Do operating reserves stabilize spending by nonprofit organizations?

• Date: 01 March 2018
• Published date: 01 March 2018
• DOI: http://doi.org/10.1002/nml.21282
• Author: Thad D. Calabrese

RESEARCH ARTICLE

Do operating reserves stabilize spending by

nonprofit organizations?

Thad D. Calabrese

Robert F. Wagner Graduate School of Public

Service, New York University, New York

Correspondence

Thad Calabrese, Robert F. Wagner Graduate

School of Public Service, New York University,

295 Lafayette Street, 2nd Floor, New York, NY

10012.

Email: thad.calabrese@nyu.edu

Funding information

New Research Support Grant

The public budgeting literature has a long and rich tradi-

tion that examines the role of budget stabilization funds

as fiscal stabilizers for state and local governments during

periods of declining revenues and deteriorating economic

conditions. Similarly, nonprofit organizations may accu-

mulate operating reserves that allow them to smooth out

annual imbalances between revenues and expenses, espe-

cially when facing a fiscal shock. Agency theory, on the

other hand, indicates that managers might use these

reserves to enrich themselves at the expense of the orga-

nization. This article is a step toward addressing a gap in

our knowledge by analyzing the implications of reserves

on nonprofit spending in general and also on particular

functions (program versus overhead spending). Using a

long panel of data from 1995 to 2011 and controlling for

sample selection bias, the empirical results suggest that

operating reserves held by nonprofit organizations do

reduce expense gaps during downturns, but the effect is

small. The results also suggest that nonprofit managers

value current spending more than reserving funds for the

future. Further, operating reserves are not associated with

agency problems as predicted by theory. The empirical

results suggest that the current rule of thumb—that non-

profits ought to hold up to 6 months of operating

reserves—is inadequate if these pools of savings are

intended to maintain all spending at trend during poor fis-

cal times. If, however, reserves are intended to only offset

trend deviations partially while alternative strategies are

sought, then the current rule of thumb may be sufficient.

KEYWORDS

finance, principal-agent

Received: 30 September 2016 Revised: 25 August 2017 Accepted: 28 August 2017

DOI: 10.1002/nml.21282

Nonprofit Management and Leadership. 2018;28:295–311.wileyonlinelibrary.com/journal/nml © 2017 Wiley Periodicals, Inc. 295

1|INTRODUCTION

Over the past several decades, significant empirical scholarship has analyzed the savings behavior

of state and local governments, developing a rich body of knowledge about the accumulation, use,

manipulation, and other second-order effects resulting from such savings—termed budget stabiliza-

tion funds (BSFs), reserve funds, rainy day funds (RDFs), or fund balances depending on the spe-

cific entity. These pools of savings are designed to provide resources for governments during

economic downturns so that spending is not reduced—perhaps when needed the most—or that taxes

need not be increased—perhaps slowing recovery efforts in the process.

In a similar vein, nonprofit organizations might desire operating reserves to promote service con-

tinuity over business cycles rather than cutting program delivery, increasing prices during an eco-

nomic downturn, or finding new revenues in a potentially difficult environment. Nonprofits, though,

are hesitant to appear “too wealthy”because stakeholders take a negative view of charities that

appear to hoard wealth (Calabrese, 2013). Further, nonprofits are expected to appear “lean”by

devoting most spending directly toward programs (Mitchell, 2015). As a result, nonprofits face diffi-

culty in accumulating reserves in the first place, and reserves might come with significant costs that

are unique to nonprofits.

This article focuses on whether operating reserves held by nonprofits stabilize spending (in total

and also by function) and what the magnitude of this stabilizing effect is, using Form 990 data from

1995 through 2011. Despite financial management theory pointing to the obvious benefits of operat-

ing reserves, significant numbers of nonprofit organizations operate with no reserves (Blackwood &

Pollak, 2009; Calabrese, 2013). The question whether reserves stabilize spending by nonprofits dur-

ing periods of economic volatility remains fundamentally an unanswered empirical issue in the cur-

rent literature. Additionally, this article asks whether operating reserves lead managers to enrich

themselves at the expense of the organization as predicted by agency theory. The article tests several

hypotheses using ordinary least squares (OLS) fixed effects regression, and then uses a Heckman

model to address potential selection bias when analyzing nonprofits spending above trend separately

from nonprofits below trend.

Using the Statistics of Income (SOI) data from the Internal Revenue System (IRS), the empirical

results suggest that nonprofits use reserves when expenses fall below trend. However, operating

reserves are not sufficient to fully restore expenses that fall below trend, which limits their effective-

ness as fiscal stabilizers. Further, when expenses are above trend, the results suggest that reserve

accumulation is insufficient to keep spending in line. These findings suggest that the current rule of

thumb—that nonprofits ought to hold up to 6 months of expenses—is inadequate if these reserves

are intended to fully replace lost resources during poor fiscal times, and that nonprofit managers

value current spending over accumulating reserves. If, however, reserves are intended to only offset

trend deviations partially while alternative strategies are sought, then the current rule of thumb may

be sufficient. The results also find that nonprofits do not use reserves to stabilize overhead and pro-

gram spending differently. Finally, the empirical results find no significant evidence that managerial

compensation increases as a result of operating results, suggesting that agency problems are not a

major concern associated with these pools of savings.

The rest of the article is organized as follows. Operating reserves in nonprofits are defined in the

next section, prior theories on savings are then discussed and applied to nonprofit organizations, and

testable hypotheses are articulated. Then the data are described, followed by a discussion of the

empirical methodology. Models are proposed to test the counter-cyclical effects of operating reserves,

and also on the compensation of managers. Results are then discussed, and conclusions drawn.

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