How do we set fair compensation for the chief executive and the staff?

Few, if any, nonprofit professionals get paid as much as those doing similar work in the business community. Typically, nonprofit boards want to pay competitive wages so they can attract top talent but not exceed the salary guidelines of similar organizations.

Following are some questions to ask when setting guidelines for compensation decisions.

What is our financial strength? You can’t pay more than you have. Payroll and program costs must be in a reasonable balance to fulfill your charitable purpose. You should have a reserve account of at least 10 to 12 percent of your operating budget so you can pay salaries when cash flow is down. If you are struggling financially, you may not be able to pay what the salary surveys say is average.

What is our philosophy about compensation? A board should reflect on what kind of nonprofit entity it governs and how donors and moral owners feel about compensation in your sector. Staff in social services organizations, for example, seldom make what their counterparts do in health-related organizations. Donors to religious organizations do not expect employees to earn what business trade associations might pay. Once the board realizes what is publicly acceptable, however, it still needs to determine philosophically whether it would like its employees to be near the mean or median, or in the upper quarter of similar organizations.

What can we learn from salary surveys? You can obtain state, regional, and national surveys conducted by either nonprofit associations or private firms. The data from such surveys typically offer overall averages as well as salaries reported according to budget size, staff size, and type or scope of organization. Although useful, salary surveys should not be the sole means of setting compensation because sample size and other variables can influence the results.

What is our goal? Some boards decide salaries are less than what they would like them to be. They set a goal say, to have salaries reflect approximately 80 percent of salaries in similar jobs in the local business market. It may take three years or more to reach this goal, but board members and staff could be motivated to find the financial means to meet it. In addition, a board should have this kind of framework within which to plan.

Who determines specific salaries? The board should set only the chief executive’s compensation but carefully review the senior staff members compensation. Then the chief executive, within budget guidelines, should determine the rest of the payroll. The chief executive is in the best position to know what it takes to recruit and keep good people. Staff members should feel that someone who knows their work is setting their compensation.

Should we use performance’based compensation? Taking a cue from the corporate world, more nonprofits are offering merit based pay that links salaries, bonuses, or both to job performance. Acknowledging that this practice can complicate compensation calculations and create internal competition, the chief executive should set some guidelines. For example, will bonuses be considered for work groups in addition to, or instead of, individual performance ratings? Should cost-of-living adjustments be dropped entirely? Should performance pay increase the base salary or be paid in onetime, lump-sum bonuses? Approximately what percentage of the staff should receive performance raises? By how much should the highest merit increase exceed the smallest merit increase? These are all value judgments a chief executive should explore in detail, with broad guidance from the board. However, percentage-based compensation should never be considered in a nonprofit.

Merit based compensation can work well as a small part of the total compensation program if the staff has a role in deciding the pros and cons. If staff members help create a system for rewarding performance, they may be more open to the idea that those who go the extra mile should be rewarded, or that measuring performance is a good strategy for accomplishing the organization’s mission. They may agree that people should be allowed to compete for something extra in a nonprofit organization that pays modest salaries. This discussion takes place at the staff level, facilitated by the chief executive and possibly an outside expert.

For its part, the board must support merit-based efforts, monitor the results, and understand the criteria for awarding bonuses. The board should apply the same criteria when deciding how to compensate the chief executive.

What kind of compensation can we offer besides cash? From the board’s perspective, the total outlay for employees should be more important than how benefits are distributed. For the chief executive in particular, it may be preferable to provide a lower salary and greater benefits, such as additional health and life insurance, deferred compensation, coverage of educational expenses, an annual executive physical exam, a sabbatical, or use of a vehicle.

Chief Executive Compensation

Remember, the organization’s mission demands effective leadership, not just average management and that requires a financial investment. Even in a nonprofit it is totally appropriate to compensate a qualified leader in a fair manner that acknowledges positive results and feeds into job retention. However, the board needs to pay attention to overcompensation. The Internal Revenue Service can assess intermediate sanctions on board members and managers who approve or receive “excess benefits,” or unreasonable compensation for their work or service .

Consult with legal counsel to ensure that your organization is taking the appropriate action to avoid excess-benefit transactions in the area of executive compensation (including health benefits, retirement benefits, incentive plans, and other perquisites).

SUQQESTED ACTION STEPS

1. Board chair, ask the chief executive to gather and summarize for the board facts and trends about staff compensation in your field.

2. Board members, identify the five nonprofit organizations most comparable to your own. Check their most recent Form 990s at www.guidestar.org so you can compare compensation levels.

3. Board chair, purchase a national compensation survey for board education purposes.

4. Board chair, engage an outside expert to review your current policies and practices and make recommendations to the board.