President Obama’s announcement this week that he plans to limit executive pay and perks at financial companies seeking federal bailout aid should send a message to nonprofit groups’ leaders and their board members.
The White House tapped into a growing public concern about the appropriate levels of compensation for people who benefit in at least some way from direct or indirect government subsidies.
While policy makers have yet to seriously suggest ceilings or other restrictions on compensation for nonprofit groups’ leaders, there is a growing sense that such pay must be based on common sense and an understanding of the country’s economic turmoil. Savvy trustees will get the message and and immediately re-evaluate how their organizations compensate top leaders.
Nonprofit groups’ boards need to both understand the government’s proposed guidelines on compensation for officials of companies receiving federal bailout money and think about perceptions of the standards for executives’ compensation.
Not only would President Obama limit their annual pay to $500,000, but he would also require full disclosure of their employers’ compensation structure and strategy. In addition, the guidelines would prohibit or strictly limit “golden parachutes” and other forms of severance arrangements, and would require boards to adopt policies to ensure that executives henceforth avoid spending lavishly on private jets, office renovations, entertainment, and attendance at certain types of conferences and events.
The guidelines are intended to assure that taxpayers are not in the awkward position of “rewarding” executives of failing organizations. They are not, however, intended to apply to other publicly traded corporations, much less to tax-exempt organizations.
But it is important to note that the president said the guidelines would be part of “long-term effort” to figure out how executive compensation structures have contributed to the current financial mess, and how corporate governance and compensation rules can be changed for the better. From that perspective, the guidelines would open the door to a broader governmental consideration of executive compensation structures and their relationship to tax revenue.In essence, the federal bailout plan has let the genie out of the bottle by introducing into mainstream discourse topics, such as caps on executive compensation, that were previously considered too extreme to be seriously considered. The age-old lesson, of course, is that once released, the genie can never be put back in.
Given concerns that lawmakers and regulators have raised about whether nonprofit groups are providing enough social benefits to justify their tax-exempt status, it seems logical to think that those authorities will raise new questions about compensation arrangements.
State and federal charity officials are already increasingly willing to scrutinize alleged abuse of charity status in cases involving specific organizations.
Such concerns are likely to be exacerbated by a report soon to be released by Internal Revenue Service summing up its extensive investigation of nonprofit hospitals. The report is expected to point to high levels of executive compensation and a wide disparity in how much hospitals do to serve their communities and provide charity care.
Concerns about abuse in the nonprofit world have also led some government officials to suggest that charity groups must adhere to stricter governance standards and perhaps compensation guidelines, as a precondition for federal tax subsidies.
It is thus conceivable that the federal financial-bailout guidelines may signal a new, populist-themed regulatory era for organizations—whether publicly traded or tax-exempt—that rely on government money in one form or another. In response, nonprofit groups’ boards and their compensation committees will want to increase their emphasis on the exercise of sound, common-sense business judgment consistent with the general economic environment.
Specifically, compensation committees will want to take steps to assure:The independence of both the compensation consultant and committee members. The “apples-to-apples” nature of data used to compare pay levels at other organizations and recommend salary ranges and benefits for executives. Ways to reduce reliance on compensation data from for-profit companies in producing recommended salary ranges based on comparative data. The appropriateness of the organization’s benchmarking for each element of compensation, not just salary. The nature and rigor of the performance goals established for incentive compensation. The use of “clawback” provisions that allow the nonprofit organization to recover bonuses and other types of incentive pay in the event financial results must be restated. Limitations on the terms and length of severance benefits. The ease with which outsiders can understand the compensation structure and the review-and-approval process. Reasonable controls on executive and board travel and on education and entertainment expenditures. Whether pay levels throughout the organization have been reviewed for internal equities.
While it’s important to pay attention to compensation policies and practices, it is also vital for charity leaders not to overreact. Government-enforced compensation restrictions for the nonprofit world are not inevitable.
But it is up to nonprofit groups themselves to set their compensation so fairly and publicy that policy makers will not be tempted to consider limiting them. It is not just to avoid new regulation that boards must act, but to maintain the trust of of the American public.
Ralph De Jong and Michael Peregrine are lawyers at McDermott Will & Emery, a law firm in Chicago. They specialize in advising nonprofit organizations.