Charity Watchdogs Denounce
Overhead Ratios as Meaningless in Evaluating Charities
Several charity watchdog agencies including
Guidestar,
Charity Navigator and
GiveWell recently
announced that donors should not rely on overhead ratios (overhead expense as a
percentage of total expense) when choosing whether or not to support specific
charities.
The Watchdog agencies now say that donors should focus on the
charity's effectiveness when making philanthropic
choices. Charity Navigator in particular, has announced that
it is revamping its rating systems to de-emphasize overhead ratios,
so that the ratings will be more useful to donors. Because a
large number of donors and foundations routinely check these
watchdogs' ratings of charities, this has not simply been a
theoretical issue, the ratings have a real impact on who gets funded
and who doesn't.
For years, charity regulators, rating agencies
and donors have been debating whether expense ratios (the percentage
of spending on program as opposed to other expenses like
administration or fund raising) are a valid way to evaluate a
charity. In fact, several states have even tried to statutorily
require charities to disclose, at the point of solicitation, their
fund raising expense ratios to potential donors, but those laws have
consistently been struck down by the Courts because they were not
narrowly tailored to further a compelling government purpose and
thus violated the First Amendment.
Tim Benton of
Philanthropy Action
(and a member of GiveWell’s board) noted that, “there are plenty of
reasons that overhead ratios are meaningless as a measure of
effective charities”:
-
They tell you nothing about the impact the
charity has on people it’s trying to help
-
The rules for determining overhead costs
are vague and every charity interprets them differently
-
Accounting experts estimate that 75% of
charities calculate their overhead ratio incorrectly
-
It discourages charities from investing in
tools and expertise that would make them more effective
While GuideStar does not rate charities -- it
only provides data so potential donors can make their own
evaluations -- other groups do issue ratings, and those ratings can
be quite influential. The ratings process is not regulated, and as
many charities can attest, disagreements about the accuracy or
usefulness of the ratings are common. However, change is clearly in
the air. Charity Navigator, the largest of the ratings agencies, has
said it will now look at the following factors in rating charities
on effectiveness:
1. Financial health – Is the nonprofit
sustainable? Does it have robust financial strength to survive in
good times and bad? Is the overhead at the extreme end of the
continuum?
2.
Accountability – Does the organization have ethical practices, good
governance and transparency? Is it accountable to its constituents?
3.
Outcomes – Can the nonprofit supply information about meaningful and
lasting change in the communities and lives of the people it serves?
Can they show evidence that these changes are a result of their
efforts? Do they have systems and processes in place to effectively
manage their performance?
It is worth noting that the IRS is
also looking at the relationship between good governance and tax
compliance, and is actively collecting data about charities’
governance and fiscal practices. The new IRS Form 990 was redesigned
in part to require many new disclosures about governance practices.
The data collected through
the new Form will probably serve as the basis for changes at both the IRS and the rating agencies.
If you have questions about the rating
agencies, rating systems, or are simply wondering how these rules
might affect you, please call Allen Bromberger at 212-889-0575.
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