Societal trust and the economic behavior of nonprofit organizations
Introduction
Societal generalized trust (hereafter “trust”) can serve as a key tool to reduce financial frictions and agency problems. Trust between agents can enhance successful relational exchanges (Morgan & Hunt, 1994). To that end, prior research finds that higher trust is associated with an array of positive outcomes, such as higher levels of earnings quality and greater credibility of earnings news (Pevzner, Xie, & Xin, 2015; Wei & Zhang, 2015) as well as lower levels of corporate misconduct (Dong, Han, Ke, & Chan, 2016). However, an underlying assumption is that trust is usually accompanied by enforcement mechanisms, which are discussed below in further detail (Knechel, Mintchik, Pevzner, & Velury, 2017; Robinson & Robinson, 2015). In the nonprofit setting, enforcement mechanisms are generally weaker than those in the for-profit environment. Therefore, institutional differences between the for-profit and nonprofit settings make it unclear ex-ante whether trust would have a similar impact on nonprofits. Accordingly, we examine the impact of trust on nonprofit managerial opportunism in an attempt to shed light on the role of trust on managerial behavior in the nonprofit setting.
Societal trust can be expected to play a more positive exchange-enhancing role in “repeated game” long-term relationships between agents and principals (Garbarino & Johnson, 1999). In the for-profit setting, shareholders, as residual claimants, have an incentive to monitor and discipline managers for violating trust. Consequently, for-profit managers understand that exploiting trust can lead to long-term consequences of lower stock prices and/or reduced employment (Fama & Jensen, 1983a,b). Thus, shareholders can use the stock market as a disciplining mechanism. In the for-profit setting, external enforcement mechanisms, such as the Securities and Exchange Commission (SEC) and active class-action shareholder litigation, are extra layers of discipline that enforce the principal-agent trust. Therefore, in the for-profit environment, disciplining mechanisms accompany the direct-monitoring relationship between principal and agent.
In the nonprofit environment, the principals are the donors and, unlike shareholders, they are not residual claimants (Desai & Yetman, 2015). Donors are commonly inspired to give because of the “warm glow” surrounding a nonprofit's mission (Andreoni, 1990; Becker, 1974). Since donors do not attempt to preserve their own wealth, their incentives for monitoring nonprofit managers (agents) are generally weaker than those of shareholders. In addition, stringent enforcement mechanisms such as the SEC and shareholder litigation, as well as an equivalent market disciplining mechanism, are largely absent in the nonprofit setting. This relative lack of nonprofit monitoring and enforcement may mean that, compared to their for-profit counterparts, nonprofit managers have less incentive to respect the trust relationship.
Using 93,117 observations of nonprofit entities from the National Center for Charitable Statistics (NCCS) database for the period between 1986 and 2012, we examine the effect of trust on the likelihood of overspending on administrative expenses. Overspending on administrative expenses indicates inefficient resource allocation (Baber, Daniel, & Roberts, 2002; Trussel and Parsons, 2007), which can suggest managerial opportunism. We measure trust as the percentage of people in a given U.S. geographic region who consider themselves to be trusting, according to surveys conducted by the World Values Survey.2
Our primary result reveals that nonprofits operating in higher trust areas are more likely to overspend on administrative expenses, suggesting that managerial opportunism can prevail in response to high trust. In other words, the institutional make-up of nonprofits enables managers to overspend on administrative expenses in the presence of higher trust. Our main result concerns the average effect among nonprofits. However, nonprofits differ in their mission, operation, and relationship with donors. Accordingly, our results vary by nonprofit type. Though there are a wide variety of nonprofits (Yetman & Yetman, 2012a), a broad distinction can be made based upon whether the donor receives a service from the nonprofit (Hansmann, 1980).
Using this distinction, we examine the effect of trust on two nonprofit categories: service organizations and public charities. Consistent with Kitching, Roberts, and Smith (2012), our public charities category excludes art and culture nonprofits, religious organizations, and nonprofits in the education or medical field. These excluded organizations, where donors receive a service or benefit from the nonprofit, are categorized as service organizations. Donors to service organizations are likely to be actively involved with the nonprofit on a regular basis, which can “build trust and obviate the need for a formal feedback mechanism” (Gordon & Khumawala, 1999, p.48). In such case, these donors resemble consumers. As long as donors are satisfied with their service from the nonprofit, they may be less inclined to monitor (Gordon & Khumawala, 1999). Thus, while donors may trust the service organizations, they also may have less incentive to properly monitor those nonprofits, thereby creating a situation where trust could be exploited.
In public charities, which make up the remaining nonprofit entities, the donor does not receive the service. This creates a clear distinction between donor and service recipient (Balsam & Harris, 2014). Compared with donors to service organizations, donors to public charities are likely to be more reliant on formal mechanisms, such as financial information, to ensure that their donations are properly expended. We find that the association between trust and overspending is driven by service organizations, as opposed to public charities. This is consistent with the view that trust can be exploited in service organizations because of the lack of proper monitoring.
Service organizations appear to overspend on administrative expenses in the presence of higher trust due to a relative lack of monitoring by their donors. As such, we perform additional testing to determine whether the presence of other potential monitoring mechanisms has an impact on this behavior. In the additional cross-sectional tests, we find that service organizations are most likely to overspend on administrative expenses in the presence of high trust when there is weaker governance, less external monitoring, less competition, or lower information quality. Overall, we suggest that weaker forms of oversight help enable opportunistic behavior when there is high trust.
In additional analysis, we find that trust is positively associated with abnormal accruals and excess compensation in service organizations. This is consistent with the results of Balsam and Harris (2014), who suggest that service organization donors are less likely to react negatively to the excessive compensation of service organization executives. Overall, this provides support for our main finding of managerial opportunism in the presence of higher trust, which is contrary to what has been observed in “for profit” literature (Hilary & Huang, 2015). Our results are robust to alternate definitions for service organizations and public charities as well as to an industry - adjusted calculation of the trust variable. We also find that the trust-overspending association for service organizations is present only for education and religious organizations.
Our study advances the literature by exploring the association between trust and the economic behavior of managers in the nonprofit sector. To the best of our knowledge, this is the first study to examine and provide an important understanding of the impact of societal trust in the nonprofit sector. By documenting that trust is associated with overspending on administrative expenses, our study suggests that trust plays a different role in the nonprofit setting than in the for-profit environment. Moreover, our study also reveals that trust does not affect all nonprofits in the same way. Specifically, we document that service organizations are more likely to behave opportunistically in high-trust environments than are public charities. Although we attribute this to the potentially different principal-agent relationship in these two nonprofit types, we also note there is variation even among the service organizations. To that end, education and religious institutions were the service organizations most likely to overspend in the presence of high trust. Furthermore, we document that weaker oversight is associated with opportunistic behavior in the presence of higher trust. This suggests that increased monitoring may help reduce a nonprofit's likelihood of overspending when trust is high (Robinson & Robinson, 2015).
Our paper proceeds as follows. Section 2 provides hypothesis development. In Section 3, we describe our research design and sample. Section 4 describes our empirical results and Section 5 concludes with a discussion of our results and future research opportunities.
Section snippets
Hypothesis development
Recent research has emphasized the potential benefits of trust in for-profit capital markets. The broad theme of this research is that higher societal trust is associated with lower levels of transaction and agency costs. Higher-trust societies experience stronger economic growth and GDP (Zak & Knack, 2001; Knack and Keifer, 1997), experience lower levels of corruption (Aghion, Algan, Cahuc, & Shleifer, 2010), and have lower levels of earnings management and more credible reported earnings (
Sample selection
We compile nonprofit data from the Statistics of Income (SOI) file made available by the National Center for Charitable Statistics (NCCS) for the years 1986–2012. The SOI data are based on Form 990 that nonprofit organizations file with the IRS. These include all organizations with total assets of at least $10 million for years before 2000 and at least $30 million in assets for years 2000 and after. The data also include a stratified sample of smaller organizations. The SOI database captures
Summary statistics
Table 2, Panel A, displays descriptive statistics by each of the nine regions used for the trust data. As indicated, the national mean for Trust is 0.395. Trust is reported highest in the Rocky Mountain region (0.439) and lowest in the East South Central region (0.231). The mean of Over Spend Admin is 0.522, suggesting that over half the sample nonprofits are likely to spend more on administrative expenses than would be expected. The mean of Over Spend Admin is relatively even among the
Conclusion
Our paper explores the impact of generalized societal trust on opportunistic behavior of nonprofit organizations. Evidence from the for-profit literature suggests that the level of generalized trust enhances the credibility of financial information and is associated with lower levels of managerial opportunism (Pevzner et al., 2015). However, the significant differences that exist between the for-profit and nonprofit environments make it unclear whether trust plays a similar role for nonprofits.
Data availability
Data are available from commercial and non-commercial sources identified in the text.
Acknowledgements
Mikhail Pevzner gratefully acknowledges the assistance of EY Chair in Accounting at the University of Baltimore.
References (43)
- et al.
Lost in translation? The effect of cultural values on mergers around the world
Journal of Financial Economics
(2015) - et al.
Does corporate governance matter in competitive industries?
Journal of Financial Economics
(2010) - et al.
When firms talk, do investors listen? The role of trust in stock market reactions to corporate earnings announcements
Journal of Financial Economics
(2015) - et al.
Web disclosure and the market for charitable contributions
Journal of Accounting and Public Policy
(2014) - et al.
Financial reporting factors affecting donations to charitable organizations
Advances in Accounting
(2007) - et al.
Regulation and distrust
Quarterly Journal of Economics
(2010) Impure altruism and donations to public goods: A theory of warm-glow giving
The Economic Journal
(1990)- et al.
Fraud and corruption in U.S. nonprofit entities: A summary of press reports. 2008–2011
Nonprofit and Voluntary Sector Quarterly
(2015) - et al.
When does trust matter? Antecedents and contingent effects of supervisee trust on performance in selling new products in China and the United States
Journal of Marketing
(2002) - et al.
Compensation to managers of charitable organizations: An empirical study of the role of accounting measures of program activities
The Accounting Review
(2002)
The impact of CEO compensation on nonprofit donations
The Accounting Review
A theory of social interaction
Journal of Political Economy
Determinants of generalized trust: A cross-country comparison
Public Choice
Healthcare nonprofits: Enhancing governance and public trust
Business and Society Review
Constraining managers without owners: Governance of the not-for-profit enterprise
Journal of Government & Nonprofit Accounting
Social trust and corporate misconduct: Evidence from China
Journal of Business Ethics
Separation of ownership and control
Journal of Law and Economics
Agency problems and residual claims
Journal of Law and Economics
Using archival data sources to conduct nonprofit accounting research
Journal of Public Budgeting, Accounting & Financial Management
The different roles of satisfaction, trust, and commitment in customer relationships
The Journal of Marketing
Funding sources and excess CEO compensation in not-for-profit organizations
Accounting Horizons
Cited by (11)
Financial reporting timeliness and its determinants in UK charities
2024, Advances in AccountingThe effects of local newspaper closures on nonprofits’ executive compensation
2024, Journal of Accounting and Public PolicyThe audit in a modern economy
2023, Handbook of Financial Decision MakingNonprofit Scandals: A Systematic Review and Conceptual Framework
2023, Nonprofit and Voluntary Sector QuarterlyIs it time to clean up US tax-exempt nonprofit reporting?
2023, Sustainability Accounting, Management and Policy JournalThe impact of forensic auditing techniques on non-government organisations' fraud risk management in South Africa using a proactive approach
2023, International Journal of Monetary Economics and Finance