Governance In Not-For-Profits : It starts with fiduciary responsibility

Not-for-loss boards have peculiar almost love-hate relationship with fiduciary responsibility. On the one hand the classification of these organisations as not-for-profit suggests that outcomes other than profit ought to be at the focus of their boards’ attention. But on the other is the actual achievement of profit – especially the cash or near-cash components of profit that are critical for longevity in both the short and medium term. It is only after fiduciary responsibility and consequentially profit, however minimal, is recognised as essential by the not-for-loss board that other key performance indicators (KPIs) follow.
In its strategic capacity, the not-for-loss board must clearly distinguish between activity and outcome, for it is through the achievement of well selected and measurable outcomes that the performance of not-for-loss organisation should be measured. What role does the board have in identifying these outcomes, other than profit, and then setting appropriate targets for achievement?
Only rarely will board come into the strategy conversation cold. Inevitably there is some form of process in place, for better or for worse. The board must take responsibility for first, understanding the relationships between key metrics and second, establishing appropriately stretched performance targets.
In social housing complex, for example, occupancy rate is often the critical variable in determining financial performance, assuming that rental rates have been set below market, or at market with the management of access to accommodation supplements. However, the value of turnover of tenants through active placement in permanent accommodation via social services, education, and or financial support needs to be considered.
A social housing estate may achieve near 100 percent occupancy with very little turnover of tenants. Is this the best outcome to be achieved from the assets, and is this the best outcome for the organisation? Namely, once it is occupied its contribution to new emerging accommodation needs is limited. Is lower occupancy rate acceptable if accompanied by higher turnover of tenants through their managed placement in longer-term accommodation, the provision and development of skills, and better access of tenants to social services?
The determination of those outcomes and the relationship between key variables and how they are to be managed are strategic decisions for the board. social housing complex, accompanied by the correct services, that remains accessible by managing accommodation needs will make greater contribution to the community in the long term than one that is inaccessible by virtue of full occupancy through near perpetual tenants.
Sustained periods of economic growth, such as that experienced in New Zealand from 2001 to 2007, can mask number of weaknesses in the not-for-loss organisation. Appreciating asset values, through increases in the value of realty or land holdings have been reported as profit (although GAAP requires that book values – cost less depreciation – be reported on the balance sheet for most assets). Under such circumstances it is easy for governance not to examine performance with the scrutiny required to ensure that outcomes, especially those requiring cash, continue to be delivered.
For instance, the significant demand placed on the tertiary education sector by international students during this period appears to have ‘hidden’ weaknesses in curriculum and the relevance of programmes for many Kiwi students. Yet throughout this period the sector apparently bloomed. The dramatic downturn in international demand in 2007 and 2008 caught the sector by surprise, exposing these weaknesses. However, head count, like occupancy rates in social housing, continues to be the sector’s key performance metric. It remains the sector’s primary source of income. Given the requirement of open entry (or near open entry), the partial state funding of around 750 institutions, and tax system that does not reward philanthropy on the scale of the United States, this sector struggles with determining effective outcomes, namely, teaching and research that actually achieves impact – especially on the economy.
The second consideration for the governance of not-for-loss organisations, following the determination of outcomes and how that will be measured, is to come to terms with and understand the limitation of this absurd classification, namely, ‘not-for-profit’. At some ridiculous and largely unhelpful level of organisational classification we can find division between profit and not-for-profit. However, the division of organisations supposedly on the importance of the profit motive, relative to other outcomes, is naive in terms of their governance and leadership.
Over decade ago, Jim Collins and Jerry Porras produced irrefutable evidence in Built to Last that the for-profit sector is not solely motivated by profit. Continued classification on these lines is misleading as it suggests that fiduciary responsibility is somehow less important in not-for-loss organisations. Reality is likely to be quite different.
The fiscal constraints imposed on not-for-loss organisations whether that be hospice, the local school, or the Royal New Zealand Ballet, are considerable. Their boards are often overwhelmed with the difficulty of making ends meet, more so in funding environment that fails to recognise declining real terms of trade (ie, nominal income may have increased, yet purchasing power – taking into account inflation – has actually declined).
These not-for-loss organisations typically have less resistance than others in an economic downturn, relying heavily on balance sheet assets (which don’t necessarily produce cash) to pass tests of solvency. Therefore, during an economic downturn, their fiduciary responsibility is all the more important as they will typically have fewer cash reserves, immobile assets, declining income and often ‘greater’ demand on the services they provide. Governance of not-for-loss organisations must accept fiduciary responsibility, and be equipped to do so, and then set appropriate financial outcomes (and KPIs) to which management should be held accountable.
The third requirement of effective governance in the not-for-loss sector is board competence. Much research has been conducted on the structural and measurable attributes of boards – namely attributes such as the qualifications of directors, their tenure, age and sex, independence (typically by virtue of ownership), the separation of chair and chief executives and so on.
To date this research has been largely fruitless. There is, as yet, no systemic evidence that any of these attributes have persistent effect on organisational performance. Even more embarrassing, from research perspective, is why these attributes would have been considered to have sustained impact in the first place. Attempts to reduce organisational performance to dependency on such metrics ignores the fundamentals of governance, that is, the collective decision making of group of individuals (a team) assigned the responsibility of delivering long-term organisational performance.
There are two core attributes of an effective board. These two attributes are common across all sectors of the economy and community. The first is the range of individual competencies and skills held by directors and trustees. These competencies and skills include financial and legal nous, strategic thinking, visionary leadership, the acceptance of responsibility, commitment to transparency, enthusiasm for the organisation, desire to serve and so on. However, these individual director attributes are of little value to the organisation if they are accompanied by arrogance, hubris, or passive acceptance by trustees and directors of the status quo.
Not-for-loss organisations make significant contribution to the community; their boards, like all others, are not the place to retire, show