Thoughts on Nonprofit Compensation


Bad Press for Good Will

A front page article in the October 27th issue of the Omaha World-Herald blasted Goodwill Omaha for “outrageous” CEO pay. As is clear from the article, Omaha Goodwill’s Board of Directors made every mistake they could in handling this situation.

First, it appears that the compensation paid to the CEO and other officers of the organization may have been excessive, a problem exacerbated by the payout in 2014 year of a 20-year retention bonus of $519,000, pushing his reported compensation for that year close to $1 million.  The smaller annual amounts contributing to this bonus over the 20 years had been previously reported, of course, but one of the problems with the IRS requirements on reporting nonprofit executive compensation is that in the year that these payments vest and are distributed, annual compensation looks grossly unreasonable.

That notwithstanding, the news reporter found many other issues with Goodwill’s executive compensation:  CEO pay much higher (even without the bonus) than other Goodwill organizations or Iowa nonprofits of similar size; an unusual number of executives (fourteen) earning six figures per year; three high-paid employees who are related to the CEO or Goodwill Omaha board members (including the CEO’s daughter); and most of the Goodwill store profits going into administration and overhead costs, rather than programs.

As if these problems weren’t enough, the board shot itself in the foot with every aspect of their response.  They refused for two months to let the news reporters interview management or any board members; they did not respond to written questions submitted by the paper six days before the story was published.  Finally, on the day before publication, the CEO responded to some but not all of the questions in a self-serving statement that was published in a follow-up article on October 28th.

The upshot of this pile of inpetness was the worst kind of headline a nonprofit can get:  “Susie Buffett, now ex-donor, calls CEO’s defense of pay outrageous”.  Within the article, Ms. Buffett is later quoted as saying “I think the board should be embarrassed.  I think (the CEO) should have been fired Monday or earlier. . . . They will never get another penny from (Ms. Buffett’s foundation).  There is my statement.”

The Goodwill Omaha board should be embarrassed.  Obviously, they should have done a better job setting executive pay and prohibiting nepotism.  But perhaps their biggest mistake was not recognizing and getting on top of this highly damaging publicity.  They should have opened the kimono at the first inquiry from the reporter; they should have appointed a special committee to investigate the situation; they should have put the CEO on administrative leave during the investigation; and they should have had the person heading the board investigation committee — not the CEO — respond in public.

The October 27th article can be found here:  http://www.omaha.com/news/metro/susie-buffett-now-ex-donor-calls-goodwill-ceo-s-defense/article_8a3f3ac0-9bbc-11e6-9651-d35471a141c5.html; the October 28th follow up is here: http://www.omaha.com/news/metro/goodwill-omaha-statement-regarding-the-world-herald-s-investigation-into/article_031ab9e8-9bad-11e6-bc7d-4726d0b56948.html

Does CEO Pay Affect Organization Performance?

An interesting article in the International Nonprofit Times finds a correlation between high CEO pay in nonprofit hospitals and hospital performance.  Reportedly, a study conducted by Mercer and Truven Health Analytics found that hospitals with higher performance in terms of patient quality, finance, and other measures paid higher compensation to their CEO’s than other hospitals.

The authors of the study point out that “the finding is not causal” but the results of the study are interesting, nonetheless.  The full article can be read here:  Nonprofit Hospital CEO Pay Article.

 

Incentive Compensation Design for Nonprofit Organizations

If well designed, an incentive bonus plan can be an effective component of an organization’s overall compensation program.  Many nonprofits avoid incentive plans, either because their mission makes individual performance measurement difficult or in the belief that bonuses aren’t appropriate in a nonprofit setting.

Nevertheless, where incentives are appropriate they can:

  • Tie compensation expenses to financial results.
  • Enhance the competitiveness of your compensation program without increasing fixed costs.
  • Provide a stronger relationship between compensation and performance.
  • Focus executives on specific board-approved goals.

The last point above is important. With rare exceptions, employees in nonprofits with incentive plans don’t work harder than they would if their cash compensation were all in the form of base salary. Nonprofit executives are mission driven, and if money were their primary motivation they would be working in the private sector. However, well-designed incentives can focus employees’ energies on specific goals and objectives, thus strengthening the organization’s alignment and performance.

Based on our experience with hundreds of nonprofit incentive plans, the following comments outline our thoughts on incentive plan design.

Participation

Our bias is that incentive plans are most effective when designed for the senior management group, or specific groups of employees (such as fundraisers). While there have been some notable and successful exceptions to this, the incentive value of bonus payments to employees below the management level tends to fall off rapidly after the first year or two of the program. The reason: in any sizeable organization, each manager has a stronger impact on the organization’s results than any rank and file employee.

Thus, in years when overall performance generates good bonuses, everyone is happy.   But in years when either a bad economy or bad decisions by the management or the board result in no or low bonus payments, rank and file employees, who may have been working just as hard as they did in good years, feel cheated, and the program falls out of favor.

Another reason for limiting bonus participation to higher-level employees is that they are likely to have more discretionary spendable income than other employees, enabling them to experience ups and downs in their total cash compensation (salary and bonus) without undue financial stress.

Is it unfair to limit bonus participation to upper management? Not if your overall compensation strategy is equitable. For example, let’s assume your target is to pay median cash compensation in years of good performance for all employees. You might target upper management salaries below the median, with incentive opportunity that brings their cash compensation to the median in good years, and target base salaries for all other employees at the median. This way, the target cash compensation for all employees is the same (relative to the market median), although in different form for different levels of employee.

How Large Should Bonuses Be?

As a general rule of thumb, target incentive bonuses should be at least 5% of base pay – targets less than 5% aren’t large enough to provide a meaningful incentive.

In our experience, target bonuses for nonprofit chief executives are generally in the neighborhood of 20% to 30% of base pay; targets for executives reporting to the CEO are typically from 10% to 15% of pay. These figures assume that the target is what the organization intends to pay in a good year (when goals are successfully met) and that actual payments will be greater or less, depending on performance. Thus, the target incentive percentage is not the maximum incentive payable.

That said, it is advisable to set a maximum limit – often 150% and sometimes as much as 200% of the target incentive – to clarify expectations for the board and the executives involved, and to avoid excessive payments such as might occur in the event of a financial windfall totally beyond management’s control.

Incentive Plan Performance Goals

Here are our thoughts for setting effective incentive plan goals:

  • Do not rely on a fully formulaic approach. Measuring an organization’s effectiveness over a year is always difficult, especially so in the nonprofit world. Incentive goals should be combination of goals that can be measured by clear metrics (such as growth in membership or completion of a project on a certain date), and less measurable goals (such as improvement in board-management relationships or influencing significant legislation).
  • Set from four to seven goals that will be used to fund the bonus pool (the amount that will be paid in relation to total target bonuses).  These goals should relate to the strategic plan, represent significant accomplishments, and include both operational and mission based goals. At least one of these goals should be financial (such as achieving a specific operating margin).
  • When the goals are drafted, ask yourself whether each of these goals is truly important in terms of what the organization needs to accomplish in the coming year, and whether any important objectives are missing.

Adjustment Provisions

In our experience, the worst incentive plans we have seen are ones that tied all payments to specific numerical formulas, without the ability of the board to adjust payments based on unforeseen conditions. The programs we design contain special adjusting provisions that:

  • Allow the board to adjust the size of the bonus pool (or eliminate bonus payments entirely) if factors not included when the plan’s goals were adopted require such an adjustment. For example, this would allow cancellation of bonuses in a year when most goals were met but when a severe publicity problem threatened the future of the organization.
  • Include a financial threshold that must be met for any bonuses to be paid. This might be a requirement that the operating margin be a certain percentage of revenues, or that operating reserves not fall below a specific percentage of the annual budget.
  • Allow the board to adjust the bonus pool up or down on a discretionary basis to reflect qualitative factors knowable only at the end of year, not when the goals were set. For example, if achieving key goals turned out to be much more difficult than anyone expected, the board might want to increase the formula-calculated bonus pool. Or, if a revenue growth goal was met only through a totally unexpected windfall, the board might decrease the pool.

Obviously, these discretionary adjustments should be used carefully, only in unusual circumstances, and with open and clear communication with management. But they can be a great help in keeping the bonus program effective and fair.

Frequency of Payments

Incentive bonuses are almost always are paid annually, usually shortly after the end of the organization’s fiscal year. Shorter payment cycles do not provide enough time for major objectives to be achieved, and it is very difficult to set good performance goals two or three years in advance.

Some effective incentive plans defer a portion of the payment for from two to five years, funding the future payments through a 457(f) plan, thus combining the benefits of a performance-based incentive bonus with a retention plan. This can be an effective approach, but given that a portion of the bonus is delayed and at risk, you need to be careful to insure that the target incentive amount and the portion paid in cash, combined with base salary, are competitive in the marketplace.

Further Information

For more information on incentive plans, please contact us at info@smithpilot.com.

Year-End Compensation Planning Checklist for Nonprofits

With many organizations on a calendar fiscal year, compensation decisions are often made in the period between Thanksgiving and Christmas.  Here is a checklist to help you ensure your compensation house is in order.

  1. Make sure that your compensation strategy is clear, and update it if necessary. Determining individual salary increases is difficult to do correctly if you haven’t decided where salaries should be relative to the market, the desired balance between compensation and benefits, and the degree to which pay should be varied based on individual or organization performance.
  2. If necessary, update your market comparisons to determine whether current compensation levels reflect your desired market position. With nonprofit salaries increasing at a consistent 3% rate over the past few years, it is not necessary to survey the market every year.  But if you don’t have a good idea of how your pay stacks up against your peers, you should check published surveys or the IRS 990 forms.
  3. Pay particular attention to the compensation of top executives. The IRS Intermediate Sanctions regulations require that the remuneration of top executives be determined by an independent party (not the executives themselves); that remuneration levels should be within a reasonable range of the pay for executives in comparable organizations; and that board decisions on executive compensation be documented contemporaneously.
  4. Determine your 2016 salary increase budget, taking into account your organization’s financial position, the competitiveness of your current salary levels, the effect that employee benefit cost increases may have on your ability to finance desired salary increases, and expected salary increases in the marketplace.  (Various surveys predict that nonprofit salary increases will average 3.0% next year, although increases may be higher for specific functions, such as development or IT.)
  5. Consider updating your salary ranges. If you have a formal salary grade structure, do the ranges still reflect market salary levels?  If not, and if you haven’t updated the structure for a few years, an update may be needed.
  6. If you have one, evaluate your incentive compensation plan. Are the goals clear and aligned with your organization’s long-term strategy?  Is the program generating the right level of payments in relation to performance?
  7. Assess the board’s effectiveness in determining compensation strategy and executive compensation. Does the board annually review the performance of the chief executive, and are the results of this review documented?  Does the board apply the right level of “advice and consent” on executives reported to the Executive Director/CEO?  Does the entire board vote on decisions affecting the CEO’s remuneration?

In most nonprofits, compensation represents the largest non-program expense.   Even though year-end is usually very busy, taking the time to make sure your compensation programs are in order is a good way to make sure that you are getting the most mileage from this expense.

Excessive Compensation at Blue Shield of California

According to the Chronicle of Philanthropy, Blue Shield of California executives have apparently reaped significant salary increases and severance benefits in the past year (see brief article below).  It is just this kind of excess that brings regulatory scrutiny to the nonprofit sector, damaging the reputation of the vast majority of nonprofits whose executive pay and benefits are reasonable by just about any standard of measure.

Continue reading

The Board’s Role in Setting Executive Compensation

When it comes to governance of executive compensation, effective boards recognize that their primary responsibilities are to review and approve the CEO’s remuneration, advise and consent on the pay of other key executives, ensure that the organization’s compensation and benefit levels are sufficient to attract and retain the needed talent, and ensure that the costs of these programs are reasonable from a budgetary perspective.

Most boards (or their compensation committees) do this well. When they don’t, it is usually the result of one or more of these three problems:

Failure to conduct periodic CEO performance evaluations. Continue reading

How Much is Too Much? Assessing Leadership Pay in Nonprofits

(note:  this is an update of a blog originally posted a few years ago; the content remains pertinent and useful )

High compensation for nonprofit leaders often creates an outcry for federal limits on nonprofit executive compensation. The concern is understandable, but much that’s been written about this is off the mark.

Critics objecting to high levels of nonprofit compensation often hold one or more of the following views:

  1. Pay for leaders in nonprofits should be reasonable in terms of competitive levels for similar nonprofit executives, and the expectations of donors and funders of charitable organizations. As such, they should almost always be below those paid in the private sector.
  2. Pay for nonprofit leaders should be less than some arbitrary standard, such as the salary of the President of the United States.
  3. Nonprofit leaders should work primarily for the psychic income of fulfilling important missions; compensation should not be an important factor in recruiting or retaining leaders.
  4. The world is full of competent leaders who would work in nonprofit positions for compensation that critics deem reasonable.

Continue reading

Assessing an Egalitarian Approach to Management Incentive Bonuses

One of my clients of many years has had an annual incentive bonus plan that pays the same dollar amount to Chief Executive’s direct reports. The amount differs from year to year, depending on the organization’s overall performance, but once it is determined the same amount goes to the four executives reporting directly to the CEO. Continue reading

Salary Increase Trends

Even though many nonprofits have completed their budgeting process, we’re still getting a number of requests for projected salary increase budgets for 2015. Continue reading

A Fresh Approach to Performance Reviews

For a very interesting idea about how to get rid of the nightmares of performance reviews, see what Deloitte is doing, as reported recently in the Washington Post. Deloitte has researched its performance review process thoroughly and developed a novel, simplified approach that may be well worth considering. Continue reading