small segment

of a market. The existing literature mostly focuses on the role of consumer reviews and

independent ratings in for-profit sectors. For instance, Luca (2011) investigates the effect

of online consumer reviews on restaurant demand. Using data from Yelp.com, he finds

that a one star increase in online rating leads to a 5–9% increase in restaurant revenues.

Jin and Sorensen (2006) show that publicized health plan ratings have a significant

impact on individuals’ health plan choices, particularly for individuals choosing a plan

for the first time. Varkevisser et al. (2012) find that patients have a high propensity to

choose hospitals with a good reputation measured by publicly available quality ratings.

I thank the Co-Editor, two anonymous referees, and participants of Charitable Giving: Theory and Evidence

Workshop at Duke University (2014) for helpful comments.

C2015 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume25, Number 1, Spring 2016, 195–219

196 Journal of Economics & Management Strategy

Similarly, recent studies also show that expert reviews may play an important role

in consumers’ decision making process. For example, Ali et al. (2008) document the

positive impact of expert ratings on wine prices and Reinstein and Snyder (2005) show

that positive expert reviews have a significant effect on the box office revenue of movies.

The impact of expert reviews or the third-party ratings on the services and products

provided by nonprofit organizations are relatively unknown.1Few studies investigate

the effect of the third-party ratings on charitable giving. Using panel data of charities

from American Institute of Philanthropy, Chhaochharia and Ghosh (2008) find that

compared to charities with the lowest ratings, charities with the highest rating receive

16% more charitable donations. Using data from405 charities rated by Charity Navigator,

Gordon et al. (2009) find a 39% increase in private donations for a one star increase in

Charity Navigator ratings. Sloan (2009) uses nonprofit ratings for New York charities

from the Better Business Bureau’s (BBB) Wise Giving Alliance to estimate the impact of

accountability ratings on the amount of contributions an organization receives. She finds

that the Wise Giving Alliance “pass” ratings have a statistically significant effect on the

contributions received; however, the effect of “did not pass” ratings are insignificant.

Using data from New Yorkcharities, Chen (2009) investigates the effect of BBB standards

on giving. She finds that the BBB standards have a positive effect on giving behavior and

meeting the BBB standards is associated with higher levels of public support. Using a

sample of charities rated by Charity Navigator,Grant (2010) finds that a one star increase

in ratings is associated with a 3–8% increase in contributions received by charities.

She also shows that upon being rated, charities tend to receive fewer contributions

than before. On the other hand, using data on 51 charities that operate in the State of

Washington, Szper and Prakash (2011) find no significant relationship between charity

ratings and donor contributions. Similarly,Frumkin and Kim (2001) find that nonprofits

that position themselves as cost efficient by reporting low administrative to total expense

ratios fared no better over time than less efficient appearing organizations in the market

for individual, foundation, and corporate contributions. They argue that economizing

may not always be the best strategy in the nonprofit sector.

This paper contributes to the existing literature which investigates the effect of

the third-party ratings on charitable behavior. I use data from Charity Navigator, the

largest independent charity evaluator in the United States. Compared with Gordon et al.,

my sample is relatively larger and includes 5,400 charities that are assigned an annual

quality rating during 2007–2010. In order to identify the effect of the third-party ratings

on charitable giving, previous studies mostly relied on either cross-sectional data and

simple ordinary least squares (OLS) estimation or panel data models using fixed effects

and first differences estimators. Simple OLS estimation fails to control for potential

endogeneity of third-party ratings in charitable giving models. Similarly, time-variant

unobservable charity characteristics that are correlated with charitable contributions

may also be correlated with the third-party ratings. In this case, panel data models may

provide a biased estimate of the effect of third-party ratings on charitable behavior.

Because Charity Navigator prominently displays a charity’s star rating, which

is assigned based on its actual overall rating, one can identify the causal impact of a

one star increase in ratings on charitable contributions with a regression discontinuity

(RD) framework that exploits the threshold values of the overall ratings. The qualities

1. An exception is a recent paper by Luca and Smith (2013). They show that when explicit rankings of

colleges are published in U.S. News, a one-rank improvement leads to a 1-percentage-point increase in the

number of applications to that college.