Pinching pennies to please donors can hurt nonprofits

The end of the year is a popular time to give to charity.

Historically, Americans have made 30 percent of their annual donations in December.

But no matter what time of year it is, donors want help deciding which charity to support.

One approach to evaluating nonprofits is to rank charities according to how much of their budgets they spend on everything from paperclips to insurance.

A dangerous obsession

Known as the overhead ratio, this covers expenditures that might appear to be unrelated to a charity’s mission. Such money, the argument for low overhead ratios goes, might be wasted.

Nonprofits typically have overhead ratios of about 20 percent, meaning that they spend about 1 out of every 5 dollars on fundraising expenses, accounting, publicity and everything else needed to operate. Some salary and benefits expenditures count as well, depending on what the employee does.

Pressure from donors, charity watchdogs, the media and even lawmakers to keep overhead costs low can conspire to deprive nonprofits of the money they need to run smoothly. In some cases, pressure to keep overhead low can depress pay and bring about skimpy staffing and benefits, making it harder for charities to hire and keep good employees.

Scholars and other experts call the unintended damage caused by donors who want to see their money support the groups with the lowest relative overhead the “nonprofit starvation cycle.”

Monitoring overhead ratios may help flag charities that are perhaps being wasteful – or even worse, carrying out scams.

But when donors use their influence to insist on restricting overhead costs, it can be counterproductive.

Five large foundations have acknowledged this. The Ford Foundation, Hewlett Foundation, MacArthur Foundation, Open Society and the Packard Foundation said that they found that the charities they supported, even well-known organizations, weren’t getting enough money to cover the cost of their operations. The foundations are increasing the amount of their funding that nonprofits may spend on overhead.

A widespread problem

Those foundations give away millions of dollars every year. But much smaller-scale donors also traditionally use overhead ratios to guide their decisions about which charities to support.

In a study with economist Javier Portillo, participants were told to choose between two similar charities. The charity they chose would receive a donation of $100. Their choices varied according to how much their donation went to overhead.

The share who chose the first charity fell from 66 percent to less than 30 percent when the study’s participants heard that some of the donations they directed would be covering overhead expenses. This pattern held regardless of whether 20 percent or 50 percent of the donation went to overhead costs, and whether that overhead cost went to fundraising, salaries or both.

In a follow-up study, participants donated their own money, and about 40 percent of them were willing to give up money so as to withhold donations from a charity with a higher overhead ratio.

Lower overhead ratios can hamper operations, leading to fewer donations and assets.

Better alternatives

Despite years of research pointing out the drawbacks of relying on overhead ratios as a way to see which charities to support, the temptation to keep using them remains strong.

Many charity evaluation firms, such as Charity Navigator, Charity Watch and, still use them.

Yet, mounting evidence suggests that organizations with higher overhead ratios can actually be more effective.

Some scholars are working on better ways to evaluate nonprofits, but so far they are more helpful for foundations and other big donors than for average givers.

If you are in the giving spirit this holiday season, by all mean support causes you are passionate about. To reduce the risk of your money being squandered, check with the charity evaluators to see if they’ve had problems with fraud.

Many evaluators also provide accountability and transparency ratings, which measure whether nonprofits are open about their finances. It’s a more meaningful signal than overhead ratios.

By Joseph Stinn of Miami University; republished from The Conversation under a Creative Commons license. 

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