Toward a valid approach to nonprofit efficiency measurement

Abstract

Past literature in nonprofit management uses the overhead ratio of nonprofits as a measure of efficiency. Although the overhead ratio might measure top-heaviness, we argue that it does not measure nonprofit efficiency. To investigate this, we use financial and operational data to rank the efficiency of Habitat for Humanity affiliates with the overhead and administrative ratio, as well as data envelopment analysis (DEA) and stochastic frontier analysis (SFA), two of the most popular efficiency measures. While the DEA and SFA rankings are statistically correlated, overhead ratio rankings are negatively correlated with both SFA and DEA rankings. We argue that nonprofit scholars, managers, and donors should move away from concepts and measures of efficiency based on financial ratios, and toward ones that embrace maximizing what nonprofits are able to make and do.

The more you know, the more you give: Influence of online disclosure on European community foundations' donations

“…Some researchers who hold that administrative costs enhance the capacity of the organizations to do their work have questioned this view (Bowman, 2006). Although nonprofits are increasingly under pressure to spend less on overheads and more on direct program costs, shortages in the administrative expenses can cause managers to under‐invest in key physical, technological, and human capital assets, and thus fail to build productive capacity and to sufficiently support overall infrastructure, which ultimately undermines the organization's efforts to serve charitable causes effectively (Coupet & Berrett, 2019; Garven, Hofmann, & McSwain, 2016; Gneezy et al, 2014; Hager & Flack, 2004; Lecy & Searing, 2015).…”

If Someone Else Pays for Overhead, Do Donors Still Care?

“…The overhead ratio, measured by the proportion of a nonprofit organization’s expenses devoted to administration and fundraising, that is, resources not being spent to direct mission-related work, has emerged over the years as an important efficiency indicator for nonprofit organizations. Although the overhead ratio provides a concise snapshot of an organization’s short-term financial position, the indicator is regularly criticized on various grounds, such as its inability to comprehensively capture financial health (Knowlton, 2016), efficiency (Coupet & Berrett, 2019), effectiveness (Gregory & Howard, 2009), or its inaccuracy due to deliberate manipulation (Krishnan et al, 2006). Despite such criticism, some nonprofit stakeholders continue to strongly focus on overhead ratios.…”

Starting from scratch: Building of meaningful endowments by public charities

“…In contrast to total spending, how a nonprofit directs its spending might also influence meaningful endowment building. The program expense ratio is commonly used by donors considering contributions (see Mitchell, ), although the approach is not without its critics (Coupet & Berrett, ). As a proxy for attractiveness to donors, organizations with higher program expense ratios may have an easier time attracting endowment dollars.…”