Board Compensation in Grantmaking Foundations: Reasonable and Necessary?

(Mark Hager is associate professor of nonprofit studies in the School of Community Resources and Development at Arizona State University. This post originally appeared on the Foundation Center's Transparency Talk blog.)

Tradition dictates that board members work for free in most quarters of the nonprofit sector, but that isn't necessarily true for grantmaking foundations, especially independent ones. In a new paper (free access until late March) published in Public Integrity, the ethics journal sponsored by the American Society of Public Administration, Elizabeth Boris and I consider the question of what varieties of grantmaking foundations compensate their board members for governance duties. It reboots and reframes an earlier analysis conducted by the Urban Institute, the Foundation Center, and GuideStar.

In the paper, we point to several interesting examples, including a very large foundation's generous policy of trustee compensation spelled out in its organizing documents, another with seven-figure annual compensation paid to a bank to act as a very part time "institutional trustee," and another that underwent IRS investigation for eye-popping compensation that essentially amounted to trustees looting a charitable trust. These cases aren't typical, but they are part of the big picture of how work gets done in grantmaking foundations and how much insiders get paid to do it. In more typical cases, foundations might have justifiable reasons to compensate board members, including to ensure representation from beneficiary populations or to extend health insurance benefits to family founders. It's the extreme cases, however, that threaten to color all of philanthropy.

Compensation for governance duties is perfectly legal, so long as it falls under the IRS' broad standard of "reasonable and necessary." The practice is pretty rare in community foundations, partly due to the fact that they rely so heavily on public contributions and are therefore subject to public scrutiny. It also appears to be fairly rare in corporate foundations, but that may largely be due to the fact that many corporate foundation trustees get paid as corporate executives, making their compensation invisible on the foundation side. About one in five independent foundations, however, appear to report compensation of their board members for governance duties, as reported on Form 990-PF.

The practice is always concentrated in larger foundations. Of the ten thousand largest U.S. foundations that are the subject of the study, more than half compensate no one, including any staff. Most foundations are small and get their work done by family volunteers. Foundations that compensate staff members are more likely to compensate their board members. However, for the typical foundation, board compensation levels are eminently reasonable. The median individual board member compensation in independent foundations is only about $8,000. That's not an indication of a rampant problem.

However, a few bad apples always threaten to spoil the bunch. The median may be $8,000, but the mean was $15,700 due to a number of well-compensated apples. When a board member's one-year compensation reaches $200,000 (this happens), or a bank trustee is compensated $1,000,000 to spend a few hours a month managing investments (noted above), or aggregate board compensation in a given foundation exceeds its grants in a given year (this happens, too), we might rightly ask whether compensation has exceeded what is "reasonable and necessary." At the same time, $1,000 here and $100,000 there adds up to real money, to the tune of more than $100 million paid out to foundation board members in any given year. People hear that and start asking why that money isn't being allocated to community nonprofits instead.

Who is going to check to see whether board compensation is reasonable and necessary? For many organizations in the nonprofit sector, the general public is the first regulator. Service providers and advocates, especially those that rely on public contributions, reign in compensation and overhead costs due to public pressure. This is not the case with independent foundations, however, since they are not beholden to public contributions. Since the general public has no skin in the private foundation game, the public tends to ignore them.

A second regulator candidate, then, is government. Certainly, the IRS can prosecute private foundations that exceed the vague "reasonable and necessary" standard. Thing is, they don't, at least not very often. For one thing, identification of board member compensation is very difficult on Form 990-PF. For 2008, the IRS revamped Form 990 for public charities so that compensated individuals are identified as board members or employees. No similar revamp happened to Form 990-PF, where administrative and governance duties are conflated. Picking out board members working on governance duties is tricky; board compensation must be inferred from titles or numbers of hours worked, if reported. So, board compensation is not always obvious on the federal form. And even when unreasonable or unnecessary compensation appears evident, the IRS is often unwilling to take on community elites with deep pockets.

The third regulator, maybe, is private foundation executives and board members themselves. That's one of the ideas underlying the Foundation Center's Glasspockets initiative: private foundations will regulate themselves as their practices become more transparent. Private foundations certainly do not need to eradicate the practice of compensating board members for governance duties. However, when outliers cause observers (like me) to raise their eyebrows, the whole field can get painted as out-of-touch with community needs. Maybe Glasspockets can plant a stake in the ground on this issue to encourage foundation leaders themselves to openly disclose this information as a best practice. Voluntary and widespread disclosure of board member compensation, venues for discussion, and bright lights on questionable practices can help stem criticism of compensation that may or may not be "reasonable and necessary" for carrying out the exempt purposes of grantmaking foundations.

Everyone benefits when somebody, somehow, enforces the "reasonable and necessary" standard. Grantmaking foundations will keep better faith with their local communities. Regulators will be able to concentrate on more worthy offenses. And nonprofits will benefit from resources that are otherwise diverted into trustee pockets. Win, win, win.

-- Mark Hager

Comments

[Jason Born, Senior Program Director, National Center for Family Philanthropy]

Nice piece - for another take on board compensation, written specifically for family foundation boards, see the National Center for Family Philanthropy's 2001 issue paper, coincidentally also titled "Board Compensation: Reasonable and Necessary?"

[Mark Hager, Arizona State University]

Jason: Ha, I didn't realize I was stealing that part of the title! The 'reasonable and necessary' comes from the regulatory language, so not too surprising that we landed in the same place. MH

[Martin Paley]

I just discovered your blog and find the scope and breadth of your essays most impressive. A number of years ago I directed a large community foundation that confronted a challenging ethical question that many in the foundation world found disturbing.

The issue remains to be explored.

Keep up the good work.