What affects nonprofit executive compensation?
Nonprofits need strong leadership and that comes with a price. Yet, donors generally pass over nonprofits that seek funds to pay for executive compensation. That means funds have to come from somewhere else. Nonprofit boards need to find ways to offer competitive executive salaries because effective leadership is necessary to reach their goals and serve their communities.
Nonprofits compete with other nonprofits for grants and donations and they’re also competing with their peers and corporate boards for top talent. These issues make it especially challenging for nonprofits to recruit and appoint great leaders.
To compound matters even more, for-profit corporate boards have come under scrutiny for liability issues in recent years and nonprofit boards have felt some of the ancillary effects from that. Since nonprofits obviously operate in a different space, they’ve made slow moves toward revamping their executive compensation packages.
Today’s nonprofit boards need to take extra time and effort to recruit the best people to run their organizations to prevent their organizations from liability issues.
After carefully writing job descriptions for executives, the next task for nonprofit boards is to consider the factors that go into setting up executive compensation plans that are attractive, work for their budgets and that will stand up to IRS guidelines.
IRS regulations for nonprofit executive compensation
To preserve the integrity of nonprofits, the IRS set new rules for nonprofit executive compensation in 2002. The rules require nonprofits to set executive compensation according to other nonprofit organizations of similar type and size. Nonprofits that don’t comply can receive sanctions or be fined. The rules aren’t highly specific. They broadly describe the definition of nonprofit compensation as “reasonable.” The IRS considers compensation reasonable if it compares to like services by organizations that have similar circumstances.
The National Council of Nonprofits developed three basic criteria for interpreting the IRS’ rules including:
- Organize a committee or body to determine executive compensation.
- Compare the compensation to other executives at nonprofits of a similar size that are in the same location and do the same type of work.
- Compensation committees or workgroups should document their process, including the names of people on the committee and the data they reviewed.
That said, the IRS rule is not designed to force all nonprofit organizations to offer the same executive compensation plans. It does, however, require the board of the nonprofit organization to be able to justify its decisions if questions are ever brought forward – for example, in a lawsuit mounted by employees, donors, funders or other stakeholders.
With that in mind, executive compensation committees should consider all the factors that the IRS is likely to consider when establishing executive compensation packages.
Factors that affect nonprofit executive compensation
Depending on the type and size of the nonprofit, executive compensation committees will come up with a unique list of factors that will help them meet their strategic goals. Here’s an overview of nonprofit executive compensation by some of those factors:
Performance
Much like for-profit corporations, nonprofit executive compensation should be based, in part, on the executive’s performance. In general, nonprofit executive committees should focus more on social outcomes related to the mission over financial metrics.
Another cue that nonprofits have taken from the corporate world is having a focus on environmental, social and governance (ESG) and they need leaders that can lead in the area of these issues.
Some of the elements of performance objectives are fundraising goals, program goals, growing the membership if there is one and reducing costs.
Size
Leadership in many large nonprofits reflects similarly-sized corporations. Organizations with complex structures, multiple funding streams, products to sell, and multiple layers of staffing require chief executives with the same types of experience and expertise as their for-profit counterparts.
For this reason, larger nonprofits often face stronger competition for top talent, and have to compensate the chief executive accordingly. That said, the salaries offered must be comparable to those offered by similarly-sized nonprofits in order to avoid scrutiny by the IRS.
Geography
The location also plays a role in executive compensation levels. Big cities with a higher cost of living, like New York and Los Angeles, tend to pay their nonprofit executives more. Nonprofit executives in the Northeast and Mid-Atlantic regions of the U.S. typically receive higher salaries than nonprofit executives in the Midwest or Southwest regions, where nonprofit leaders generally are paid less.
Type of nonprofit organization
Nonprofits usually depend on a few different sources of revenue to keep them going. These sources include:
- Grants from government sources, private foundations and public charities
- Donations from individuals and corporations
- Sales from goods
- Fees earned through programs and activities
- Membership fees or dues.
Religious organizations tend to offer some of the lowest nonprofit executive salaries as base pay. To help recruit talented executives, boards may offer retirement pensions, housing, transportation, or pay for other living expenses.
Many higher education institutions provide their chief executives with compensation packages that rival those of for-profit companies and include perks like housing, travel expenses, and coverage of other personal expenses. College and university presidents often work in highly visible roles with complex sets of responsibilities and multiple stakeholders: the board of trustees, faculty, administrative staff, students, parents, elected officials and communities.
Larger academic institutions often have multiple campuses globally with hundreds of buildings and thousands of staff members. Given the scope of the responsibilities of the top executives of larger academic institutions, their compensation packages tend to be the largest in the nonprofit sector.
Similarly, hospitals and healthcare organizations tend to pay their chief executives more than nonprofits in other fields — in part, because the decisions these executives make have such a direct impact on the lives and welfare of patients and their families. Nonprofits in the healthcare arena tend to rely on a variety of funding sources, including government funding, private donations, as well as healthcare payments from insurance companies and patients.
That said, as the cost of healthcare continues to rise and insurance coverages restrict, many nonprofit healthcare institutions find themselves cash-strapped and struggling to compete to attract and retain top talent.
Most often, nonprofits in the arts rely largely on the support of donors and private foundations, and with the exception oflarge performing arts organizations, less on commercial revenue from products and programs. The pay for executives for nonprofits in the arts is strongly linked to the organization’s size, with only a small minority of arts institutions able to offer compensation packages that rival similarly sized for-profit organizations.
In the area of international nonprofit organizations, they’re generally supported by revenue from their programs, especially for organizations that have very large annual revenues, for example, in excess of $10 million.
Technology to support your nonprofit executive compensation planning
Regardless of the size, type or location of the organization, all boards benefit from strong board management skills and technology that supports key decision-making. BoardEffect offers all the tools for nonprofit executive compensation committees to do their work of hiring the best talent including:
- Dedicated private workroom spaces for the committee to collaborate in
- Annotation tools for board and committee members to make notes to prepare for meetings
- Centralized resource library to store key documents that can be accessed by committee members, any time, anywhere
- Granular permissions to ensure the integrity of the compensation development process.
Request a demo to find out how we can help support your work today.
