Rajesh Aggarwal

Nonprofits Unaware of Hidden Costs of Growth

Sunday, April 1, 2012

Adding board members can help resource-starved nonprofits raise funds, but the practice likely makes the organization less effective and causes it to drift away from its mission. Those were the findings of Associate Professor of Finance Rajesh Aggarwal who studied the Internal Revenue Service (IRS) filings of more than 35,000 501(c)3 nonprofit firms.

“There’s a benefit to having more board members, but there’s also a real cost,” says Aggarwal, who holds the Carlson School’s US Bancorp Professorship in Financial Markets and Institutions. “You’re going to wind up increasing the number of tasks and programs that you work on and then you’re going to be less effective on each individual task or program.”

Studying IRS Form 990s between 1998 and 2003, Aggarwal and his colleagues were able to closely examine the revenue, expenses, board composition, and areas of activities of each nonprofit. Hypothesizing that each new board member has individual objectives and interests, they expected (and found) each additional board member is associated with the nonprofit taking on a new task or program.

“When you add board members, the scope of what the nonprofit does is going to expand because it’s going to start internalizing and taking on those tasks and objectives that matter to the board members,” adds Aggarwal.

According to Aggarwal, it isn’t apparent to nonprofits that just because they have more board members they will end up with more tasks. Instead they imagine they can strictly add board members who care about what the organization cares about and nothing else.

To illustrate his point, he offers an example of a hospital system that specializes in cardiac care. It begins with board members who are only interested in making certain the hospital has an outstanding cardiac facility. Over time, finding similar individuals who only care about cardiac issues becomes more difficult.

You're going to wind up increasing the number of tasks that you work on and then you're going to be less effective on each individual task or program.

Rajesh Aggarwal

“As you add board members you may also wind up in situations in which you get board members who also say, ‘Well it’s also possible we could do a little research on cancer. It’s possible that we could do a little research on joint replacement,’” he says. “All sorts of things like that where you find yourself, ever so slowly but through time, shifting your focus to incorporate more things, and that has a cost, and that’s the part where I felt people hadn’t focused before.”

The research also found that taking on different tasks diluted the nonprofit manager’s efforts and resulted in the manager having few incentives on each individual task.

Aggarwal plans to continue researching governance in nonprofits to determine whether there is an optimal board size that provides the right tradeoff between more assets and the diseconomies of too many members.

“Nonprofit Boards: Size, Performance and Managerial Incentives” was co-authored with Mark Evans (Indiana University) and Dhananjay Nanda (University of Miami). The paper was published in the Journal of Accounting and Economics.