Managerial Incentives, Financial Performance, and Governance Quality: Evidence from Nonprofit Organizations Ashley N. Newton Division of Finance

Systematic differences in the organizational forms of nonprofit and for-profit entities have elicited a variety of concerns that remain largely unaddressed. Specifically, the nonprofit sector is characterized by weaker monitoring mechanisms and potentially more severe agency problems relative to their for-profit counterparts, due in large part to an absence of shareholders in nonprofit organizations. These unique aspects of the nonprofit organizational structure result in a heightened sensitivity about their governance quality, particularly with respect to its ability to mitigate the undesirable consequences of agency conflicts, such as excessive executive pay and poor financial performance. To address these concerns, I study the relationship between chief executive compensation, financial performance, and governance quality. I find a significant negative relationship between the CEO-to-employee relative pay ratio and multiple measures of nonprofit financial performance. I document a similar inverse relationship between executive perquisites and nonprofit performance. The results also highlight the importance of corporate governance; specifically, strong governance mechanisms (1) mitigate excessive executive pay in nonprofits marred by potentially severe agency conflicts, and (2) significantly negate the decreases in performance that tend to accompany increases in relative pay. Collectively, these results demonstrate a positive association between disparities in nonprofit executive pay and agency conflicts, and highlight the importance of implementing strong governance mechanisms as a means to curb self-interested managers’ tendencies. I thank Louis Ederington for valuable comments and suggestions.