Stanford Social Innovation Review

Rethinking Compensation for Nonprofits

Imagine that you’ve built a business that generates $10 million in revenue per year.  What would be a fair level of compensation to expect?  Now, imagine that this enterprise is a program that helps low-wage workers receive Earned Income Tax Credit funds, and that the $10 million is the net amount of value the program brings to low-income neighborhoods.  How did this change your estimate of fair compensation?

As a society, we pride ourselves on our generosity of spirit and purse – on helping people in need and on championing causes that matter to us.  Why, then, do we pay so little to the people who work for the things we say matter most to us – the well-being of our children and the elderly, our environment, the interests of groups like disabled veterans or disaster survivors?

In his book Uncharitable, Dan Pallotta makes a compelling case for completely rethinking compensation in the nonprofit sector .  (Incidentally, chapter 2 of Pallotta’s book should be required reading in all business, law and management courses claiming to put the nonprofit sector in context.)  The challenging question Uncharitable poses to all of us is what would a new approach to nonprofit compensation look like?

Let’s start off by looking at approaches to compensation in the for-profit world.  While nonprofit workers struggle to get adequate compensation for their contributions, the for-profit world, of course, presents compensation problems at the other extreme.  Most recently, the bonuses AIG paid out using federal bailout funds has symbolized these excesses, but over the past 20+ years we’ve seen leading executives receive shockingly high amounts of pay.  In the aftermath of the financial meltdown, the government’s response to the problem so far has been to appoint a “compensation czar” to set executive pay limits.

A more promising approach being discussed in the finance world is tying compensation to longer-term results and productivity gains. The argument is that such an approach, sometimes referred to as “Silicon Valley Compensation,” may both preserve high rewards for innovative or significantly superior performance and simultaneously reduce the potential for kleptocracy.  As noted economist Brad DeLong explains in a recent post:

The engineers of Silicon Valley startups are significantly smarter and work a lot harder than do the traders of Wall Street.  Some of the engineers of Silicon Valley make fortunes: they are compensated with relatively low salaries and large restricted equity stakes in the startup businesses they work for, and so if the businesses do well they do very well indeed—in the long run, in the five to ten years it takes to assess whether the business is in fact going to be a viable and profitable going concern.  And the engineers of Silicon Valley have every incentive to use all their brains and all their hours to make their firm viable and successful: they get their cash only at the end of the process.  They don’t get big retention bonuses if they stick around until the end of a calendar year.  They don’t get big payouts if they report huge profits on a mark-to-market basis. 

Nonprofit pay dynamics also call out for Silicon Valley rules, not because pay is excessive but because it is too low. When successful nonprofits deliver extraordinary results, we all benefit, but the sector does not capture and recycle any of that value into attracting and keeping more talented people.  Because it is hard to “see,” and therefore put a price upon, the value that nonprofits produce, funders, employers and watchdogs alike all focus solely on the pay nonprofit leaders and employees receive, rather than the value they create. That leaves them – and more importantly, the people and causes they serve – at the mercy of the perverse expectation that nonprofit workers should sacrifice financial stability and secure futures for themselves and their families. (Pallotta traces this distortion to the carry-over effect of Puritan ethics). 

Remember the thought exercise from the first paragraph?  In the first example (for-profit), “fair compensation” would include a nice salary, bonuses and perhaps an exit package that will allow you to maintain a comfortable lifestyle.  In the second case (nonprofit) however, you could expect no more than a base salary, simply because you work for a charitable organization.

Paying people tied to the value they deliver over a longer term would seem to make sense for any enterprise.  But for nonprofits, the problem is two-fold; the challenge is not just how to measure value creation, it is also where to find the surplus revenue to fund increased compensation.

For all the talk and debate about results in our sector, in practice, results are rarely measured for a number of reasons.  These include the time lag between providing a service or activity and the manifestation of the results, the difficulty in determining what share of the results is attributable to the service or activity rather than other factors, the lack of adequate resources to enable meaningful measurements, and the reluctance of most donors to pay for costs they do not see as essential to the continuing mission of the organization.

But assume for the moment we could measure productivity gains and added value. Where, then, would the funding to pay deferred compensation for superior performance come from?  Given all the attention venture philanthropy and social enterprise has received over the past 10-15 years, we’ve seen surprisingly little discussion about how to compensate organizations and people who make extraordinary contributions.

There is much that funders and the government could do, such as offer loan forgiveness or ROTC-type programs that cover education costs for people who choose to work in the sector (as I’ve argued in SSIR previously). 

The much harder question is how to offer higher performing nonprofit workers a reasonable chance at increasing income over their careers – the ability to make a living that allows them to stay in the sector without asking their families to sacrifice too much.

In a recent post, Robert Egger posed the question of whether the economic downturn, which has created a buyer’s market for talent, offers the nonprofit sector the chance to try out what he calls the “Starbucks” model .  This model is one in which moderately increased compensation, significantly improved health and other benefits,  could help nonprofits compete for the best people .  It would be a very positive sight to see more public good organizations and their donors adopt this model.  Unfortunately, the dominant trends at the moment – layoffs, hiring and wage freezes, sharp cuts in foundation and government funding – are pushing in quite the opposite direction.

It will likely take years of experimentation (and yes, venture capital) to solve this challenge. There has been a great deal of energy put into prize philanthropy in recent years. What if a similar amount of funding and attention were put into bonus pools for collaboratives working on challenges suitable for result measurement?  Might we learn something from the way cooperatives measure and reward contribution to the whole? Perhaps the workforces of different organizations could be assigned shares of a pool of “success funds.”

Think about your favorite cause or nonprofit. If you could prove that your favorite charitable venture produces, let’s say, $5 in value for every $1 invested in it, how would you persuade donors to pay a premium for that rate of value creation, what would that premium be, and how would you allow your workers to participate in that success?

Peter Manzo is President & CEO of United Ways of California, which improves health, education and financial results for low income children and families by enhancing and coordinating the policy advocacy and community impact work of California’s 37 United Ways.