The Investment Returns of Nonprofit Organizations, Part II

• Author: Garth Heutel,Richard Zeckhauser
• DOI: http://doi.org/10.1002/nml.21101
• Published date: 01 September 2014
• Date: 01 September 2014

59

N M  L, vol. 25, no. 1, Fall 2014 © 2014 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/nml.21101

Journal sponsored by the Jack, Joseph and Morton Mandel School of Applied Social Sciences, Case Western Reserve University.

Correspondence to: Richard Zeckhauser, Harvard Kennedy School, 79 JFK Street, Cambridge, MA 02138.

E-mail: richard_zeckhauser@harvard.edu

 e Investment Returns of Nonprofi t

Organizations, Part II

THE VALUE OF FOCUSED ATTENTION

Garth Heutel,1 Richard Zeckhauser2

1Georgia State University and NBER, 2Harvard Kennedy School

We continue our examination of the investment performance of nonprofit charities and

foundations. This analysis tests hypotheses about what types of organizations do better. Our

motivating intuition is that nonprofits with greater focus on investment performance will

secure higher returns. Our hypotheses are tested by regressing the rate of return for each

organization on various characteristics. As expected, nonprofits whose primary business is

predominantly financial, such as insurance providers and pension or retirement funds,

consistently earn higher returns. The data also support our hypotheses that larger nonprof-

its, older nonprofits, and private foundations will tend to outperform. The evidence is

mixed as to whether nonprofits that pay higher executive salaries or spend more on man-

agement earn higher returns.

Keywords: endowment; investment returns; public charity; private foundation

THE FIRST PART of this study introduced the data set that we used to analyze the investment

performance of nonprofi t organizations. Data from Internal Revenue Service (IRS) forms

were used to assess the rate of return for each organization in each year.  is data source is

not ideal. Most important, the rate of return itself is not directly reported. Nevertheless, as

we argued in part I of our study, the data do enable us to analyze investment perfor mance.

Moreover, because the data are reported to the IRS, they are more likely to be accurate than

fi gures provided to the media or trade associations given the incentive to exaggerate per-

formance. A further advantage of our data set is its size and its coverage of many types of

nonprofi t organizations. Previous studies tended to focus on a single class of nonprofi ts (for

example, universities).  is second and concluding part of the study presents and tests our

hypotheses about which types of nonprofi ts should have better investment performance.

Our hypotheses are deduced from the literature.  ey provide an intuitive understanding

of factors that have the potential to infl uence performance. All fi ve of these hypotheses

We thank the National Center for Charitable Statistics for data, and Guan Yang, seminar participants at UNCG

and UWM, the editor, two anonymous referees, and various colleagues, for helpful comments. Garth Heutel thanks

the Kernan Brothers Fellowship at the Harvard University Center for the Environment for funding.

60 HEUTEL, ZECKHAUSER

Nonprofi t Management & Leadership DOI: 10.1002/nml

contribute to an overarching hypothesis of focused attention. Some nonprofi ts will focus

more heavily on investment performance than will others, and those that do so will secure

superior investment returns, controlling for risk. Intuition indicates that some observable

characteristics of nonprofi ts will determine how strongly a nonprofi t focuses on investment

performance. Most nonprofi ts see themselves as fulfi lling important societal missions, such

as educating children or eliminating disease.  e more strongly the nonprofi t focuses on

its mission, other factors equal, the less attention it will pay to managing its endowment.

 e further is its core mission from building an endowment, the less well it should do

on securing returns to its endowment. Starting from the presumption that virtually any

organization has limited attention, we posit that organizations that relegate endowment

performance to a secondary consideration will perform less well.1 Of course, no organiza-

tion would announce such a preference; thus we can only posit attributes that are likely to

be related.

Our fi ve hypotheses are labeled the size hypothesis, the management hypothesis, the compen-

sation hypothesis, the age hypothesis, and the fi nancial orientation hypothesis. Each of these

hypotheses should be understood to hold other factors equal and to control for risk. In other

words, organizations that do better are not merely moving to a diff erent point along the risk/

return frontier, but are rather operating closer to the frontier.

It seems plausible that larger nonprofi ts would do better.  ey can aff ord more professional

management and may get access to superior investments, say, in private equity. Furthermore,

over a reasonable range, we would expect there to be economies of scale in securing returns,

whether one uses outside managers or invests in house. For example, a nonprofi t with twice

the endowment of another that paid twice as much to its investment manager should get bet-

ter results2 given economies of scale in investment management.3 It should also have access

to better investment opportunities, say, with hedge funds that have superior records, which

normally shun small investors. Finally, larger nonprofi ts secure a much greater fraction of

their budgets from their endowments; hence they would be expected to secure more of their

focus.4

Size Hypothesis (1). Larger nonprofits will secure greater investment returns.

Many nonprofi ts consider their public purpose to be their primary responsibility and would

be hesitant to spend a great deal, either in executive or board time or direct dollars, on man-

aging their endowments. Partly this has to do with how they present themselves to the pub-

lic. Signifi cant disparities in expenditures on management are even found within nonprofi ts

of the same size and type. Nonprofi ts that push mission at the expense of investment per-

formance might also plausibly spend less on management generally. In eff ect we are arguing

that there are pressures for nonprofi ts to spend less on fi nancial management than would be

optimal, given the “focused attention” issue.

Management Hypothesis (2). Nonprofits that spend more on management will secure

greater investment returns.

We stress that these hypotheses are interpreted as holding all else equal. Management expen-

ditures are correlated with overall endowment size, to be sure.  us, we control for size in

our regressions. But among two equal-sized charities, the hypothesis predicts that the one

that spends more on management will secure superior returns.