Executive compensation, organizational performance, and governance quality in the absence of owners

Abstract

I study the relationship between chief executive compensation, organizational performance, and governance quality in large U.S. nonprofits. Due in large part to the absence of shareholders, the nonprofit sector is characterized by weaker monitoring mechanisms and potentially more severe agency problems relative to their for-profit counterparts. As a result, there have been numerous instances of executive abuse, such as exorbitant pay for very little work. Despite the size of the nonprofit sector (5.5% of GDP and 9% of employment) and the obvious monitoring and legal responsibility concerns, governance issues at nonprofits have received much less attention than that at for-profits. Using recent IRS data on governance practices at nonprofits, I find that, after controlling for known determinants, both the CEO-to-employee relative pay ratio and the consumption of perquisites are significantly negatively related to an index of nonprofit governance quality. Furthermore, consistent with governance problems at nonprofits and inconsistent with the Pay-for-Performance Hypothesis, I find a significantly negative relationship between CEO-to-employee relative pay and multiple measures of nonprofit performance. These results highlight the importance of strong governance mechanisms in mitigating high levels of relative pay to and poor performance by executives in organizations marred by severe agency conflicts and ineffective monitoring mechanisms.