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Executive Compensation in the Nonprofit Sector: Getting It Right

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Excessive executive compensation is at the forefront of discussions about public companies, but what about the nonprofit sector? In fact, one of the most important things that nonprofit boards can do to strengthen the organizations that they govern is to get the salaries right for the CEOs of their nonprofits.

What does it mean to get compensation right? And why does it matter so much?

Getting it right is called "fair and reasonable" by the IRS. It's what the law requires, it's what any CEO wants, and it's what any donor and member of the public expects.

Executive compensation: Getting it wrong has serious consequences

If a nonprofit violates the IRS standard by exceeding "fair and reasonable" compensation, then the organization can be fined or their tax status can be revoked. Under the excess benefit transaction excise taxes law, also known as intermediate sanctions, the executive who is overpaid can also be fined.

Note also that in New York State, Gov. Andrew Cuomo and Attorney General Eric Schneiderman have separately announced proposals that may significantly impact executive compensation practices of New York nonprofits.

Additionally, exposure in the media can destroy a nonprofit's reputation and brand, as we have seen in many situations. Merely the suggestion of impropriety can severely limit the organization's fundraising potential long into the future, if not forever.

A nonprofit board can err in the other direction too; it's not unusual for nonprofit boards to undercompensate executives. In those cases, very qualified and dedicated people can be quite discouraged. Heading up a nonprofit organization is tough, and passion and commitment only go so far if a person does not feel fairly compensated. Additionally, it becomes clear to most business executives whom I train and place on nonprofit boards that it's often more challenging to run a nonprofit than a for-profit.

While not violating the law, boards that undercompensate their executives are not doing their organizations any favors. I have seen nonprofits lose outstanding executives when the board has neglected to determine a fair and reasonable compensation package. This hurts the organization and the public that relies on its services.

Unfortunately, only 71 percent of nonprofit boards looked at comparable data when determining the chief executives compensation, and only 70 percent of boards sought full board approval for the chief executive's compensation (according to the most recent study by BoardSource in 2010).

Executive compensation: Doing it right

Boards will fulfill their responsibilities by ensuring that 1) there are no conflicts of interest over the compensation matter, 2) conducting a compensation study -- possibly by engaging an outside firm -- to determine a fair and reasonable compensation package for the executive, 3) documenting the process of the board's deliberations and vote, and 4) filing all of this information on the IRS Form 990. The IRS Form 990 is made available to the public via Guidestar.

It's also important for the board to ensure that the CEO has a clear and current job description, and annual and three year goals that align with the organization's strategic plan; boards should conduct annual evaluations of the CEO related to the job description and annual goals. Unfortunately, only 69 percent of nonprofit CEOs had a performance review in the past 12 months, according to BoardSource.

Evaluations provide critical opportunities for the board to give the CEO encouragement and support, and productive feedback to help the leader to be as effective as possible in advancing the organization to its greatest potential. Furthermore, boards must understand that the CEO's and the board's effectiveness are interdependent. This is described further in Chapter 5 in "Leveraging Good Will."

Nonprofit boards are responsible for maintaining the public's trust in the integrity of organizations that are provided with tax exempt status and supported with charitable dollars as well as government funds. Together with the community's blessing and support, nonprofits pursue their vital missions to make the world a better place.