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Pitfalls and Promises: How to Set Competitive Compensation

Recent front page controversies involving excessive pay for nonprofit executives have brought the issue of nonprofit executive compensation under scrutiny. Stories like the ousting of former United Way of the Central Carolinas CEO for a multi-million dollar retirement package or the decision by the State of New York to impose salary caps on nonprofit CEOs receiving state aid. Not public organizations and not private, nonprofit organizations fill a special role in the community. These organizations embody many public service values seen in our government and public service institutions, but nonprofits have the flexibility found in the private sector in their governance, funding resources, employment contracts, and structure.

Public pressure from communities, donors and volunteers and legal pressure from federal and local governments have increased to regulate nonprofit compensation. Numerous human resource functions are impacted by setting compensation, including understanding legal issues, employee recruitment and retention, compensation data compilation and performance evaluations, just to name a few. Given the relationship between nonprofit executive compensation and key human resource functions, HR managers should define and explore their role in setting fair, reasonable, and justifiable compensation that helps to recruit and retain the best talent while keeping the organization out of trouble.

 

What do nonprofit executives make?

A 2012 survey conducted by Charity Navigator, a nonprofit watchdog, revealed the median annual compensation for nonprofit executives to be around $130,000 in organizations with operating budgets of $1 million or more. This information was based on data collected from 3,786 mid to large sized U.S based charities that depend on public support. Charity Navigator concluded that “there is a predictable relationship between the size of a charity and the CEO’s salary – the larger the charity the higher the median pay.” As the size and thus complexities of running a nonprofit increase, so does the salary of the institution’s top executive.

Compensation varies across types of nonprofit organizations based on the organization’s mission and geographic location. Nonprofits in the mid-Atlantic and northeast regions report the highest median salaries, just above $150,000. Organizations in the south and the mountain west report the lowest, between $111,000 and $119,000. Across industries, nonprofit health organizations, education institutions, and arts organizations report median salaries above $150,000, whereas animal focused organizations and religious organizations report median salaries of $100,000 or less.

In defense of high executive pay, officials and governing boards cite exceptional performance, renowned credentials, high levels of responsibility, and the role of executives in fundraising, generating revenue, and organizational management. However, despite this defense, some nonprofit executives and their organizations are subject to close scrutiny, and public or government pressure can lead to controversy and organizational change.

 

What are the legal requirements?

Prior to implementation of state regulations like the impending salary caps in New York, the federal government imposed rules and regulations on nonprofit executive compensation through the Internal Revenue Service. Nonprofit resource Guidestar.com notes that the IRS permits “fair and reasonable” compensation, but there is no universal standard definition of “fair and reasonable” because this standard may differ from one nonprofit to another. The IRS has no formula, such as percentage of total revenues or expenses, for determining compensation, nor are there any tables or schedules that define fair and reasonable. Charities are allowed to pay their executive at market rate, determined by researching what someone in a similar position would earn at an organization that is of the same size and has a similar mission or field of activity. Charities can even look at for-profit compensation when determining market rate, as long as the job, organization size, and organization mission/purpose are comparable. However, organizations found to be in violation of these guidelines of “fair and reasonable” may experience consequences that range from fines to revocation of tax-exempt status. Guidestar offers two suggestions for protecting yourself and the organization when determining executive compensation:

1. Base decision on data (such as a compensation survey) obtained prior to the decision, and

2. Document the decision-making process

 

What is the role of strategic human resource management?

As previously noted, key human resource functions are utilized to set and defend nonprofit executive compensation. These key functions include knowing the legal requirements and considerations, using compensation surveys, understanding the role of compensation in employee recruitment and retention, and conducting performance evaluations. Nonprofit leaders should understand these functions and work with the governing board to influence compensation setting procedures.

Managers should provide directions to boards on setting and reviewing executive compensation. Organizations should set compensation that falls within acceptable IRS parameters and within acceptable public perception. In order to do this, management should conduct salary surveys, collecting comparable compensation data from other organizations of similar size, mission, and location. Nonprofits should review this data before compensation decisions are made rather than compiling data afterwards in an attempt to justify previous decisions. Though they may be vague, IRS guidelines are written and documented. Public perception, however, is more difficult to define. In the case of the United Way of the Central Carolinas, a multi-million dollar compensation package was unacceptable to the community, and the public pushed strongly for the resignation or ousting of the CEO. Public demand and a poorly documented compensation setting process influenced management’s decisions to quickly cut ties with the CEO.

In addition to knowing about salary surveys, human resource managers should encourage the governing board to learn about the role of compensation in employee recruitment, retention, and motivation. Understanding the impact of compensation in these areas can emphasize the importance of setting competitive compensation. As it relates to recruitment and retention, compensation levels should be set intentionally to recruit executives who are qualified, but who also embody public service values such as openness, political neutrality and concern for public welfare.

Finally, managers must educate the governing boards on the importance of conducting annual performance evaluations and on the available types of performance assessments. Competitive compensation is a building block of effective human resource management. Performance evaluations are vital to assessing, rewarding, and guiding employees. Strategic management links compensation and performance assessments with the mission, vision and goals of the organization and its employees. Leaders should train board members on how to conduct performance evaluations, when to conduct these and how to set effective goals and reward systems.

In short, in order to set fair, reasonable and competitive compensation packages, nonprofit leadership should:

  • Educate the governing board in the role of compensation in recruitment and retention
  • Know federal, state and local regulations for nonprofit executive compensation
  • Be aware of community sensitivities and public perception
  • Facilitate compensation studies of peer and aspirant organizations
  • Conduct performance evaluations and set goals that align with organizational mission

Setting compensation levels remains a difficult topic in all sectors. This is a look into why compensation setting is a tricky issue in the nonprofit sector, specifically for chief executives. Regardless of organization size, nonprofits bear a special burden of transparent and responsible use of public funds. Nonprofit executive compensation impacts four key areas of human resource management: understanding legal issues, the role of compensation in recruitment and retention, use of compensation surveys and facilitating performance evaluations. Human resource managers play a vital role in setting nonprofit executive compensation and ensuring organizational compliance with federal, state and public standards. Human resource managers need to build relationships with the board of directors so they can prepare and educate governing boards in the best practices for recruiting, retaining and evaluating nonprofit executives. Education and preparation will help your organization avoid the pitfalls, legally and publically, of excessive compensation while promising a just, competitive compensation package to the best talent.

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Author: Marilyn Minter is a graduate student in the School of Public Affairs and Administration at the University of Kansas in Lawrence, Kansas. She can be reached at [email protected]

 

Image courtesy of http://tuftscareerservicesambassadors.blogspot.com/2012/11/show-me-money-notes-from-salary.html.

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The American Society for Public Administration is the largest and most prominent professional association for public administration. It is dedicated to advancing the art, science, teaching and practice of public and non-profit administration.

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