Public Trust in the Public Face of Charities

8Georgetown University | The Center for Democracy and the Third SectorDemocracy & Society | Inaugural Issue | Spring 20049By Mark A. HagerOne reason that we give our hard-earned dollars to charity is that we trust that charities can make a difference with these contributions. We hear about the ills of society, or the value of public association, and we trust that charities can effectively combat these ills or add to the aggregate value of community in some way. Many can and do, but many do not. Most of us give our trust blindly and do little to assess how well the charities we support are carrying out their missions. When we hear that particular charities (or the sector as a whole) are ineffective or unfaithful in some way, we feel betrayed. We might feel less betrayed if we took the time to assess the charities we support and make wise giving decisions. However, especially for those givers who seek to ex-ercise due diligence in their giving, assess-ment runs into two major roadblocks. One is the difficulty in gauging the effectiveness (and therefore the trustworthiness, or donation-worthiness) of charities. The other is the active management of the public face of charities in their efforts to attract contributions. The effort to gauge the effectiveness of charities has long been a stumbling block for sector researchers and individual organizations alike. Even when particular orga-nizations (like hospitals or theatre troupes) come up with reliable indicators of success, these indicators are invariably specific to the services or missions of unique varieties of nonprofits. And they should be. Using measures of hospital effectiveness to gauge the effectiveness of theatre troupes would be foolhardy. The lack of common measures of non-profit effectiveness is a firm barrier for those who seek such measures to assess the donation-worthiness of charities. Nonetheless, the market demands some kind of com-mon measure. Inexplicably, we seem to have found them in the apparent sameness of financial reporting across otherwise wildly different nonprofit organizations. The only public document required of public charities in the United States is Form 990, the form that charities use to report their finances and activities to the IRS each year. The revenues, expenses, assets, and liabilities reported in this Form have become a substitute for evaluating the ef-fectiveness of charities. Watchdog organizations espouse guidelines for ratios built from these financial reports, or base their watching primarily on the financial ratios of the organizations they assess. Media publications rank the donation-worthiness of charities according to these same financial ratios. Federated givers and donor-advised funds show these ratios in their donee profiles and assert that financial efficiency is a reliable indicator of how well chari-ties carry out their missions. Given the absence of other manageable ways to rank and rate the broad array of nonprofits requesting our contribu-tions, perhaps financial ratios are a reasonable alternative. After all, donors say that they care about how much of their contributions are spent on programs, as opposed to admin-istration or fundraising. However, this brings us squarely up against the second problem regarding the due diligence of donors: they are constrained to trust the self-reports of charities that seek their donations. Unfortunately, in many cases, this trust appears to be misplaced. Should we trust the financial self-reports of charities? Ongoing research by the Urban Institute and the Center on Philanthropy at Indiana University (www.coststudy.org) indicates that many charities do not carefully track or accurately allocate their expenses, mak-ing it difficult for them to reliably report the sums that make up the ratios used by evaluators. Accounting rules are compli-cated and technical, and many contract accountants are not well-versed in details of nonprofit accounting. Many bookkeep-ers pay more attention to the immediate demands of their organization than the arcane details of cost accounting. Who can blame them? The IRS, funders, donors, and even most watchdogs do not scrutinize their fi-nancial reports, so charities are rarely motivated to comply with rules and standards. Consequently, financial reports do not always faithfully represent the internal workings of charities. The most famous example is that roughly two out of five charities that report public contributions also report zero total fundraising expenses. This issue has been the subject of both media and federal government scrutiny, but it has not deterred most users from taking Forms 990 at face value. While ignorance, sloppiness, or lack of capacity might explain or excuse poor reporting by public charities, there is another more insidious force at work as well. That is, while charities are not given many incentives to accurately track and report their financials, they are faced with incen-tives to rep