CPA & Business Advisory Blog

Not-for-Profit Organizations Should Consider Formalizing their Executive Compensation Process

Posted on Thursday, December 1st, 2011 by

Not-for-profit organizations face many challenges in attracting and retaining executive talent. Compensation programs (types and amount) that can be offered to these executives are much more limited than those which are offered to private sector executives.  Many organizations do not have in-house capabilities to analyze and propose programs that provide competitive compensation. Donors may perceive that executives are overpaid, and are therefore the organization is providing fewer services. This article will discuss why a not-for-profit should be concerned with this issue, the Board’s involvement and a simple approach for looking at executive pay in a not-for-profit environment.

Why should the process become more formalized?

There are several reasons why the executive compensation process should be formalized at a not-for-profit institution. 

  • First, the public views  management’s setting of its own compensation very skeptically—the “fox guarding the henhouse” analogy comes to mind—and perceived excessive pay could result in donors reducing their contributions. 
  • Secondly, the IRS continues to actively pursue its ‘intermediate sanctions’ program, in which federal tax-exempt status can be revoked, and penalties imposed, if the IRS determines that executives receive excessive pay. 
  • Finally, the organization should use an organized approach to determine market levels of executive pay; this would ensure that the organization isn’t offering too little (and not being able to attract/retain the right executive) or too much (and alienating donors and the IRS, as discussed above). 

 

 

The process should start and finish with the boardThe public, contributors, executives and the IRS all want to see the organization’s Board of Directors directly involved in the executive compensation process.  We suggest that the Board create a compensation committee, whose primary purpose is to establish and monitor the compensation and benefit arrangements provided to the organization’s executives.  In forming, appointing and administering the committee, the following should be considered:

 

 

  • The committee should be comprised of independent members of the Board—no employees should serve on this committee (an inherent conflict of interest).
  • The committee's charter should specify what types of decisions are to be made by the committee and what decisions must be made by the Board of Directors as a whole.
  • The committee should be able to engage outside compensation and legal advisors if funding permits.  If funding is not available, if any member of the Board has expertise in this area (or works for a firm that has expertise in this area), the Board should consider appointing that member to the committee to take advantage of his or her knowledge and relationships.
  • The committee should sometimes meet without members of senior management in attendance.  The head of the organization should not be present for, or participate in, discussions concerning his/her own compensation but should provide insight concerning the compensation of other members of senior management.

 

 

An approach to analyzing executive payA reasoned approach to determining (and justifying) executive pay must involve a formal analysis; a statement of ‘that’s what we have historically paid for this position’ or ‘we must be paying the proper amount because the executive is still working here’ will not sit well with the community or the IRS.  The simplest method is to obtain a description of the position and compare similar jobs through compensation surveys; comprehensive surveys would allow the organization to select respondents with similar demographics (for example, geographical location and number of employees), and often include information relating to retirement programs and fringe benefits.  There are other, more expensive and time consuming methods (private surveys, review of IRS filings).  Using a source which is based on facts rather than hearsay will help the organization justify the amounts of its executive compensation package to the various constituencies that it serves (including the IRS).

 

 

 

 

Have questions about the compensation your Board of Directors is receiving? We would be pleased to assist not-for-profit organizations create, govern and monitor effective compensation programs.  For more information on this topic, post a comment below or contact our Compensation & Benefits Advisory Services Group at 440-449-6800.

 

 

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