Nonprofit cash holdings and spending: The missing role of government funding

• Author: Joanna Woronkowicz,Shinwoo Lee
• Date: 01 March 2019
• Published date: 01 March 2019
• DOI: http://doi.org/10.1002/nml.21342

RESEARCH ARTICLE

Nonprofit cash holdings and spending: The missing

role of government funding

Shinwoo Lee

1

| Joanna Woronkowicz

2

1

School of Public Affairs, University of South

Florida, Tampa, Florida

2

School of Public and Environmental Affairs,

Indiana University, Bloomington, Indiana

Correspondence

Shinwoo Lee, School of Public Affairs, University

of South Florida, 4202 E. Fowler Ave., Tampa, FL

33620.

Email: shinwoolee@usf.edu

Charitable nonprofit organizations have long been under

scrutiny with regard to how they manage excess funds,

particularly cash holdings. Given previous empirical evi-

dence, agency problems have been treated as an effective

lens to explain the consequences of cash holdings among

nonprofits. That is, nonprofit managers spend cash hold-

ings for their own interests as opposed to the social inter-

ests of the organization. This study revisits the question of

how charities manage extra cash and further examines the

role of government funding in nonprofits' spending deci-

sions. The results suggest that nonprofit managers make

decisions on how to manage extra cash in accordance with

the level of cash holdings; therefore, agency problems do

not effectively explain how nonprofits manage extra cash.

Furthermore, the results illustrate two contrasting roles of

government funding in nonprofits' financial behavior:

government funding may be used to monitor unscrupulous

behaviors among managers, but it may also restrain non-

profits from investing in human capital.

KEYWORDS

agency problems, government funding, nonprofit cash

holdings

1|INTRODUCTION

Charities (defined as 501(c) (3) organizations and hereafter referred to as charities, nonprofits, and

organizations) have long been under scrutiny with regard to how they manage excess funds, particu-

larly cash holdings. Two contrasting perspectives, which are grounded in the distinctive nature of

nonprofits as opposed to for-profits, predict different outcomes. The first perspective emphasizes that

nonprofits are mission-driven organizations. Unlike for-profits, nonprofit organizations pursue activi-

ties that benefit the public and society; therefore, nonprofits must dedicate excess revenues or funds

Received: 31 October 2017 Revised: 5 September 2018 Accepted: 10 September 2018

DOI: 10.1002/nml.21342

Nonprofit Management and Leadership. 2019;29:321–340. wileyonlinelibrary.com/journal/nml © 2018 Wiley Periodicals, Inc. 321

to further invest in an organization's mission-related activities. Hansmann (1980) defined this feature

of the nonprofit as the “nondistribution constraint,”suggesting that nonprofits use excess funds to

support operating expenses, primarily during times of revenue volatility, or to support program and

service expenses.

The second perspective emphasizes the lack of internal monitoring systems for nonprofit financial

activities. Unlike for-profits that are subject to monitoring from shareholders, nonprofit organizations

do not have shareholders and therefore do not have a formal body in place that closely monitors how

the organization spends its money. From a practical standpoint, scholars have challenged nonprofits'

use of excess funds. In particular, empirical studies of cash holdings and spending among charities

have generally confirmed that nonprofits increase compensation expenses in the presence of extra

cash (Core, Guay, & Verdi, 2006; Fisman & Hubbard, 2003; Frumkin & Keating, 2010; Ramirez,

2011)—in other words, the practice of managers expropriating accumulated cash for their own inter-

ests, as opposed to the social interests of the organization.

Nevertheless, previous literature examining nonprofits' use of cash has several limitations. First,

except for a few (e.g., Calabrese, 2017), studies of nonprofit cash holdings often use data with an

overrepresentation of large nonprofit organizations in the sample (e.g., Core et al., 2006; Fisman &

Hubbard, 2003; Ramirez, 2011). Second, studies have failed to consider the influence of environmen-

tal factors on nonprofit financial behavior (Prentice, 2016). In particular, scholars offer two contrast-

ing perspectives on the influence of government funding on nonprofits' financial management,

including the role government funding plays in improving organizations' financial accountability and

restricting growth opportunities (Ferris, 1993; Guo, 2007; Kramer & Terrel, 1984; Lecy & Searing,

2015; Lipsky & Smith, 1990). Nevertheless, there are no empirical studies to date that examine how

government funding may or may not influence nonprofit spending. As a result, the literature on this

topic is limited with respect to confirming theoretical perspectives and discussing the implications for

nonprofit managers.

This study examines how charities manage extra cash. We seek to make several contributions to

the literature on nonprofit cash holdings and spending in the area of nonprofit finance. First, given

the importance of maintaining at least a certain or optimal level of cash to maintain fiscal sustainabil-

ity, we examine whether nonprofits' spending decisions vary by the level of accumulated cash

(e.g., lower than optimal vs. higher than optimal). Second, this study explores the role of government

funding as a moderator in the relationship between nonprofit cash holdings and spending. Third, we

empirically test a set of hypotheses using a more reliable set of data that have previously not been

used to examine the use of cash among nonprofits.

This paper is organized as follows: we begin with a brief discussion of nonprofit cash holdings.

In the following section, we develop our hypotheses concerning relations between cash holdings and

nonprofit spending on mission and nonmission-related activities. This section also presents hypothe-

ses for government funding as a moderator of cash spending. We present the data, variables,

methods, and results in the next two sections. We proceed with a discussion of the results from the

empirical analyses. We conclude the paper with a summary of the study's findings, note directions

for future research, and—most importantly—state the practical implications of the study's results for

nonprofit managers and government agencies.

2|NONPROFIT CASH HOLDINGS

In corporate finance, “cash holdings”refer to cash-on-hand and savings, including temporary or short-

term investments that can easily be converted to cash. Previous research in nonprofit finance has

322 LEE AND WORONKOWICZ