Here at Astron, we receive many questions from our nonprofit clients regarding trends in and planning for executive compensation around this time of year. To wrap up our annual three-part series on compensation planning, it’s time to turn our focus to what’s happening in the dynamic world of nonprofit executive compensation.
In early September 2022, Candid.org released its annual review of nonprofit executive compensation trends.
- This year’s report found that while median compensation for CEOs increased by 4.7% overall, it decreased by 5.2% for nonprofit organizations in the largest budget band (>$50 million).
- According to Candid.org, “We don’t know for certain that this is a direct impact of Covid-19, nor are we certain why larger nonprofits saw this decrease while smaller nonprofits saw an increase or held steady. It’s not the first time we’ve observed this trend, but it looks to be the largest decrease we’ve seen in quite some time. It will be interesting to see if this trend continues.”
- The pay gap is slowly declining, but median compensation for female CEOs still trailed the median compensation for male CEOs in all budget groups.
- The percentage of female CEOs grew in all budget groups, but female representation declined as organization budget size increased.
- Science & technology research and health-related program areas had the highest median compensation, whereas religion and animal-related organizations had the lowest median compensation.
- The District of Columbia had the highest median executive compensation, followed by New York and Massachusetts.
- Representation in leadership remains a challenge at nonprofit organizations. Only 13% of responding organizations have a CEO of color.
- Women lead 64% of responding organizations and far outnumber men as leaders of small-to-medium nonprofits. At the largest budget categories, men outnumber women.
- Because male CEOs are more commonly found at larger, higher-paying organizations, male CEO pay is higher than a woman’s, on average.
The Need to Re-educate Nonprofit Boards on “Reasonable Compensation”
An issue recently identified by the National Council of Nonprofits is the lack of Board understanding of their responsibilities towards maintaining “reasonable compensation” for their Executive Director / CEO and other disqualified positions. The following is a reminder of the Board responsibilities related to executive compensation and the overall importance of these responsibilities. Of particular note is that during the COVID pandemic many nonprofits deferred compensation discussions. But with a return to some normalcy, Boards are once again making these decisions impacting the executive team.
- The IRS recommends that charitable nonprofits follow its three-step process to determine that compensation is reasonable and not excessive. (See also Treas. Reg. § 53.4958-6(a))
- The board should arrange for an “independent body” to conduct a “comparability review.” The person receiving the compensation therefore should not be part of the review process.
- The independent body should take a look at “comparable” salary and benefits data, such as data available from salary and benefit surveys, to learn what nonprofit employers with similar missions, budget sizes, and locations pay their senior leaders. The Internal Revenue Service will look to the independence of any compensation consultant used, and the quality of any study, survey, or other data used to establish executive compensation.
- Compensation includes salary and benefits, such as insurance, a car, housing allowance, or other fringe benefits, that should be included in the calculation of total annual compensation. The instructions to Form 990 include a glossary of terms and a table that shows precisely how and where to report the many types of “other compensation” that should be included in total compensation.
- The board/independent body conducting the review should document who was involved and their “independence” (i.e., that they do not receive compensation from the nonprofit), the process used to conduct the review, and the disposition of the full board’s decision to approve the executive director’s compensation. Meeting minutes work well for this purpose. The documentation should demonstrate that the board took the comparable data into consideration when it approved the compensation.
- The process boards should use to review comparability data and approve the compensation and benefits of the Executive Director / CEO is explained in more detail in the instructions to the IRS Form. Nonprofits filing the Form 990 must describe the process on Schedule O.
- Having a robust conflict of interest policy is another important aspect of ensuring fair and reasonable compensation, as well as transparency in financial transactions.
Drivers of Nonprofit Executive Compensation
The Non-Profit Quarterly released a study on the key drivers in determining compensation levels for non-profit executives. The following is a summary of their findings:
- Due to commercialization and increased competition from for-profit and other nonprofit providers, the thinking around executive compensation practices has changed significantly over this period.
- Some nonprofits have shifted from fixed salaries to ones containing a variable cash-compensation component based on fundraising, cost reductions, or specific programmatic outcomes. However, these plans have met with resistance because they tend to focus heavily on financial measures of nonprofit performance rather than on the social dimensions—namely, mission fulfillment. Nonprofit managers also have sought “comparable pay” with business managers.
- Also influential is the fact that the benchmarking of salaries of nonprofit and business executives has become more prevalent and encouraged in the United States because of the IRS regulations allowing sanctions and fines to be levied on nonprofit organizations that pay their executives excessive compensation relative to similar nonprofit and for-profit firms.
- According to Non-Profit Quarterly’s research findings, in most parts of the nonprofit world base rates of pay increases in direct proportion (in most cases) to every $1,000 of operating expenses.
- CEO compensation is more sensitive to organizational size and free cash flows than to performance. CEO compensation is significantly higher in the presence of free cash flows.
- Nonprofits typically produce services that are complex and that generate not only direct outputs but also indirect, long-term, and societal benefits. These types of services often make it difficult to both develop good outcome measures and establish causality between program activity and impact. In the absence of effective metrics of social performance and mission accomplishment, many organizations rely on other factors in setting compensation.
Astron Solutions’ Observations for 2023
Taking into consideration the above information, as well as our read on the executive compensation market, Astron Solutions has our own viewpoint on the topic. The following perspectives are based on recent client projects on nonprofit executive compensation and our vision for 2023:
- Benchmarking: Boards have become more in tune with decisions regarding market strategy and philosophy, especially in identifying the universe to include in benchmarking compensation levels.
- The use of IRS Form 990 in the benchmarking process has come into question based on the age of the data available (often two or more years old) and often the lack of current deferred compensation arrangement reporting. 990s often do not provide the compete picture of how executives are compensated. The focus has been more on available published data from major consulting survey houses than on 990 data.
- Boards have increased their interest in “deferred compensation” arrangements as a way to provide a “golden handcuff” to retain key executive talent. The use of 457(f) plans have grown during 2022 and will continue into 2023.
- With better strategic planning Boards are becoming more comfortable in setting up “goal-sharing” incentive plans utilizing a scorecard methodology linked to the organization strategic plan.
- The focus also has moved away from individual executive incentive plans to team-based plans in which all executives share in the results of key strategic goals. This “one for all, all for one” approach strengthens the executive leadership in terms of team support and interaction.
What trends are you seeing with respect to non-profit executive compensation? Please share your thoughts in the comments box below!