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Hauser Center Researchers and Staff

Elizabeth Keating

Senior Research Fellow

Lecturer, Harvard Law School

Profile Home: Publications: RESEARCH

Working Papers
Work-in-Progress
Programming Code

Working Papers

"Is it Time to Address Selective Disclosure"

Abstract:
Over the past two decades, there have been several highly publicized nonprofit scandals1 that have eroded the publics confidence in the sector (Aviv 2004). Significant changes in nonprofit regulation have been implemented to address these concerns athat have expanded the financial information available to the public. Interestingly, the calls for more nonprofit accountability have not focused on an important concern, that of selective disclosure. This is a practice under which an organization provides material information to some constituents while withholding it from others. This paper argues that practice is frequently observed in the nonrofi sector. As the New Era Philanthropy scandal highlighted, this practice can pose substantial risks to the nonprofit sector by facilitating fraud and harming the publics trust. The paper describes the existing nonprofit reporting requirements and potential shortcomings. It examines two alternative disclosure environments, the Freedom of Information Act (FOIA) in the federal government and corporate securities regulation, particularly Regulation Fair Disclosure, and their limitations. It will then discuss what measures could be taken to address selective disclosure in the nonprofit sector.

"Misreporting Fundraising: How do Nonprofit Organizations Account for Telemarketing Campaigns?" with Linda M. Parsons and Andrea A. Roberts

Abstract:
The purpose of this study is to examine the frequency, determinants and implications of misreporting fundraising activities. We compare state telemarketing campaign reports with the associated information from nonprofits annual Form 990 filings to directly test nonprofits revenue and expense recognition policies. Our study indicates that smaller nonprofits, and those with less accounting sophistication, are more likely to inappropriately report telemarketing costs as a component of net revenues rather than as expenses. In addition, less monitored firms are more likely to report telemarketing campaign revenues net of expenses. Additionally, among those firms that do report telemarketing costs as expenses, we find that smaller firms, and those with relatively less officer compensation, are more likely to allocate telemarketing expenses to non-fundraising expense categories.

"Unfunded Public Employee Health Care Benefits and GASB 45" with Eric S. Berman

Abstract:
The Government Accounting Standards Board (GASB) recently released Statement 45, Accounting and Financial Reporting by Employers for Post-Employment Benefits Other than Pensions and its companion Statement for pooled standalone health care plans, Statement 43, that will profoundly affect American governmental finance. This paper will review Statement 45s potential impact on governments and review existing disclosures in financial reports as well as bond offering statements. The paper will discuss the Statements impact on budgets and governmental operations, including collective bargaining. Funding options under Statement 45 will be detailed, including the advantages and disadvantages of irrevocable trusts and OPEB bonds. The paper will also discuss the impact of Medicare Part D subsidies received by governments, as well as the bond rating implications of policy decisions surrounding OPEB. Finally, the paper will discuss case law that has already come before state courts related to restructuring of benefits.
 

"Organizational Slack in Nonprofits" with H. Woods Bowman and Mark Hager

Abstract:
A distinguishing feature of nonprofit organizations is their complex revenue structure, which may include a significant amount of revenue in the form of grants, gifts and investment revenue. An organization with investment income can spend it any way it chooses without having an adverse effect on generating future revenues from this source. Incentives for cost control are weak. This raises the possibility that investment income creates organizational slack. The concept of organizational slack has been well-studied in for-profit firms, but hardly at all in nonprofit organizations. We hypothesize that investment revenue creates organizational slack, which is defined three ways: (1) available slack or liquidity, (2) recoverable slack or overhead or non-essential costs and (3) potential slack or solvency. Controlling for financial health, organization size, fixed costs, and sub-sector, the regression results reveal slope coefficients with the expected signs and highly significant t-values. The financial health of a nonprofit plays an important role in determining its willingness to convert use investment revenues to build organizational slack. Cash-strapped organizations are as willing as healthier nonprofits to increase officers compensation, enhance their unused borrowing capacity at somewhat slower pace than other firms but avoid growing overhead costs. Unprofitable nonprofits behave much like the full sample although they are less quick to expand their future borrowing ability. Overall, human services providers develop less organizational slack of all forms, health-oriented nonprofits accumulate relatively less available and potential slack, while arts organizations create relatively high recoverable slack.

"Assessing Financial Vulnerability in the Nonprofit Sector" with Mary Fischer, Teresa Gordon & Janet Greenlee

Abstract:
Effective nonprofit governance relies upon understanding an organizations financial condition and vulnerabilities. However, financial vulnerability of nonprofit organizations is a relatively new area of study. In this paper, we compare two models used to forecast bankruptcy in the corporate sector (Altman 1968 and Ohlson 1980) with the model used by nonprofit researchers (Tuckman and Chang 1991). We find that the Ohlson model has higher explanatory power than either Tuckman and Changs or Altmans in predicting four different measures of financial vulnerability. However, we show that none of the models, individually or combined, are effective in predicting financial distress. We then propose a more comprehensive model of financial vulnerability by adding two new variables to represent reliance on commercial-type activities to generate revenues and endowment sufficiency. We find that this model outperforms Ohlsons model and performs substantially better in explaining and predicting financial vulnerability. Hence, the expanded model can be used as a guide for understanding the drivers of financial vulnerability and for identifying more effective proxies for nonprofit sector financial distress for use in future research.

"The Risks and Rewards of Nonprofit Revenue Concentration and Diversification" with Peter Frumkin

Abstract:
A central tenet of nonprofit management holds that revenue diversification is desirable. Researchers have long argued that by establishing and maintaining multiple streams of funding, including some combination of earned income, government contracts, foundation and corporate grants, and individual contributions, nonprofits will be able to avoid excessive dependence on any single revenue source, stabilize their financial positions, and thereby reduce the risk of financial crises or interruptions in funding. This paper investigates whether this basic claim about the desirability of revenue diversification is both correct and complete. Against the dominant trend in the literature that focuses on the risks of revenue concentration, we find that nonprofits that have highly concentrated and specialized forms of revenue actually experience some significant benefits, in the form of lower administrative and fund raising expenses. These savings are associated with greater exposure to swings in an organization's financial position, however. We conclude that nonprofit managers face a far more complex set of choices about the composition of their revenue than much of the research to date on nonprofit financial management might lead one to believe.

"The Effectiveness of Regulating Governance: The Case of Executive Compensation in Nonprofit Organizations" with Peter Frumkin

Abstract:
Recent corporate scandals have precipitated legislation designed to strengthen board governance. To assess the effectiveness of regulating corporate governance, we examine an important legal requirement that prohibits nonprofit organizations from distributing excess profits for private benefit. Of particular concern is that boards may violate this constraint when determining executive compensation. We provide evidence consistent with two different types of violations. First, CEO executives appear to be compensated for stronger financial performance. Second, CEO pay is significantly higher in organizations with "free cash flows," suggestive of agency problems. While significant, these two factors are not the dominant determinants of nonprofit CEO compensation.


"The Relation between Auditor Selection and Adverse Audit Findings; Examination of Nonprofits Subject to the Single Audit Act" with Mary Fischer, Teresa Gordon & Janet Greenlee

Abstract:
Under the Sarbanes-Oxley Act, the selection of an independent auditor has become the responsibility of the audit committee and the board of directors. The legislation is designed to address a concern that if management selects the auditor, it will choose the auditor based on the likelihood of receiving a "clean" audit opinion rather than on auditor competence. To determine the importance of this concern, we examine auditor selection by nonprofit organizations subject to the Single Audit Act (SAA). In this setting, auditors have traditionally been selected by management and the adverse audit findings are publicly disclosed. Using a sample of 12,656 SAA audit reports from 1997 to 1999, representing 11,892 unique nonprofit entities and 3,592 audit firms, we find that nonprofits select more experienced auditors when the nonprofits are larger in size, receive larger federal grants and operate in certain sectors (Education, Public/Societal). However, we find that nonprofits avoid audit firms that issue more adverse audit findings.


"How to Assess Nonprofit Financial Performance" with Peter Frumkin

Abstract:
The fundamental reason for nonprofit financial performance assessment is to determine how well an organization is fulfilling its mission. The financial numbers alone cannot answer this question, but they can provide insight into the sources of funding, the cost of service delivery, and an organization's ability to operate in the future. Over the past decade, a second reason for conductng financial performance analyses of nonprofits has emerged. Several major financial scandals have rocked the nonprofit world, including embezzlement by the president of the United Way of America for (Murawski 1995) investment fraud by the head of the Foundation for New Era Philanthropy for perpetrating (Stecklow 1997), theft by leaders of the Episcopal and Baptist churches (Greene 1995; Fletcher 199), improper use of funds by the head of the National Association for the Advancement of Colored People (NAACP) (Greene 1995), and excessively generous compensation of the president of Adelphi University due to an (Thornburg 1997). In the past decade, the issue of the non-profit financial reporting and accountability of the nonprofit sector has surfaced, including the adequacy of the current reporting and oversight mechanisms. Given these issues, we argue that the nonprofit community's future economic success depends not only on the quality of its social and economic activities, but also on improving the way it measures its work and communicates these results to the sector multiple and diverse stakeholders. This report is designed to help participants in the nonprofit sector better address two issues:

                  How should nonprofit financial performance be assessed?

                  How can information about financial performance be made accessible to and usable by the multiple stakeholders in nonprofit organizations?

"Why Do Firms Voluntarily Choose a CPA Audit? An Examination of U.S. Credit Unions".

Abstract:
This study investigates the reasons for selecting a CPA audit in a voluntary audit environment and the associated benefits. The setting for the paper is the credit union industry, which is a sector of the US economy has allowed voluntary audit choice. Despite frequent regulatory audits, mandated annual audit committee reviews, and the availability of relatively inexpensive non-CPA audit services, one-quarter of US credit unions complete independent CPA audits. I find that credit unions with higher business risk, size, legal liability and certain agency costs are more likely to engage CPA auditors. The paper examines two potential benefits from choosing a CPA audit: (1) lower probability of financial distress, and (2) decreased earnings and/or balance sheet management. No association was discerned between audit choice and financial distress for credit unions operating in 1992-1997. Additionally, I find little evidence that key financial ratios are managed by credit unions, regardless of audit quality. Hence, regulatory examinations and the use of non-CPA services may be cost-effective alternatives for monitoring the financial health and quality of financial reporting. Since reducing financial distress and earnings management are not unique benefits of independent CPA audits, the paper suggests that legal liability may be the major factor contributing to the voluntary decision to complete CPA audits.

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Work-in-Progress

"Advancing the Overhead Debate" sponsored by the Hewlett Foundation and in collaboration with the Independent Sector.

"CPA Survey of Auditing and Overhead Allocation Practices," Nonprofit Overhead Cost Project with Mark Hager, Natasha Pilkauskas, and Patrick Rooney.

"The Federal Budget and the States" with Herman B. Leonard.


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Programming Code

SAS Code to calculate the BSM-PB measure in Assessing the Probability of Bankruptcy (contact Elizabeth Keating for more information)

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