Nonprofit Boards: Size, Performance and Managerial Incentives

The following post comes to us from Rajesh Aggarwal of the Department of Finance at the University of Minnesota; Mark Evans of the Department of Accounting at Indiana University; and Dhananjay Nanda, Professor of Accounting at the University of Miami.

In the paper, Nonprofit Boards: Size, Performance and Managerial Incentives, forthcoming in the Journal of Accounting and Economics as published by Elsevier, we study the relation between a nonprofit organization’s board of directors and the number of programs or objectives it pursues, its performance and its manager’s incentives. We posit that board membership is only conferred on directors that bring assets that are valuable to the nonprofit. However, the conferred control rights allow the directors to use the organization to pursue their own objectives. We hypothesize that directorship is only granted when the value of a director’s asset exceeds the cost of accommodating their objective. Consequently, we predict that board size is positively related to the number of objectives a nonprofit pursues, its performance in raising and spending funds, and inversely related to its managers’ incentives.

We test our hypotheses using a sample of 501(c)3 nonprofit firms that filed Form 990’s with the Internal Revenue Service between 1998 and 2003. The sample consists of 154,475 firm-year observations from 35,040 unique firms. The Form 990 contains information about financial performance, program services offered, listing of officers and directors, and compensation paid to the officers and directors. Our empirical results are consistent with our predictions. Specifically, we find that board size is positively associated with the number of programs pursued by a nonprofit and to its revenues and program spending. In addition, we find that board size and the number of programs are negatively related to a nonprofit manager’s pay-performance sensitivities. We also show that program spending and revenue growth are positively related to incentives, board size, and program variety. Our results are robust to various specifications and the inclusion of numerous controls.

While our empirical results are consistent with our predictions, we have only begun to scratch the surface of explaining board behavior. Our proxies for board heterogeneity are rather crude. While it is certainly plausible that greater board size reflects greater disagreement about firm objectives, it would be preferable to have direct measures of differences in board members’ objectives. For example, European firms often have employee union representation on the board, bank or debtholder representation on the board, and in some cases, charitable foundation representation on the board. To the extent that we have been able to find results consistent with the theory in US nonprofit data, this suggests that multiple objectives may in fact explain board behavior more generally.

The full paper is available for download here.

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