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Three features of nonprofit and voluntary organizations
Attempting to define the fundamental features of the disparate entities that constitute the nonprofit and voluntary sector is a complex and daunting task. Yet there are at least three features that connect these widely divergent entities: (1) they do not coerce participation; (2) they operate without distributing profits to stakeholders; and (3) they exist without simple and clear lines of ownership and accountability. Taken together, these three features might make nonprofit and voluntary organizations appear weak, inefficient, and directionless, but nothing could be further from the truth. In reality, these structural features give these entities a set of unique advantages that position them to perform important societal functions neither government nor the market is able to match.
Perhaps the most fundamental of the three features is the sector's noncoercive nature. Citizens cannot be compelled by nonprofit organizations to give their time or money in support of any collective goal. This means that, in principle at least, nonprofits must draw on a large reservoir of good will. This noncoercive character is also what most starkly differentiates the sector from government, which can levy taxes, imprison violators of the law, and regulate behavior in myriad ways. The power of coercion that the public sector possesses is a powerful tool for moving collectivities toward common ends, but it is also a source of strife and contention. Trust in government is now low, 3 making the effective use of state power more and more difficult as its legitimacy fades. For nonprofit and voluntary organizations, these issues do not arise. Free choice is the coin of the realm: Donors give because they choose to do so. Volunteers work of their own volition. Staff actively seek employment in these organizations, often at lower wages than they might secure elsewhere. Clients make up their own minds that these organizations have something valuable to offer. Though they stand ready to receive, nonprofit and voluntary organizations demand nothing. As a consequence, nonprofits occupy a moral high ground of sorts when compared to public sector organizations that have the ability to compel action and coerce those who resist.
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In some ways, the noncoercive character of the nonprofit and voluntary sector situates it closer to the market than to government. Business depends on the free choice of consumers in a competitive market where alternatives are often plentiful and where no firm has the capacity to compel anyone to purchase its goods or services. Similarly, nonprofit organizations cannot coerce participation or consumption of their services. The sector makes choices available, rather than deciding for others. When it comes to the mobilization of funds, the parallel between business and nonprofits is equally clear. Just as no one forces anyone to buy shares or invest in enterprises, no one forces anyone to give or volunteer in the nonprofit world. The flow of resources to a nonprofit depends entirely on the quality and relevance of its mission and its capacity to deliver value. To the extent that a business firm or a nonprofit organization is performing well, investors and donors will be attracted to it. Should things take a turn for the worse, investment funds and philanthropic funds usually seek out other options quickly.
The second feature of nonprofit and voluntary organizations sharply differentiates them from business firms, however. While corporations are able to distribute earnings to shareholders, nonprofit and voluntary organizations cannot make such distributions to outside parties. Rather, they must use all residual funds for the advancement of the organization's mission. 4 By retaining residuals rather than passing them on to investors, nonprofit organizations seek to reassure clients and donors that their mission takes precedence over the financial remuneration of any interested parties. The nondistribution constraint has been seen as a tool that nonprofits can use to capitalize on failures in the market. Since there are certain services, such as child care and health care, that some consumers feel uncomfortable receiving if the provider is profit driven, nonprofits are able to step in and meet this demand by promising that no investors will benefit by cutting corners or by delivering unnecessary services.
While the noncoercive feature of nonprofits brings nonprofits closer to business and separates them from government, the nondistribution constraint pushes nonprofits closer to the public sector and away from the private sector. Government's inability to pay out profits from the sale of goods or services is related to its need to be perceived as impartial and equitable. 5 With nonprofits, the nondistribution constraint also builds legitimacy and public confidence, though this does not mean that special powers are vested in these organizations. In both sectors, the nondistribution constraint strongly reinforces the perception that these entities are acting for the good of the public.
The third feature of nonprofit and voluntary organizations is that they have unclear lines of ownership and accountability. 6 This trait separates these entities from both business and government. Businesses must meet the expectations of shareholders or they risk financial ruin. The ownership question in the business sector is clear and unambiguous: Shareholders own larger or smaller amounts of equity in companies depending on the number of shares held. Similarly, government is tethered to a well-identified group of individuals, namely voters. Executive and legislative bodies—and the public agencies they supervise at the federal, state, and local levels—must heed the will of the electorate if they are to pursue public purposes effectively and retain the support and legitimacy needed to govern. There is also a long tradition in the United States of conceiving government as "belonging" to citizens, though the ways in which this ownership claim can be exercised are severely limited. In the nonprofit sector, clear lines of ownership and accountability are absent. 7
Nonprofit and voluntary organizations must serve many masters, none of which is ultimately able to exert complete control over these organizations. Donors, clients, board members, workers, and local communities all have stakes, claims, or interests in nonprofit and voluntary organizations. Yet none of these parties can be clearly identified as the key ownership group. The relative strength of these ownership claims depends on how an organization is funded and on its chosen mission. 8 Nonprofit organizations that depend heavily on charitable contributions are often held closely accountable by their donors, some of whom believe that as social investors they have a real stake in the organizations to which they contribute. Nonprofits that are largely driven by service fees or commercial revenues are in a different position. While these more commercial organizations do not have donors asserting claims over them, social entrepreneurs and professional staff may view themselves as the key stakeholders in these more businesslike organizations.
Often, however, the lines of ownership and accountability are rendered more complex by the fact that many nonprofit organizations combine funding from multiple sources—foundations, corporations, and government—with earned income, making it hard to point to any particular party as the key stakeholder to whom these special institutions must answer. 9 One might be tempted to point out that nonprofit and voluntary organizations are almost always governed by boards, and to propose this as a solution to the ownership and accountability issue. Unfortunately, board members are not owners. They are stewards who are held responsible for the actions of their organization. In the end, nonprofit and voluntary organizations are authorized to act in the public interest by the communities in which they operate, though the lines of accountability are weaker than those in the public sector and the lines of ownership far more obscure than in the business sector.
| …nonprofits occupy a moral high ground of sorts, when compared to public sector organizations… |
| — Peter Frumkin |
These three features of nonprofit organizations are not without controversy and contention. In fact, each has been called into question in recent years. First, the noncoercive nature of the sector has been challenged by the growing tendency to mandate community service or volunteer work. In the case of welfare reform, many states have required aid recipients to complete a community service requirement in order to continue receiving their monthly support payments. 10 A growing number of high schools now make volunteering with a local organization a condition for graduation. In addition, there have long been parts of the nonprofit landscape where strong norms are enforced on those who have committed to membership. Within professional associations, licenses to practice medicine, law, and other callings are granted and denied by nonprofit entities. 11 Within many religions, the behavior of adherents is severely constrained by doctrine. In some neighborhoods, independent community groups have been granted the power to plan and constrain future development by residents. The exercise of power may be subtle in some cases. For example, many private funders exercise considerable influence over the recipients of their grants. This influence can take the form of a gentle suggestion or a condition of support that programs be revamped. 12 Although the constraints imposed in each case follow a decision to participate and join, the power of some nonprofits over groups of individuals is considerable. In each and all such instances the noncoercive character of these organizations is called into question. 13
Second, the nondistribution constraint of nonprofit organizations has likewise been under assault from a number of different directions. In recent years, increased scrutiny of the high salary levels of many nonprofit executives has led some to ask whether the "profits"—or, more accurately, the increased program revenues—are not in fact being routinely distributed to staff in the form of generous compensation and benefit packages. 14 In the area of capitalization, large nonprofit organizations have been aggressive in raising funds through bond offerings, which do not offer investors the ownership stake that stock offerings do, but which have the effect of opening up major capital flows into the nonprofit sector. The accumulation of capital in the form of large endowments has also called into question the boundary between business and nonprofit organizations: Endowment funds, by their nature, are not used to fulfill an organization's immediate needs. Instead, they are invested in stocks, real estate, and other speculative investments designed in the long run to maximize financial return. This is a strategic move that some have characterized as contrary to the public purposes of nonprofit organizations. 15 Making the boundary between nonprofits and business firms even more opaque, at least one study has argued that the nondistribution constraint does not significantly increase consumer confidence in the trustworthiness of nonprofits compared to business firms. 16
Third, the ownerless character of nonprofit and voluntary organizations has come under fire as the legal claims of nonprofit stakeholders have evolved. The courts have held that only members (in the case of a membership organization), trustees or directors, and the attorney general in the state where the nonprofit is located have legal standing to contest the action of a charitable corporation. Over the years, however, the power of trustees and directors has grown substantially, not to the point where they can claim ownership of the assets of a nonprofit, but to the point where boards now have tremendous leeway in the way they operate a charitable organization. 17 While these claims have rarely come to equal those of ownership, the lines of accountability have been drawn more sharply, particularly as questions about the transfer of assets have come up when nonprofit organizations have attempted to convert to for-profit status. 18
The ultimate result of these debates and trends is that the defining features of nonprofit organizations are evolving and are the subject of considerable debate. The notion that there is some simple and unambiguous test that can be developed to decide what sector an organization belongs to is no longer reasonable. While the Internal Revenue Service (IRS) and the states have developed statutes and rules that define and regulate these special institutions, a different and far more complex reality has emerged. The legal code is often of limited value in the effort to determine which organizations are really nonprofit and voluntary in their operation.
Composition of the nonprofit and voluntary sector
In the United States today, there are more than one and a half million registered nonprofit organizations, as well as several million informally organized community groups. The formally registered organizations fall into two broad and porous categories: those that serve the public and those that serve members. The public-serving organizations, classified under section 501(c)3 of the IRS code, operate in almost every imaginable field of human endeavor, and include, among countless others, social service agencies helping children, the elderly, and the poor; independent schools and private colleges; community clinics and hospitals; think tanks; environmental organizations; cultural groups such as museums, theaters, and historical societies; and a range of international assistance organizations. They are the most visible and recognizable part of this organizational universe. But substantial resources are concentrated in the member-serving or mutual benefit organizations, which include credit unions, business leagues, service clubs, veterans' organizations, and trade associations. They tackle problems ranging from the most complex issues of business policy to the most prosaic challenges of small-town life. Also included in the sector (though not filing forms annually with the IRS) is a vast array of churches, synagogues, and mosques that form the foundation of the nation's religious life. While we tend to think of congregations as membership organizations, they are treated differently by government and are not subject to the same forms of oversight as other member-serving nonprofits.
While the largest and better-financed nonprofit organizations receive the bulk of public attention, important work is done by the army of less visible associations, clubs, networks, and groups through which communities come together and act. 19 There is considerable dispute as to whether the legally chartered nonprofit organizations share enough traits with informal voluntary associations to justify including both groups in one sector. 20 However, leaving these grassroots associations out of the picture grants far too much deference to the tax treatment of nonprofits and ignores the fact that informal associations and formal nonprofits both eschew the distribution of profits, are noncoercive, and have no owners.
Public awareness of the sector is rapidly increasing, though surprisingly little is known about the underlying purposes and values that animate nonprofit and voluntary action or the vehicles through which these values and purposes are channeled. In part, this is because these activities reflect a sometimes-confusing agglomeration of strongly held private values, as well as a set of complex public purposes. The sector can thus be conceived as a tent covering public-serving charities, member-serving organizations, and a range of informal organizations, including voluntary and grassroots associations.
This diverse and at times contradictory group of entities comprises organizations and associations that are neither part of the state nor fully engaged in the market. The sector's solutions to community and public problems at times represent a conscious disavowal of commercial markets and a realization that some exchanges are simply better conducted under terms of mutuality and trust than under the strict dictate of caveat emptor. 21 Using charitable contributions, many nonprofit and voluntary organizations can deliver services to clients who are unable to pay. At other times, nonprofit and voluntary action represents an attempt to move beyond government action to find solutions to public problems that a majority of citizens are unable or unwilling to support. Nonprofits can and do speak to community needs that lie outside the priorities of the median voter. But the position of this group of organizations in relation to the market and the state is far more complex and changeable than these simple claims of differentiation might lead one to believe. In some fields of activity within the sector, intense commercialism has eroded the moral high ground of these organizations and transformed nonprofits into shadow businesses that compete actively for clients able to pay for the services they offer. In other fields, nonprofits have lost their autonomy from government and have come to serve as dutiful implementers of public sector programs and priorities. The lack of clarity in the identity of nonprofit and voluntary organizations in relation to business and government becomes ever more evident as soon as one considers the range of names used to speak about these entities.
Five Questions for Peter Frumkin
Peter Frumkin discussed his big-picture view of the nonprofit sector in an e-mail interview with HBS Working Knowledge Managing Editor Carla Tishler.
Tishler: Many books written today about the nonprofit sector are "how-to" books instructing people on fundraising techniques, or explaining the philosophy behind a particular company's social enterprise strategy. Your book focuses on higher-level concepts and policies pertinent to this sector. Why this approach? Are we at a particular point in the history of nonprofits that we need to take a longer look at their position in American society and the economy?
Frumkin: I wrote this book because I believe that there is a need in the nonprofit sector for an appreciation of the big picture—the meaning and purpose of nonprofit organizations. All too often, nonprofit managers are mired in problems and crises that make it hard for them to understand the context of their work. They rarely have a chance to come up for air and to think about the conceptual and policy issues that are actually shaping and defining their work. For students and scholars studying nonprofits, the same narrowness of focus can be a problem. A fair amount of the recent and growing research on nonprofits has been highly focused and specialized, either considering only a small subset of organizations in the sector or delving into a neatly circumscribed problem or issue. I wanted to try something broader, something that might help people grasp the larger context, especially now that people are waking up to the fact that the nonprofit sector is a significant piece of the national economy and a critical part of many local communities.
Q: Nonprofits have been characterized in many ways: "tax-exempt" organizations, "the independent sector," the "nongovernmental sector," the "voluntary sector," and so on. Is it important to agree on what to call nonprofits?
A: The names we use are not that important. But what is important is that we realize that many of our assumptions about nonprofits, which are wrapped up in the names we have used over time, may need to be reexamined.
The sector has undergone important changes in recent decades—from increased commercialization to greater politicization—and these changes are what explain the name game that we have played with nonprofits. The term independent sector, for example, seemed plausible enough until it was abundantly clear that nonprofit organizations, particularly in the health and social service fields, were anything but independent. Heightened levels of government funding in these and other critical parts of the sector made it far less independent than earlier idealizations may have led us to conclude.
We have changed the nomenclature as our understanding of nonprofits has evolved. In the end, rather than worry about names, we need to keep our eyes on the more important issue of what public benefits the sector is generating and how public policy can advance and support nonprofit initiatives in the future.
Q: In your book you mention that nonprofit and voluntary organizations are embraced both by conservatives and liberals. Is this a reflection of public confusion about nonprofits and their role, or something else?
A: It is more a reflection of the fact that nonprofits, at their best, can create common ground between those who want to enhance and improve the safety net and those who are interested in promoting private initiative and limiting the reach of the state. Nonprofits of all kinds—from large secular service providers to small faith-based agencies—can and do cross ideological boundaries in ways that few other American institutions are capable. While it may be a bit confusing to hear both sides of the political spectrum praise the work of nonprofit organizations, I think it is ultimately a clear sign that the sector is likely to continue to grow in importance and take on ever greater responsibilities, especially at a time when trust in government and the corporate world is very low.
Q: What is the key concept you'd like readers to take away from On Being Nonprofit?
A: That nonprofit organizations work best when they achieve balance across their four main roles as service delivery vehicles, promoters of civic and political engagement, vehicles for entrepreneurship, and enactors of values. Balance is important because nonprofits have gotten into trouble when they have become too one-sided. Only when nonprofit organizations achieve some kind of balance across the four critical functions I lay out in the book is it likely that the sector will be able to maximize its potential. The conceptual distinctions I make between these central functions of nonprofits will, I hope, be helpful in clarifying why we have nonprofits, what they are capable of contributing to society, and how public policy seeks to support the sector.
Q: What other projects are you working on these days?
A: I was lucky enough to spend the past year on research leave from the Kennedy School as a senior fellow of the New America Foundation, a Washington, D.C., think tank. Much of my time was devoted to writing a new book on philanthropy, entitled Strategic Giving. In the book, I explain how donors can go about constructing a strategy to guide their giving and I provide a set of frameworks and tools to support this task. One of the underlying arguments of the approach I sketch is that philanthropy is really most effective when it simultaneously produces significant public benefits and satisfies donors by allowing them to enact their values and commitment. The book is an extended exploration of how the public and private dimensions of giving can be brought together strategically. The book will be published toward the end of 2003 by the University of Chicago Press.
Footnotes:
3. Joseph S. Nye, Jr., Philip D. Zelikow, and David C. King, Why People Don't Trust Government (Cambridge, Mass.: Harvard University Press, 1997).
4. The idea of nondistribution constraint is clearly outlined in Henry B. Hansmann, "The Role of Nonprofit Enterprise," in Susan Rose-Ackerman, ed., The Economics of Nonprofit Institutions: Studies in Structure and Policy (New York: Oxford University Press, 1986), pp. 57-84.
5. The literature on the management of public sector organizations provides insights into some of the challenges of sustaining and leading a nonprofit organization. Some of the best studies of public management include Michael Barzelay Breaking through Bureaucracy: A New Vision for Managing in Government (Berkeley: University of California Press, 1992); Sanford Borins, Innovating with Integrity: How Local Heroes Are Transforming American Government (Washington, D.C.: Georgetown University Press, 1998); Laurence E. Lynn, Jr., Public Management as Art, Science and Profession (Chatham, NJ.: Chatham House, 1996); Mark H. Moore, Creating Public Value: Strategic Management in Government (Cambridge, Mass.: Harvard University Press, 1996); David Osborne and Ted Gaebler, Reinventing Government: How the Entrepreneurial Spirit Is Transforming the Public Sector (New York: Plume, 1992).
6. A good discussion of the legal framework guiding accountability in the nonprofit sector can be found in Laura Chisolm, "Accountability of Nonprofit Organizations and Those Who Control Them: The Legal Framework," Nonprofit Management and Leadership 6, no. 2 (Winter 1995): 141-156.
7. Kevin E. Kearns, "The Strategic Management of Accountability in Nonprofit Organizations: An Analytic Framework," Public Administration Review 54, no. 2 (1994): 185-192; Kevin E. Kearns, Managing for Accountability: Preserving the Public Trust in Public and Nonprofit Organizations (San Francisco: Jossey-Bass, 1996).
8. Henry Hansmann, The Ownership of Enterprise (Cambridge, Mass.: Harvard University Press, 1996).
9. Kirsten A. Grønbjerg, Understanding Nonprofit Funding: Managing Revenues in Social Services and Community Development Organizations (San Francisco: Jossey-Bass, 1993).
10. Most notably Wisconsin and New York City transformed their public assistance programs and made community service or part-time employment a requirement.
11. Thomas Haskell, ed., The Authority of Experts: Studies in History and Theory (Bloomington: Indiana University Press, 1984).
12. One critique of philanthropy has emphasized that some funders have channeled social protest and deradicalized grassroots social movements by imposing constraints and attempting to shape these efforts. See J. Craig Jenkins, "Channeling Social Protest: Foundation Patronage of Contemporary Social Movements," in Walter W. Powell and Elisabeth S. Clemens, eds., Private Action and the Public Good (New Haven, Conn.: Yale University Press, 1998), pp. 206-216; and Rosa Proietto, "The Ford Foundation and Women's Studies in American Higher Education: Seeds of Change?" in Ellen Condliffe Lagemann, ed., Philanthropic Foundations: New Scholarship, New Possibilities (Bloomington: Indiana University Press, 1999), pp. 271-286.
13. The nonprofit and voluntary sector also includes fringe organizations that espouse extreme political and racial views and rely on violence and intimidation. Although these organizations are a small part of the organizational universe, they undercut the image of a sector that does nothing but good. On the dangers of voluntarism, see Morris E. Fiorina, "Extreme Voices: The Dark Side of Civic Engagement," in Theda Skocpol and Morris P. Fiorina, eds., Civic Engagement in American Democracy (Washington, D.C.: Brookings Institution Press and Russell Sage Foundation, 1999).
14. The issue of how much nonprofit workers earn, and the need for complete public disclosure that compensation decisions create, is taken up in Peter Frumkin, "Transparent Nonprofits," The Public Interest 142 (Winter 2001): 83-94. See also Peter Frumkin and Alice Andre-Clark, "Nonprofit Compensation and the Market," University of Hawaii Law Review 21, no. 2 (Winter 1999): 425-485.
15. See Henry Hansmann, "Why Do Universities Have Endowments?" Journal of Legal Studies 19, no. 1 (January 1990): 3-42.
16. Steven E. Permut, "Consumer Perceptions of Nonprofit Enterprise: Comment on Hansmann," Yale Law Journal 90, no. 7 (June 1981): 1623-1632.
17. The adoption by most states of the American Bar Association's Model Nonstock Corporation Statute had a significant impact on accountability and ownership issues in nonprofit organizations. Among other things, the statute shifted the fiduciary standard toward a business judgment standard and away from that traditionally applied to trusts. In so doing, it enabled nonprofit boards to use proxy voting, change by-laws without membership approval, and delegate powers to executive committees. The main effect of these changes was to empower boards and to weaken the role of members (in membership organizations). For a detailed account of this shift, see Michael C. Hone, "Aristotle and Lyndon Baines Johnson: Thirteen Ways of Looking at Blackbirds and Nonprofit Corporations: The American Bar Association's Revised Model Nonprofit Corporation Act," Case Western University Law Review 39, no. 3 (1989): 751-762; and Peter Dobkin Hall, "Law, Politics, and Charities in the Post-Liberal Era," in Paul Pribbenow, ed., Serving the Public Trust: Insights into Fundraising Research and Practice (San Francisco: Jossey-Bass, 2000), pp. 5-31.
18. For a good overview of the issues related to the conversion of hospitals from nonprofit to for-profit status, see John H. Goddeeris and Burton Weisbrod, "Conversions from Nonprofit to For-Profit Legal Status: Why Does It Happen and Should Anyone Care?" Journal of Policy Analysis and Management 17, no. 2 (1998): 215-233; John H. Goddeeris and Burton Weisbrod, "Why Not For-Profit? Conversions and Public Policy," in Elizabeth T. Boris and C. Eugene Steuerle, eds., Nonprofits and Government: Collaboration and Conflict (Washington, D.C.: Urban Institute, 1999), pp. 235-266. See also Gary Claxton, Judith Feder, David Shactman, and Stuart Altman, "Public Policy Issues in Nonprofit Conversion," Health Affairs 16, no. 2 (March-April 1997): 9-26; and Jerome E. Kassirer, "Mergers and Acquisitions: Who Benefits? Who Loses?" New England Journal of Medicine 334, no. 11 (March 1996): 722-723.
19. Studies of nonprofit organizations have tended to focus on large established nonprofits because they control the bulk of the finances within the sector. Yet one recent estimate suggested that there may well be a substantial number of small, informal organizations that operate under the radar screen of researchers. See, for example, David Horton Smith, "The Rest of the Nonprofit Sector: Grassroots Associations as the Dark Matter Ignored in Prevailing `Flat Earth' Maps of the Sector," Nonprofit and Voluntary Sector Quarterly 26, no. 2 (June 1997): 114-131.
20. On the discontinuity between traditional voluntary associations and more modern voluntary organizations, see Peter Dobkin Hall, "Vital Signs: Associational Populations and Ecologies in New Haven, Connecticut, 18501990," in Skocpol and Fiorina, eds., Civic Engagement in American Democracy, pp. 211-248. On the broad evolution of voluntary associations, see Gerald Gamm and Robert Putnam, "The Growth of Voluntary Associations in America, 1840-1940," Journal of Interdisciplinary History 29, no. 4 (Spring 1999): 511-557.
21. The importance of trust is examined in an increasing number of studies, including Roderick M. Kramer and Tom R. Tyler, Trust in Organizations: Frontiers of Theory and Research (Thousand Oaks, Calif.: Sage Publications, 1996); Francis Fukuyama, Trust: The Social Virtues and the Creation of Prosperity (New York: Free Press, 1995); and Adam B. Seligman, The Problem of Trust (Princeton, NJ.: Princeton University Press, 1997).