Playing the Numbers Game

Date01 June 2016
AuthorDwayne N. McSwain,Mary Ann Hofmann,Sarah A. Garven
Published date01 June 2016
DOIhttp://doi.org/10.1002/nml.21201
401
N M  L, vol. 26, no. 4, Summer 2016 © 2016 Wiley Periodicals, Inc.
Published online in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/nml.21201
Journal sponsored by the Jack, Joseph and Morton Mandel School of Applied Social Sciences, Case Western Reserve University.
Correspondence to: Sarah Garven, Morehead State University, College of Business, Bert Combs Building, Room 317,
Morehead, KY 40351. E-mail: s.garven@moreheadstate.edu.
Playing the Numbers Game
PROGRAM RATIO MANAGEMENT IN NONPROFIT
ORGANIZATIONS
Sarah A. Garven,1 Mary Ann Hofmann,2 Dwayne N. McSwain3
1Morehead State University, 2Appalachian State University, 3Sam Houston State University
Nonprofit organizations are often evaluated using the program ratio: the proportion of
mission-related program expenses to total expenses. Nonprofit managers have incentives
to manipulate the reporting of financial information to enhance the program ratio. This
article reviews the scholarly literature on program ratio management in nonprofit organi-
zations. Prior research has identified several motivations for and methods of program ratio
management and provided limited evidence that it occurs. Researchers have explored the
consequences of program ratio management and provided a list of factors mitigating such
behaviors. The emerging consensus is that the program ratio is of limited usefulness in
evaluating nonprofit performance.
Keywords: program ratio; program ratio management; nonprofit organizations;
earnings management; nonprofit performance measures
EXTANT LITERATURE PROVIDES CONSIDERABLE EVIDENCE of many publicly traded,
profi t-seeking corporations manipulating reported numbers to infl uence the perceptions and
decisions of fi nancial statement users (Dechow and Skinner 2000; Graham, Harvey, and Raj-
gopal 2005; Habib and Hansen 2008; Healy and Wahlen 1999; Schipper 1989). However,
for-profi t corporations are not alone in the practice of intervening in the fi nancial reporting
process to present more favorable results. Nonprofi t managers also face pressures to manipu-
late fi nancial results. Although their success is not measured by profi t margins or rates of re-
turn, nonprofi t organizations are evaluated using fi nancial reports.
Recently, the nonprofi t sector has grown substantially and has begun to attract more atten-
tion. Advances in technology, coupled with broader disclosure requirements by regulators,
have increased access to nonprofit financial information. Internal Revenue Service (IRS)
Form 990 annual reports are now publicly available through various websites.  is increased
access has resulted in heightened scrutiny of how nonprofi ts spend their money, especially in
light of several high-profi le scandals in recent decades (Dimsdale 2009; Shepard and Miller
1994; Simross 1992).  e role of charity “watchdog” agencies has grown, and donors have
become more discriminating when disbursing their scarce resources. Competing with thou-
sands of other nonprofi ts for resources and knowing they are commonly judged on their
Nonprofi t Management & Leadership DOI: 10.1002/nml
402 GARVEN, HOFMANN, MCSWAIN
nancial results, some nonprofi t managers may resort to playing a numbers game to make
the organization look as favorable as possible. Figure 1 describes the elements of this game.
Although management of fi nancial results by profi t-seeking corporations tends to focus on
net income, management of fi nancial results by nonprofi ts is more likely to focus on the
program ratio (Khumawala, Parsons, and Gordon 2005)—the proportion of total expenses
dedicated to providing programs that fulfi ll an organization’s mission.  e program ratio is
typically computed as program expenses divided by total expenses. An alternative measure
is the overhead ratio, computed as administrative and fundraising expenses divided by total
expenses (or total revenues).  e ratios sum to unity—a nonprofi t channeling 75 percent of
its expenditures to programs necessarily spends the other 25 percent on overhead—so their
relationship is inverse. Another alternative research metric is the “price” a donor must pay for
one dollar of program activity, computed as total expenses divided by program expenses.  e
product of the program ratio and price is unity; again, there is an inverse relationship. For
clarity, in this article we discuss all research in terms of the program ratio.
Like earnings management, program ratio management has implications for many stake-
holders, including nonprofi t managers, regulators, and donors. Program ratio manipulation
reduces the decision usefulness of fi nancial information and lowers the quality of fi nancial
reporting. An increased understanding of this topic can lead to improvements in nonprofi t
nancial reporting and better resource allocation within the nonprofi t sector.
e purpose of this article is to provide a summary of academic research addressing program
ratio management in the nonprofit sector. This article is not an exhaustive review of the
literature; rather, it summarizes and synthesizes the major fi ndings of prior research and helps
researchers identify any gaps in the literature that future research might fruitfully address.
Figure 1. Elements of the Numbers Game
e Players: Nonprofit Managers
e Officials: Internal Governors (directors, trustees, internal auditors, audit committee)
External Governors (federal, state and local legislators, regulators, courts, independent auditors, media)
Objectives of the Players: Higher program ratios Leading to:
Better watchdog ratings More donations, grants
Better public perception/reputation Higher compensation
Strategies used by Players: Misreporting Expenses Collateral Consequences:
Misclassification of functional expenses Misleading information
Misreporting of fundraising expenses (net) Mistrust from donors
Altering Spending Behavior
Increasing program spending
Decreasing administrative spending Starvation cycle
Decreasing fundraising expenditures
Objectives of Officials: Transparent reporting Leading to:
Accurate performance evaluation More benefits to societ
y
Efficient allocation of resources
Strategies used by Officials: More regulation by federal and state government
More guidance in the form of financial accounting standards
Utilization of professional accounting and management firms
Development of better performance evaluation methods

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