Nonprofit watchdogs: Do they serve the average donor?

Abstract

Nonprofit watchdog organizations-organizations devoted to rating the accountability and transparency of nonprofits-claimI N AN IDEAL world, all of the information necessary to compare nonprofits would be available to potential donors. If this were the case, the best nonprofits-those that produce the most public goods and that act the most effectively and ethically-would attract the most donations, and the rest would perish. However, comprehensive comparative information does not exist, and donors must accept the reality of information asymmetry. 1 In principle, a donor is capable of deciding between roughly 1.1 million 501(c)(3) NPOs, many of which are dedicated to dealing with similar issues (Brown, 2008). Most donors, however, do not possess or know how to access the information necessary to compare NPOs' ethics, efficacy, and so forth, and they therefore find it difficult to distinguish between organizations.Various watchdog organizations have emerged in response to this information asymmetry. In theory, these watchdog organizations allow potential donors to assess a nonprofit organization's level of accountability (broadly defined) and thus to make more educated decisions about where to donate money.Many nonprofit experts and textbooks praise the existence of these watchdog organizations because they supposedly help regulate the sector, particularly in the areas of monitoring fraudulent activity and the use of funds (Herman and Associates, 2005; Hewlett Foundation, 2008). However, an unresolved question lingers: Do donors actually use these watchdogs to decide which nonprofits to support? NONPROFIT MANAGEMENT & LEADERSHIP, vol. 21, no. 4, Summer 2011 © 2011 381Published online in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/nml.20032 In this article we first review the literature on information asymmetry between donors and NPOs as well as literature that suggests that donors may not need information in order to make optimal donations. This review is followed by a set of research questions regarding the role of watchdog organizations in the nonprofit sector. We then describe our research methods and present findings that shed new light on this field of study. We conclude by discussing the implications of our findings. Need for Accountability and External RatingIn economic terms, a nonprofit organization is an "agent" and a donor is a "principal." Agents produce goods and services for principals, but principals cannot supervise this production and have to rely on agents' reports. As agents, NPOs tend to claim success, efficiency, and integrity, even when struggling with failure, waste, and corruption (Bennett and DiLorenzo, 1994;Murray, 2001). When the principals/donors are unaware of the fidelity of the nonprofit, they suffer from information asymmetry.Two sets of donors can reduce this information asymmetry themselves. First, very rich donors can demand control of NPOs and access to accounting in return for large donations. Second, those volunteering with an NPO can access information direc...

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