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’s not to say that nonprofits have to mirror similar executive compensation plans from peer organizations. It just means they have to be able to justify their decisions if they’re decisions are ever in question. With that in mind, executive compensation committees should consider all the factors that the IRS is likely to consider when establishing their compensation packages.
Factors that Affect Nonprofit Executive Compensation
Depending on the type and size 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 field.
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 corporate 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.
Leadership for large nonprofits isn’t very much different from leading corporations. Organizations that have complex organizations with multiple funding streams, products to sell, and many layers of staff have the same degree of responsibility and intensity as for-profit executives. For this reason, nonprofits can only be competitive if they’re willing to compensate their executives accordingly. As long as salaries are comparable to other nonprofits of a similar size, it shouldn’t draw unwarranted scrutiny from the IRS.
The location also plays a role in executive compensation levels. Big cities like New York City and Chicago tend to pay their nonprofit executives more. Nonprofit executives in the Northeast and the Mid-Atlantic typically receive higher salaries than nonprofit executives in the Midwest and the Southwest, where leaders generally get paid the least.
Type of Nonprofit Organization
Nonprofits usually depend on a few different sources of revenue to keep them going. Some of the sources include:
- Government grants
- Private donations
- Sales from goods
- Programs and activities
- Membership fees
Religious organizations tend to offer some of the lowest nonprofit executive salaries as base pay. To keep executives interested, boards may offer retirement plans, housing, or pay for other expenses to compensate.
Higher education organizations also commonly offer perks like housing, travel, lodging, or other personal expenses. Private colleges and universities tend to pay their executives more than nonprofits in other fields. Higher education executives bear heavy responsibilities. They have to answer to their boards, faculty, students, and the community. This level of responsibility warrants higher compensation.
Private hospitals and healthcare organizations pay their executives on higher levels than executives in other fields—again because they bear much responsibility. Nonprofits in the healthcare arena tend to rely more on private donations and less on government funding.
Nonprofits in the arts rely largely on public support and less son commercial revenue from products and programs. Very large nonprofits in the arts depend heavily on government grants in addition to public donations through fundraising. The pay for executives for nonprofits in the arts is strongly linked to the organization’s size.
Environmental nonprofits also tend to rely heavily on government grants and donations, and less from the sale of goods.
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.
Regardless of the size, type, or location of nonprofits, all can need to have strong board management skills. A BoardEffect board management portal offers all the tools for nonprofit executive compensation committees to do their work of hiring the best talent. The portal supports granular permissions to ensure the integrity of the compensation development process.