Does Government Punish Nonprofits for High Administrative Costs in Contracting Decisions?

• Published date: 01 April 2020
• Date: 01 April 2020
• DOI: http://doi.org/10.1177/0275074019893807
• Subject Matter: Articles

https://doi.org/10.1177/0275074019893807

American Review of Public Administration

2020, Vol. 50(3) 286 –296

© The Author(s) 2019

Article reuse guidelines:

sagepub.com/journals-permissions

DOI: 10.1177/0275074019893807

journals.sagepub.com/home/arp

Article

Introduction

Government financing of nonprofit organizations for service

delivery and policy implementation has been a common prac-

tice in the public administration landscape in recent decades

(Salamon, 1995; Smith & Lipsky, 1993). Through “hollowing

out” of the state, a broad array of public services is increas-

ingly provided by nonprofit contractors and grantees (Milward

& Provan, 2000). For example, Steuerle et al. (2017) esti-

mated that the U.S. nonprofit sector received approximately

US$497 billion from the federal government in fiscal year

(FY) 2015 for service delivery, which was 187% higher than

in FY 1980. This close funding relationship has attracted sig-

nificant attention from public and nonprofit management

scholars (e.g., Amirkhanyan & Lambright, 2017; Brown

et al., 2018; Lamothe, 2015; Salamon & Toepler, 2015;

Suárez & Esparza, 2017). In this body of government–non-

profit relations literature, a growing number of studies explore

what factors affect government’s source selection or, framed

differently, what type of nonprofits are more preferred by

funding agencies (e.g., Garrow, 2010; Lu, 2015; Marwell &

Gullickson, 2013; Stone et al., 2001; Suárez, 2010). This

body of literature has examined the various organizational

and environmental factors that influence nonprofits’ receipt

of government funding.

Within this strand of research, findings regarding how

nonprofits’ administrative costs affect their receipt of gov-

ernment funding are still inconclusive. The existing literature

has proposed two competing lines of argument. On one hand,

the price hypothesis suggests that administrative costs repre-

sent a diversion of organizational resources from program

outputs; high levels of administrative costs are thus consid-

ered to be signals of inefficiency and waste (Tinkelman &

Mankaney, 2007; Weisbrod & Dominguez, 1986). Therefore,

nonprofits charging higher overhead costs in their funding

proposals would be less preferred by funding agencies

because these nonprofits might not use government funding

in an efficient manner. On the other hand, the quality hypoth-

esis indicates that administrative costs represent organiza-

tional capacity. Nonprofits investing more in administrative

infrastructure and operations are more likely to improve their

organizational effectiveness and provide quality services

893807ARPXXX10.1177/0275074019893807The American Review of Public AdministrationZhao and Lu

research-article2019

1Fudan University, Shanghai, China

2Rutgers University–Newark, NJ, USA

Corresponding Author:

Jiahuan Lu, School of Public Affairs and Administration, Rutgers

University–Newark, 111 Washington Street, Newark, NJ 07102,

USA.

Email: jiahuan.lu@rutgers.edu

Does Government Punish Nonprofits

for High Administrative Costs in

Contracting Decisions?

Jianzhi Zhao1 and Jiahuan Lu2

Abstract

As government financing of nonprofit organizations to deliver services and implement policies has become a common

practice in the public administration landscape, the question of what factors affect government’s source selection has

emerged as a significant one. Within this strand of research, how nonprofits’ administrative costs affect their receipt of

government contracts is still not fully understood. This article explores that relationship using a large panel data set of U.S.-

based international development nonprofits from 1967 to 2014. Different model specifications consistently demonstrate an

inverted U-shaped relationship between a nonprofit’s level of administrative costs and its amount of government contracts.

In particular, as a nonprofit’s level of administrative costs increases, its amount of government contracts will initially increase,

but after its level of administrative costs reaches approximately 16% to 18% of total expenses, further increases in the

nonprofit’s level of administrative costs will reduce its amount of government contracts. These findings have implications for

both public and nonprofit management.

Keywords

government contracting, government–nonprofit relations, administrative costs, overhead costs