The New England Not-For-Profit Accounting Advisor

Not-for-profit sector compensation has been consistently reviewed by the Internal Revenue Service (IRS) along with state and other federal governing bodies for many years. Recently, Massachusetts Attorney General Martha Coakley with the Non-Profit Organizations/Public Charities Division (“the Division”) undertook a review of not-for-profit compensation in the Commonwealth. [1] The review found annual compensation (including all components of reported compensation) for the CEOs of the selected 25 organizations ranged from $487,000 to $8.8 million. For this reason, as well as the rapid increase in executive compensation in the not-for-profit sector, there frequently have been concerns among the general public with how not-for-profit CEO compensation impacts organizations’ charitable missions.

The story is much the same elsewhere, according to a 2012 study by the Chronicle of Philanthropy [2]. That report found that more than 20 not-for-profit organizations paid top executives more than $1 million annually in 2010 and 2011. The figures produced a strong reaction from the public. In an article about the Chronicle of Philanthropy study, the president of the not-for-profit watchdog group Charity Navigator Ken Berger said, “By far the most comments we get have to do with CEO salaries and a general outrage and shock at some of the salaries that they see.”[2]

However, as stated by Martha Coakley, large public charities demand higher levels of executive abilities to lead these complex organizations. A well qualified executive, for example, has the capability to increase the amount of money raised and keep the organization running efficiently in the ever-changing marketplace.

The Division's study teaches us what organizations can do to limit the scrutiny. With this increased scrutiny comes increased due diligence in implementing policies and procedures to protect your organization from actual and perceived notions of overcompensation. Salary studies prepared in conjunction and adherence with IRS standards under the Rebuttable Presumption are critical.

What is the Purpose of the Compensation Study?

The study examined the process implemented by organizations in setting executive compensation and explored a new method of reporting executive compensation that will be reported on a form called "Schedule EC." The Division proposed the Schedule EC as a response to shortcomings in the IRS model of not-for-profit compensation reporting, which the Division described as limited in scope and reliant on data that are generally delayed by more than a year. The Division "hopes the report assists readers in understanding the ways in which charitable organizations compensate executives, how various forms of compensation relate to the organization's charitable mission and direction and how existing regulations may impact and influence compensation decisions.”

Compensation Study Methodology

The study selected the 25 Massachusetts public charities with the highest reported gross support and the highest reported compensation for the study. Of the 25 organizations, 12 were hospitals or provider systems and 7 were universities. The study went beyond the detailed information the IRS asks for in its Schedule J and had the organizations prepare a prototype "Schedule EC" that asks for explanations about each individual component with the Schedule J compensation categories.

In addition, organizations were required to provide information about the compensation process to allow the Division to assess the "reasonableness" of the compensation packages reported. This is where the Division tried to understand the practices under the rebuttable presumption. The findings of the study are ”intended to increase transparency by explaining the types of compensation and benefit vehicles large public charities use to compensate senior executives and by requiring additional detail not generally reflected in the IRS filings and by doing so on a more current basis."

Findings and Observations

Each organization appoints a compensation committee, but the scope, frequency of meetings and level of detail of each committee varied. The committees that provided more robust records, such as minutes, presentations and analysis and independent reviews of reasonableness increased the Division's confidence.

Among the 25 organizations that included for-profit companies in their list of comparable compensation data, the Division further found no explanation for the rapid increase in executive pay at public charities. This would indicate not-for-profits reserve the same complex nature as for-profits and require similar quality, effort and experiences from their executives.

According to the study, another element contributing to the high level of not-for-profit executive compensation is SERP (supplemental executive retirement program), which is used to augment the retirement benefits available to non-executive employees. SERPs are usually provided as a long-term incentive that may span many years. It is important to note that in order to satisfy the applicable ERISA rules, participation in a SERP must generally be restricted to a select group of management or highly compensated employees and subject to a substantial risk of forfeiture. Additionally, the CEO’s right to receive them depends on performance of services in the future.

The Division believes that these types of benefit plans place public charities at risk because the plans require an additional expenditure by the organization just to maintain the promised benefit. For that reason, the Division does not feel that this type of savings vehicle is a risk charities should take on.

The Division concluded that "executive compensation arrangements must be scrutinized closely, for a variety of reasons. At a surface level, they must be carefully reviewed in order to meet the requirements of the relevant Treasury regulations and to conform to the required public reporting standards. On a deeper level, other considerations should influence a Board's review. Unnecessarily large or excessive compensation packages can have a negative impact on a charity's core mission and can cause significant reputational harm. Charities should be aware of the considerable financial risks they take on with certain types of compensation arrangements and—in an exercise of their fiduciary responsibilities—should be unwilling to pay more than is necessary to secure the executive talent they need."

The Road Ahead

There will no doubt be ongoing debate regarding appropriate levels of not-for-profit executive compensation, especially in light of the findings in the Division’s report. To prepare for this scrutiny and the revised version of the up and coming Schedule EC, executive compensation arrangements should be monitored and reviewed by the appropriate board committee.

CBIZ Tofias is keeping a close watch on the compensation discussion and will provide updates as new developments arise. If you have any questions or comments, please contact us here.

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[1] Attorney General Martha Coakley. Massachusetts Public Charities CEO Compensation Review. http://1.usa.gov/1qkRmZg

[2] Jeff Green. Nonprofit CEO Pay Topping $1 Million Rises With Scrutiny, Sept. 16, 2012. http://bloom.bg/1qxBu3P

 [3] Associated Press. Average CEO pay $9.6M in 2011. May 25, 2012. http://www.politico.com/news/stories/0512/76762.html