American University a non-profit dismissed its president, Ben Ladner, for his profligate spending. He had used university money on a French chef, weekend trips abroad, and extravagant parties for friends and family. Amongst other abuses, he had used United Way funds to pay for extramarital affairs and for gambling in Las Vegas. Contributions are also misused when they are spent for purposes contributors did not intend. Evidence also shows that some non-profits also called here non-governmental organizations, or NGOs spend much on overhead or on fund-raising expenses, rather than providing public goods.
Nor does revelation that a charity poorly spent its contributions necessarily reduce contributions. Other charities have also survived scandals.
An example is the Association for the Prevention of Addiction, which rebranded itself as Addaction shortly after the head of one of its teams was exposed as a drug dealer in Why then do people contribute, knowing that much of the money contributed will be wasted? The following analysis considers the behaviour of contributors and heads of organizations providing a public good financed by private contributions, when all realize that the head wants to maximize the equivalent of profits—the difference between aggregate contributions received and spending on the public good the contributors value.
The literature on the private provision of a public good is vast, with no need to review its essentials here. Of more interest are studies of the behaviour of a non-profit. The standard model assumes that the output of the public good equals the sum of contributions by individuals, not considering how the non-profit works.
Andreoni models a charity with fixed costs, showing how a lead gift can co-ordinate a move away from a Nash equilibrium with no donations to an equilibrium with aggregate contributions sufficiently high to more than cover the fixed costs. Other works, such as Andreoni and Payne , model the fund-raising activity of charities, allowing the heads to view fund-raising as costly or unpleasant, but allowing the non-profit to use contributions only for fund-raising and provision of the public good.
Another form of fixed costs arises when the public good is discrete. An equilibrium with efficient provision of the good can then exist: the discreteness creates a threshold for contributions, below which the project is infeasible.
This principle is established in theory Palfrey and Rosenthal, ; Bagnoli and Lipman, and confirmed in both laboratory and natural experiments Albert, ; Bagnoli and McKee, If the good is discrete, an equilibrium with full efficient funding exists where each beneficiary is decisive, so that free-riding results in no spending, rather than in smaller spending. This idea of making each contributor decisive is used by Tabarrok in discussing assurance contracts: a discrete public good will be provided if and only if each person contributes the amount the fund-raiser specifies.
Groupon and Kickstarter work on this principle. Andreoni considers an organization that would provide a public good only if the capital campaign reaches some minimum threshold of contributions; his focus, however, is on seed grants rather than on profit-maximizing policies. Consideration of a non-profit with preferences different from those of contributors including budget maximization and quality maximization is found in Hansmann But he does not look at profit-maximizing behaviour of the NGO in attracting contributions.
A related problem studied in the literature is the profit-maximizing provision of an excludable good by a monopolist see Burns and Walsh, ; Brennan et al. In contrast to the assumptions in these two papers that anyone refusing to pay the price charged can be refused access to consumption, I suppose that the only threat the provider can make concerns the level of the public good it will provide. Nevertheless, one insight of the model that follows is to show how the provider of a non-excludable public good can make the contribution of each person pivotal, and thus make the problem equivalent, in some ways, to that of a monopolist selling an excludable public good.
But the central point of my basic model is not to determine output or the equilibrium contribution. Rather, I describe a mechanism that allows a charity to exploit donors, when the charity produces a non-excludable public good. People may contribute to a charity that provides little of a public good for reasons other than those discussed here. Much work examines how a profit-maximizing firm can extract consumer surplus, as by price discriminating or by using a two-part tariff.
But surprisingly little work explores how an organization financed by voluntary contributions can maximize profits and extract consumer surplus. This article does. The NGO has a monopoly on the provision of the public good under consideration. Its head, or leader, L, aims to maximize revenue minus spending on the public good, subject to the condition that individuals have an incentive to donate to the NGO.
To use the term introduced by Hansmann , I consider donative non-profits. But the same analysis applies if L spends some of the contributions on a public good that contributors value little: contributors to a university may want to improve undergraduate education, whereas the university president wants to attract star researchers who teach little.
The head of the NGO aims to maximize net revenue. The NGO can commit to a schedule, specifying how much it will spend on the public good for any given set of contributions. It is convenient to think of the amount of the public good provided as equal to the amount spent on its provision, or that the marginal cost of producing the public good is 1. But the analysis that follows also applies to increasing marginal cost of production—any amount spent on the public good determines the amount of the public good produced, so a contributor can view spending on the public good as determining provision of the public good and his marginal valuation of spending on the public good.
The number of potential contributors is N. All contributors have the same preferences. Given a fixed income, consumption of the private goods is larger the smaller the contribution to the NGO. For simplicity, let utility be separable between consumption of the public good and the other goods.
I assume unlimited commitment, subject to donations made voluntarily. Contributors cannot commit and cannot co-ordinate amongst themselves; that is, the behaviour of contributors is described by a Nash equilibrium.
L commits to a schedule relating contributions to provision of the public good. Consider an exogenously fixed number, N , of identical contributors, and let L commit as follows.
With N contributions each of d M , L will provide the quantity G of the public good. Otherwise, he will provide nothing. The head of the NGO sets d M so that the cost to the donor of his contribution equals his benefit from the public good, generating no consumer surplus.
Given this commitment by L, it is an equilibrium for each person to donate d M. For suppose that each contributor believes that each other person will make such a contribution.
Consider any one contributor, say, D. He knows that a contribution of d M makes provision of the public good be G , but generating no consumer surplus. If D contributes less than d M , then provision of the public good is 0, again generating no consumer surplus. Because D is indifferent between contributing d M and contributing 0, and the same applies to each other contributor, then it is an equilibrium for each to contribute d M. Formally, let each contributor have an endowment Y.
Further intuition into the result is given in Appendix 1. The solution is depicted in Fig. The head of the NGO can make any commitment he wishes, saying that he will provide G if and only if each person contributes d M. In Fig. Now consider an increase in G from G 1 to G 2.
Following the reasoning just given, the maximum any donor would be willing to give is d 2 , where the area under the marginal valuation curve from 0 to G 2 equals the area under the marginal cost curve from 0 to d 2. The marginal production cost of an additional unit of the public good is, by assumption, 1.
So L will choose that level of G where its marginal revenue equals its marginal cost. The outcome for the private provision of a public good differs from the standard efficiency solution in two ways. That does not make for inefficiency, but reflects an income effect, with a contributor essentially poorer because of the money taken by L.
Second, total provision is not Nd M but only G. Thus, less of the public good is provided than the amount consumers, acting jointly, would want. But the solution is Pareto-optimal, with L gaining at the expense of consumers, and with the marginal conditions for efficiency satisfied. The NGO may spend less on the public good than the amount any donor contributes.
Or consider an extreme case. I summarize with: Proposition 1 A charitable organization that can commit to its spending policy can induce an equilibrium with positive contributions, with each contributor enjoying zero surplus from his contribution. The head of the NGO does this by committing to providing G units of the public good if and only if each individual contributes d M.
If in equilibrium any one potential contributor believes that all others contribute d M , then this potential contributor determines whether provision will be G instead of 0. Furthermore, in satisfying the incentive compatibility constraint of one donor, or making a given donor willing to contribute the amount d M which may require providing only little of the public good , the NGO also satisfies the incentive compatibility constraints of all other identical donors, each of whom sees himself as pivotal.
One might ask if it is credible that L will spend G on the public good, rather than stealing all the contributions. Such a commitment can be credible if potential donors hold a set of beliefs sustaining this equilibrium.
Following the logic of the folk theorem, suppose donors believe that if in any period L provides less than G of the public good, then in all future periods he will steal all contributions, providing none of the public good. Suppose that donors believe that otherwise he will provide G in the next period. Then L will prefer to provide G of the public good in any current period if his discounted profits are greater than his discounted profits when providing none of the public good which increases current profits by G , and reduces future profits to 0.
That is, given these beliefs by donors, and given that r is not excessively large, L will prefer to provide G of the public good over providing none of it.
So far I have considered a deterministic model. The model also applies if the number of potential donors is random, but L knows how many people will contribute—for each realization of the number of contributors, L would set a different threshold.
Alternatively, even if L does not directly know the number of contributors, he does know aggregate contributions. Profit maximization could then be achieved by committing to a contingent schedule—for each level of aggregate contributions, L commits to how much he would spend on the public good.
Inability to commit to such a schedule reduces profits. Suppose that L must specify how much of the contributions he will steal before he knows the number of contributors. Suppose, however, that each contributor, at the time he makes a contribution, knows how many people are contributing, or equivalently, the level of aggregate contributions by others. These results fit best with theories in which hospitals maximize their own output.
We thank Hillary Muscato for administrative and editorial assistance. Horwitz thanks the University of Victoria School of Public Administration and Faculty of Law for her visiting appointment during the academic year. The views expressed herein are those of the author s and do not necessarily reflect the views of the National Bureau of Economic Research. Download Citation Data.
What Do Nonprofits Maximize? Share Twitter LinkedIn Email. Too often, nonprofits strive to maintain their programs while starving their own organizations in the process. Making Strategic Spending Choices With this in mind, how can nonprofits make strategic spending choices that will strengthen themselves long-term? Although not directly related to programs, they are critically important to fund.
Below, we break down example categories of spending in each. Management and General Costs These are the costs needed to operate the organization, across all programs. Examples include: Talent Management From the Board and Executive Director to employees and volunteers, nonprofits need to support the people behind their mission and invest in recruiting and retention. Leading employee satisfaction issues, according to Nonprofit Standards , include compensation considered by 78 percent to be a high or moderate-level challenge , up-to-date technology 48 percent , inflexible work schedules 34 percent , management-employee relations 52 percent , and employee training and development 68 percent.
By regularly reassessing the processes, programs and structures in place, nonprofits can understand what motivates—or demotivates—their employees. Governance and Compliance From dealing with tax and accounting changes to new data privacy laws and regulations, nonprofits should think of good governance as an imperative, not simply a nice-to-have. Even with limited resources, they must take a proactive approach to regulatory compliance and risk mitigation, because the alternative could mean betraying donor and public trust and doing more harm than good.
Earmarking funds to cover compliance costs may be painful initially, but the costs of non compliance are even greater. Technology, Equipment and Supplies People are important to an organization, but so are the technologies, equipment and supplies keeping it running.
In addition to jeopardizing employee satisfaction, having outdated IT and equipment can drain already-limited resources by reinforcing operational inefficiencies, weakening impact reporting 56 percent of Nonprofit Standards survey participants cite the lack of adequate technology to gather data on impact as a high or moderate challenge , increasing cyber and data privacy vulnerabilities and more.
Cybersecurity and Data Privacy Trust in the nonprofit world is not only expected, but foundational—a critical part of which is data privacy. Nonprofits must safeguard the data entrusted to and or collected by them as if it were their own. However, this often makes them even more appealing and vulnerable to cyberattackers.
Security needs to remain a key priority, even amidst multiple projects. Fundraising Costs These are the costs associated with seeking, soliciting or securing charitable contributions. Many investments in this category fall into similar buckets as those outlined above, especially people and technology.
They may be over confident in their current funding streams and unable to see why more investment is needed when ample funding or a loyal donor base already exists. They may ignore changing donor demographics or technological trends that change the way in which potential donors engage with the causes that are meaningful to them. But the reality is, maximizing good also requires maximizing awareness. Emphasize Financial Due Diligence Another key component of maximizing good is maintaining financial due diligence.
Maintaining Sufficient Operating Reserves Maintaining adequate liquidity is a must for every nonprofit. When organizations encounter funding disruptions or lose a major donor, a healthy supply of operating reserves liquid, unrestricted net assets is a critical fiscal safety net to keep programs up and running.
With that in mind, establishing at least six months of operating reserves is a prudent target for the sector overall. More than half 63 percent of organizations surveyed in our annual benchmarking survey, Nonprofit Standards , maintain six months or less of operating reserves. Sixty percent of organizations say liquidity is a low-level challenge, or not a challenge at all.
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