How Private Foundation Sophistication Affects Capital Campaign Grant Decisions
ABSTRACT:
We examine how charity financial
information related to efficiency and financial vulnerability is used by
private foundations in determining how much they grant to charities during capital campaigns. In general, private
foundations are likely to be better
able to evaluate charity financial information because they are sophisticated
donors. They have the incentive to incur search costs, the ability to judge
financial information, and are focused on grant-making. We find no evidence
that efficiency measures are used by private foundations in determining capital
campaign grant amounts, regardless
of foundation sophistication. We interpret this result as being consistent with private foundations
focusing on factors related to program accomplish- ments rather than on
reported efficiency. We find evidence that private foundations pay larger grant
amounts to less financially vulnerable charities. This effect is concentrated
when grants are paid by more sophisticated private foundations (i.e., those that employ a professional staff ).
Data Availability: Data
are available from the public sources cited in the text.
Keywords: private foundations; public
charities; efficiency; program ratio; financial vulnerability; donations;
capital campaigns.
|
harities play a large role in our economy by
receiving donations that are used to provide critical services to those in
need. In 2017, public charities received an estimated $410.2 billion in total donations (Giving USA 2019). Donors are primarily interested in whether
charities are effective in providing their
program services (Parsons 2003) and, ideally, donors
![]() |
This paper has benefited from helpful comments by Christine
Petrovits, Perry Solheim, session participants at the 2014 American Accounting Association
Western Region Meeting and 2014 Annual Meeting, and the work by Tim Yoder on an
earlier stage of the paper. Professor McAllister would like to thank the
College of Business at the University of Colorado Colorado Springs for summer
research funding.
Editor’s note:
Accepted by Vaughan S. Radcliffe.
Submitted: July 2018
Accepted: September
2019 Published Online: September 2019
1
would evaluate effectiveness by comparing
program accomplishments to dollars spent. However,
due to their complexity and qualitative nature, program accomplishments are
difficult to quantify. Most donors lack adequate time, expertise, and detailed
information to make a thorough evaluation.
Private foundations differ
from other donors in that their core business is evaluating charities and
distributing grants. Private foundations are ‘‘all
assets and no liabilities’’ (Schramm 2006), meaning they have extensive
resources to employ
toward grant-making activities. Because private foundations’
activities are focused on grant-making, they have both the incentive to incur
search costs and the ability to judge financial
information. Many private
foundations also formally
request charities to apply for grants, which provides access to private
charity financial and nonfinancial information that individual donors are
unable to obtain. In general, private foundations are sophisticated donors. In 2015, over 79,000 independent U.S.
private foundations existed, and combined, they held $704.0 billion
of total assets
and paid grants
totaling $44.1 billion
(Foundation Center 2019).
Our study is the first to our knowledge to examine how charity financial information is used by
private foundations in making charitable grants. We focus on grants for capital
campaigns because they involve
fundraising efforts by charities to secure significant amounts of financial
capital for specific, long-term
purposes. Capital campaigns provide a context where private foundations are likely
to provide leadership grants to charities. Leadership grants often launch a capital campaign, and therefore are important as
a credible signal of grantee charity quality (Andreoni 2006). As a result, private
foundations are likely to expend significant resources to gather, evaluate, and
communicate information about grantee charities seeking capital campaign funding.
Because most donors are less sophisticated than private foundations, the majority are likely to rely
on readily available charity efficiency measures such as the program ratio.
Prior research (Weisbrod and Dominguez 1986; Posnett and Sandler 1989; Tinkelman 1999; Okten and Weisbrod 2000) provides consistent evidence of an association between
total donations and efficiency
measures. However, donors’ reliance on the program ratio has been criticized as being incomplete and inaccurate (e.g.,
Tinkelman and Donabedian 2007). Administrative and fundraising
costs are necessary for charities
to achieve their mission. Program
ratios disregard organizational strategy and are dependent
on charity-specific factors (Baber, Roberts, and
Visvanathan 2001; Tinkelman 2006). Failure
to adequately plan, evaluate, and coordinate program activities is likely to
lead to program costs that are inefficient, even counter-productive, at
achieving charity missions. Further, prior research (Tinkelman 1998; Khumawala, Parsons, and Gordon 2005; Jones and Roberts
2006; Krishnan, M.
Yetman, and R. Yetman 2006; M. Yetman and R. Yetman 2013) has established that charities often attempt to
manipulate their program ratios. Donors’ excessive reliance on the program
ratio has the potential to lead to inefficient allocation of charitable capital, such as cutting productive administrative and fundraising costs, as well as other dysfunctional behavior (Kitching, Roberts, and Smith 2012).
We examine how private
foundations use program ratios to evaluate whether charities are using donations
received efficiently toward
program-related activities. Private
foundations as more sophisticated donors are likely to
place less emphasis on the program ratio relative to individual donors for at least three reasons.
First, they formally
request charities to apply for grants and have
better opportunities to informally request information during the grant
process, both of which provide access to private charity financial and
nonfinancial information that individual donors are unable to obtain. Second,
private foundations have greater expertise and experience to see through any
manipulation of the reported program ratio. Most importantly, foundations have greater expertise and resources
to evaluate program
results. In contrast
to prior research, we
expect that grants from a more sophisticated
donor group, private foundations, will be less sensitive to program ratios.
We also examine how
private foundations evaluate whether charities are financially vulnerable.
Financial vulnerability is typically assessed using financial measures such as debt ratio, revenue concentration, profit
margin, and working capital (Tuckman and Chang
1991; Greenlee and
Trussel 2000; Trussel 2002; Trussel and Greenlee 2004; Hodge and Piccolo 2011; Gordon, Fischer, Greenlee, and
Keating 2013; Searing 2018). Parsons and Trussel (2009) find
that financial stability (the converse of financial vulnerability) is
positively associated with total donations. However, their study does not
examine the relationship between financial vulnerability and donations by donor
type. All donors are likely to care about financial vulnerability. However,
because financial vulnerability is more difficult to assess, not all donors
are likely to have the ability
to evaluate it. Private foundations as a larger, more sophisticated donor type
are at an advantage of assessing
financial vulnerability. Again, they have greater access to private financial
and nonfinancial information through the grant application process to help
evaluate financial vulnerability. They also have more resources to employ
professional grant-making personnel with the sophistication to be able to
judge financial vulnerability. Furthermore, private foundations are likely to
be motivated to evaluate whether charities are vulnerable financially because
of the long- term focus of capital campaigns. We expect private
foundations to respond negatively to charities
that are financially vulnerable.
Finally, sophistication is
likely to vary across private foundations. We propose that the extent to which private foundations are sophisticated will impact how they respond
to program ratios
and financial vulnerability. Some private foundations are created with
the intent to operate as stand- alone entities in the formal business of professional grant-making. These are ‘‘active’’ grant makers
because they employ professional managers
and staff (Sansing and Yetman 2006) to evaluate
the likelihood and magnitude to achieve significant social impact
through their grant-making (Fleishman 2009). We classify these as ‘‘more sophisticated’’ private
foundations. Alternatively, some private foundations are established as
extensions of the founder as an individual donor. They donate to express
support toward a worthy cause,
but do not expect to make a lasting social impact through their grants (Fleishman 2009). As a result, they
have little need to employ professional managers or grant-making staff to
evaluate potential grantee charities. Sansing and Yetman (2006) identify these as ‘‘passive’’ private foundations. We
classify these as ‘‘less sophisticated’’ private foundations.
Our final sample consists
of 2,872 capital campaign grants made by 530 private foundations to 1,700
charities. Because of data unavailability, we exclude charities
that did not receive a private
foundation grant.1 Therefore, our sample consists of charities after
the use of efficiency and financial vulnerability measures by foundations to
initially screen grant applicants. We find no evidence that efficiency measures
are used by private foundations in determining capital
campaign grant size to grant-eligible charities, regardless of foundation sophistication. We interpret this result as being
consistent with private foundations focusing on factors other than reported
efficiency (e.g., program accomplishments). In contrast, we find evidence
that private foundations pay larger
Get Free Quote!
439 Experts Online