Elsevier

Advances in Accounting

Volume 39, December 2017, Pages 21-31
Advances in Accounting

Societal trust and the economic behavior of nonprofit organizations

https://doi.org/10.1016/j.adiac.2017.09.003Get rights and content

Abstract

This study explores the impact of societal trust on the economic behavior of nonprofit organizations. Although prior studies reveal that trust has a positive impact on the economic behavior of for-profit firms, the institutional differences between the two organization types make it unclear whether trust plays a similar role in nonprofits. Our results show that nonprofits operating in higher trust areas are more likely to overspend on administrative expenses. This positive relationship between trust and overspending is primarily driven by service organizations, as opposed to public charities. Moreover, within service organizations, we find that the positive trust-administrative overspending association is most prevalent in situations of weaker monitoring or governance. Additional tests show trust has a similar impact on excess compensation and abnormal accruals in service organizations. Overall, our findings suggest that trust may provide opportunities for nonprofit managers, particularly in service-oriented organizations, to engage in opportunistic behavior that may be exacerbated by weaker forms of oversight.

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)

  • S. Balsam et al.

    The impact of CEO compensation on nonprofit donations

    The Accounting Review

    (2014)
  • G. Becker

    A theory of social interaction

    Journal of Political Economy

    (1974)
  • C. Bjørnskov

    Determinants of generalized trust: A cross-country comparison

    Public Choice

    (2007)
  • M.S. Blodgett et al.

    Healthcare nonprofits: Enhancing governance and public trust

    Business and Society Review

    (2012)
  • M.A. Desai et al.

    Constraining managers without owners: Governance of the not-for-profit enterprise

    Journal of Government & Nonprofit Accounting

    (2015)
  • W. Dong et al.

    Social trust and corporate misconduct: Evidence from China

    Journal of Business Ethics

    (2016)
  • E. Fama et al.

    Separation of ownership and control

    Journal of Law and Economics

    (1983)
  • E. Fama et al.

    Agency problems and residual claims

    Journal of Law and Economics

    (1983)
  • N.C. Feng et al.

    Using archival data sources to conduct nonprofit accounting research

    Journal of Public Budgeting, Accounting & Financial Management

    (2014)
  • E. Garbarino et al.

    The different roles of satisfaction, trust, and commitment in customer relationships

    The Journal of Marketing

    (1999)
  • J.J. Gaver et al.

    Funding sources and excess CEO compensation in not-for-profit organizations

    Accounting Horizons

    (2013)
  • Cited by (11)

    • The audit in a modern economy

      2023, Handbook of Financial Decision Making
    • Nonprofit Scandals: A Systematic Review and Conceptual Framework

      2023, Nonprofit and Voluntary Sector Quarterly
    • Is it time to clean up US tax-exempt nonprofit reporting?

      2023, Sustainability Accounting, Management and Policy Journal
    View all citing articles on Scopus
    View full text