Stakeholder Theory and Nonprofits

Stakeholder Theory and Nonprofits

Stakeholder theory is largely a normative organizational theory suggesting that managerial attention to all stakeholder interests is critical to the firm’s success (Freeman, 1984). As Jones and Wicks (1999) describe stakeholder theory “the interests of all stakeholders have intrinsic value, and no set of interests is assumed to dominate the others” (p. 207). essentially, stakeholder theory implies a need for organizations to expand the domain of corporate governance to be both sensitive and responsive to all stakeholder interests and not simply those of shareholders. This normative approach to stakeholder

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theory inspired by Freeman has clearly served as the prevailing analytical framework upon which most stakeholder studies have been based (Berman et al., 1999; Clarkson, 1995; Donaldson & Preston, 1995; evan & Freeman, 1993; Freeman & evan, 1990; Jones & Wicks, 1999).

given that nonprofits do not have shareholders who stand to profit from the organization’s activities, stakeholder theory has been scarcely applied to nonprofit organizations and only in a descriptive sense (Abzug & Webb, 1999; Keating & Frumkin, 2003). This lack of scholarly attention to how nonprofit organizations manage their stakeholders may be attributed to the fact that nonprofits do not have shareholders who own a personal financial stake in the organization. If nonprofits do not have shareholders, then who are the stakeholders of nonprofit organizations? Institutions and individuals that finance the work of nonprofits, such as government, private charitable foundations, corporations, clients, and individual citizens who donate, comprise key groups of nonprofit stakeholders. These actors finance the work of the organization, and may therefore play a critical role in shaping nonprofits’ stakeholder management practices. As a condition of both receiving and maintaining contracts, grants, and other forms of financial support, nonprofits are required to demonstrate their accountability through financial audits and various forms of performance reporting. Some organizations have embraced highly sophisticated performance measurement programs and use the results as a marketing tool in promoting their services to prospective funders (Ott, 2001). However, organizations vary in the amount of time they allocate to these and other activities related to interactions with funders.

In addition to funders, clients who function as the organization’s “customer” base represent another key stakeholder group to which the organization must allocate time, both in the form of direct services and in indirect governance activities that support client interests, such as advocacy, client education, and linkages to community institutions. Although they provide the justification for organizations’ existence, clients are far less powerful than funders as a stakeholder interest. On the whole, clients are likely to be less influential in shaping organizational resource allocation decisions, particularly if they do not pay for the services they receive.

Like for-profit firms, private nonprofit organizations are governed by boards of directors that are fundamental to organizational governance. Boards are the policy-making and oversight body of nonprofit organizations, and their influence on organizational priorities and resource allocation

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decisions is often substantial (green & griesinger, 1996). Board members may play a particularly salient role in shaping nonprofits’ stakeholder orientation, because they are uniquely positioned at the nexus of internal and external demands made on the organization. Board members do not influence the organization’s resource allocation decisions from outside of the organization as funders do, or from “below” the organizational governance level as clients do, but rather they help shape organizational management through their authoritative role in internal decision making. each of these groups—funders, clients, and boards will be examined in greater depth below along with hypotheses about the predicted effect of each on organizations’ stakeholder orientation.

Models of Stakeholder Orientation

Stakeholder orientation refers to how organizations manage their stakeholders through resource allocation decisions (Berman et al., 1999). Time is a critical resource that must be allocated among a number of organizational activities in order to accomplish the organization’s objectives. Organizational time allocation decisions have consequences for stakeholders. Two divergent views exist in the corporate governance literature about the ways organizations allocate time and attention to stakeholder groups. These divergent views form the basis for the two models of stakeholder orientation: the normative model (intrinsic stakeholder commitment) and the instrumental model (strategic stakeholder management; Berman et al., 1999).

As suggested in the preceding discussion of the theory, the normative approach that originated with Freeman’s (1984) work has served as the prevailing theoretical model in stakeholder management research. The intrinsic stakeholder commitment model is grounded in the corporate ethics literature and views values and ethics as being inextricably linked to strategy and organizational behavior. This model speaks to the frequently cited argument made by Freeman and gilbert (1988) that an organization must ask “what do we stand for?” when making organizational decisions (p. 70). The intrinsic commitment model suggests that organizations give equal attention to all stakeholder interests, or as Clarkson (1995) states, “the economic and social purpose of the organization is to create and distribute increased value to all its primary stakeholder groups without favoring any one group at the expense of others” (p. 112). This predominant model is thus a normative theory proposing the way that organizations should act, but proponents of this model also claim it to have descriptive utility (Donaldson & Preston, 1995; Jones & Wicks, 1999).

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However, a second view challenges the normative model as an inaccurate reflection of organizational behavior (gioia, 1999; Jawahar & McLaughlin, 2001). This alternative perspective draws on the resource dependence view of organizational behavior (Pfeffer & Salancik, 1978) which suggests that organizations seek to defend against environmental uncertainty through conscious attempts to manage their external dependencies. This forms the basis for a competing model of stakeholder management in which organizations can and do strategically place some stakeholder interests over others because financial performance (revenue growth) is contingent upon such a strategy. For example, Jawahar and McLaughlin (2001) argue that “organizations are likely to favor certain stakeholders depending on the extent to which they are dependent on those stakeholders for resources critical to the organization’s survival.” (p. 397). The instrumental model acknowledges that stakeholder management presents opportunity costs; devoting time to stakeholder interests that provide opportunities for financial gain may require trading off some time and attention to other stakeholder interests. Thus, organizations with an instrumental stakeholder orientation will systematically invest more time in activities that offer the potential for yielding financial gains for the organization.

The Budget-Maximizing Nonprofit Executive?

Can nonprofit leaders be motivated by financial gain, when the organizations they govern are, by definition, not-for-profit? The motivations of both public and nonprofit executives for financial gain are thought to be held in check by what Weisbrod (1977) termed the “non-distribution constraint,” referring the legal prohibition on public and tax-exempt organizations from distributing their profits to employees or board members. However, nonprofit organizations can and do, generate profits. Surplus revenues, interest and dividends on assets, and “unrelated business income” are legally permissible under the tax-exempt regulations, with the caveat that such forms of surplus income are reinvested into organizational programs and activities, broadly defined.

The nondistribution constraint suggests that nonprofit leaders would have no interest or incentive for attempts to procure more revenues for their agency because they cannot personally reap the rewards of financial gain. Yet in the same way Niskanen (1971) argued that program budget size functions as a proxy for bureaucratic utility, budget growth would serve the same utility function for nonprofit leaders. Niskanen suggested that public managers have personal goals that might be attained through maximizing

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discretionary budgets, and the same logic can be applied to nonprofit leaders. Whether in public or nonprofit organizations, larger budgets typically bring the benefits of power, prestige, enhanced reputation, productivity, additional staff, and ease of management (Niskanen, 1971). Frequently, it also brings the reward of increased salary for staff and organizational leaders. Indeed, in the case of nonprofit organizations, there is direct correlation between size of the organization and executive directors’ compensation (National Council of Nonprofit Associations, 2007). Therefore, larger nonprofits may be more likely to adopt an instrumental orientation than smaller and medium sized organization.

Predicting Orientation: Budgets, Boards, and Clients

Nonprofits are generally viewed as displaying an intrinsic commitment to all stakeholders, balancing organizational time commitments between current and prospective funders, and serving their “customers.” However, certain factors may enhance the likelihood that nonprofits will adopt an instrumental orientation, whereby the organization displays a severe imbalance in time commitments between funders and clients, favoring the former. Specifically, who governs the organization, and which mix of sources it relies on most for funding may have significant consequences for how organizations orient themselves toward stakeholders. The issue of nonprofit financing is examined first.

Nonprofit social service organizations rely on a variety of sources for their income, but their largest sources of funding are government, independent foundations, private for-profit corporations, client fees and other forms of earned income, and charitable contributions from individual donors (Independent Sector, 2002). Nonprofits vary widely, however, in their extent of reliance on this range of sources. Some social service organizations are solely dependent on government, whereas others rely entirely on client fees. Still others depend on a variable mix of revenues. Funds from government, private foundations, and corporations shape nonprofit behavior in distinctive ways because they represent institutional forms of support. As such, they have the power to embed their own desired values in the organizational practices of nonprofits they fund. However, the values transmitted to nonprofits by corporations will produce different organizational behavior than the values extended by government and independent foundations.

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Corporations

Corporations are a set of economic institutions defined by capitalist values of profit-seeking and market-based competition. Corporations serve as an important source of financial support for many nonprofit social service organizations. Corporate donations may be made directly, or channeled through a corporate foundation. In addition to cash gifts, corporations are frequent sponsors of special events, annual fundraisers, and provide several forms of in-kind support. grønbjerg (2001) has argued that nonprofit executives forge strategic alliances with corporations that serve the mutual economic interest of both parties. Nonprofits benefit from the wealth corporations have to offer, and corporations benefit from the large tax deductions they can claim for their contributions. Based on her research of child welfare and community development organizations, grønbjerg (2001) demonstrated how nonprofit executives formalize their alliance with corporations by appointing corporate leaders to serve on their boards of directors. In turn, this alliance serves strategic purposes for corporate executives. She suggests that “for corporate leaders, financial support of nonprofit organizations and membership on nonprofit boards are indirect opportunities to promote corporate interests and extend their sphere of influence” (grønbjerg, 2001, p. 222).

To the extent that nonprofits are reliant on corporate sponsorship, they may have an increased likelihood of becoming market-like in their own governance practices. Corporate funding may have the effect of transmitting capitalist values and business sector practices to nonprofits, especially among organizations that have forged strong alliances with corporate sponsors. Indeed, Lenkowsky (2002) has observed that some corporations have suffered public scrutiny for tying their nonprofit support too close to business objectives. Thus, the more heavily nonprofits rely on corporations for their financing, the more likely they are to adopt an instrumental stakeholder orientation.

Government

government represents the largest single source of support for nonprofits, accounting for approximately half of all revenues in the social services sector (Independent Sector, 2002). Like corporations, government also represents an institutional form of support to nonprofits. However, rather than the capitalist oriented values that corporations may impart, the values that get transmitted to nonprofits through government funding are public

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values. These values favor democratic participation, responsive service delivery, and equitable distribution of resources. Lester Salamon (1995) has argued that nonprofits, in their original voluntary state, suffer from inherent weaknesses of financial insufficiency, amateurism, paternalism, and particularism—tendencies to favor serving some clients and not others. Salamon’s partnership theory of government–nonprofit relations suggests that government sponsorship corrects for these inherent weaknesses by imposing rules and obligations on the part of nonprofits that accept government funding. government funding institutionalizes values of equity and responsiveness, promotes professionalism, and increases nonprofit accountability. Therefore, nonprofits more heavily funded by government are likely to demonstrate a greater balance in managing their stakeholder interests. Nonprofits will be less likely to adopt an instrumental orientation when they rely heavily on government, because public funding mediates instrumental tendencies in favor of a broader, more inclusive stakeholder management approach.

Foundations

Institutional philanthropy, embodied in independent and community foundations, (Lenkowsky, 2002) is another major source of revenue to nonprofit social service organizations. Foundations are private organizations, but unlike corporations, they are not-for-profit, and exist primarily to make grants to other nonprofits performing work that aligns with the foundation’s own mission or purpose. Thus, while they are private organizations, they are a part of the “public-serving” nonprofit sector (Salamon, 2002), which exists to promote the public interest rather than narrow, individualistic interests. Serving as financial intermediaries, foundations help to bridge the gap between private resources and public needs. Their role is to generate private funding, to manage wealth once it is accumulated, and distribute monies to other organizations in the sector. While they do not provide the largest source of revenue to social service organizations, foundations have been hailed as a very important source of financing for nonprofits because this form of revenue helps to ensure the independence and autonomy that the distinguish the nonprofit sector (Salamon, 2001). Indeed, many government grants made to nonprofit social service organizations are designed to fulfill specific programmatic objectives, whereas foundation grants typically carry fewer restrictions and less extensive requirements. Therefore, nonprofit social service organizations that rely heavily on foundation funds may be less

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likely to adopt an instrumental orientation. Foundation funding reinforces the public-serving disposition of social service organizations and affords agency leaders the time to devote attention to their full range of stakeholder interests, including those that fulfill client interests.

Individual Donors

In contrast to the way government, foundations, and corporate funding shapes nonprofit behavior by embedding specific values into organizational practices, direct contributions from individual donors take the shape of diffuse values and expectations. Yet, heavy reliance on individual donors may increase the likelihood of nonprofits adopting an instrumental orientation. Direct contributions from individuals represent a shrinking form of support for the sector, and have steadily declined as a share of social service organizations’ revenues over the last two decades (Independent Sector, 2002). As such, organizations that rely heavily on this form of support have become more market-like in their competition for donors. Individual donors are fickle in their choices about where to donate and how much they contribute, and thus their support is much less predictable as a source of income for nonprofits. As a result, nonprofits that rely heavily on private donations for their survival must invest a great deal of time and organizational resources attempting to sustain, and perhaps grow that base. To this end, nonprofit leaders engage in targeted appeals directed at individuals or small groups of wealthy citizens in the community who might become consistent, reliable supporters of the organization. When nonprofit leaders identify such individuals, they often attempt to formalize reliable donors’ commitment to the organization by inviting these individuals to serve on the board. In this way, nonprofits can bind well-off influential community elites to the organization, providing them with a voice in agency governance in exchange for their patronage.

Referring to one of the major pitfalls of reliance on individual charitable contributions, Salamon (1995) argued,

So long as private charity is the only support for the voluntary sector, those in control of the charitable resources can determine what the sector does and whom it serves . . . Not only is this situation undemocratic, but it can create a self-defeating sense of dependency on the part of the poor since it gives them no say over the resources that are spent on their behalf. (p. 47)

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Without the intermediary of a foundation to buffer them, nonprofit ser- vice agencies are more susceptible to the influences and demands of indi- vidual donors, and the potential exists for conflict between satisfying individual donors’ wishes and expectations, and adequately representing the interests of clients. Nonprofits are more likely to adopt an instrumental orientation when they rely heavily on individual donations, because this form of revenue is increasingly scarce, promoting competitive behavior among nonprofit leaders, and creating an incentive for them to satisfy indi- vidual donors’ preferences which have the potential to conflict with actual client needs.

Fees and Direct Payments

As another major source of revenue, direct payments, also represent dif- fuse values and expectations of the clients who pay the fees. However, when clients become paying customers, nonprofits have an added incen- tive to become more attentive their interests. If clients pay for their ser- vices, they are better positioned to make demands on organizational governance, particularly if they perceive problems in their level or quality of service. When clients become paying stakeholders, they comprise a more powerful contingent of organizational funders. This ensures their interests will be accorded a higher level of priority in the allocation of time and governance activities. Organizations that rely on client fees for a large proportion of their revenues are likely to become more responsive to cli- ent needs and increase their level of activity related to advancing client interests, and thus will have a decreased likelihood of adopting an instru- mental orientation. Based on this, the following testable hypotheses are proposed:

Hypothesis 1: Organizations will be more likely to adopt an instrumental orientation when they rely heavily on corporate contributions.

Hypothesis 2: Organizations will be less likely to adopt an instrumental orientation when they rely heavily on government revenues.

Hypothesis 3: Organizations will be less likely to adopt an instrumental orienta- tion when they rely heavily on foundation income.

Hypothesis 4: Organizations will be more likely to adopt an instrumental orientation when they rely heavily on direct charitable donations from individuals.

Hypothesis 5: Organizations will be less likely to adopt an instrumental orientation when they rely heavily on client fees.

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Nonprofit Boards

Boards may also play a critical role in shaping nonprofits’ stakeholder orientation. In studying the boards of several hundred for-profit organizations, Wang and Dewhirst (1992) found that board members feel a responsibility to respond to stakeholder expectations. As the policy-making and oversight body of the nonprofit organization, board members often have substantial influence in setting organizational goals and priorities, and in determining how resources will be allocated to meet those goals. However board members bring different values, disciplinary norms, functional expertise, and social connections to their board role, and thus there are likely to be differences of opinion when it comes to setting organizational priorities and making resource allocation decisions. Thus, the composition of the board may be critical to determining stakeholder management practices. Salamon (1995) describes one of the inherent weaknesses of the nonprofit sector as “philanthropic paternalism,” referring to the historical tradition of nonprofits to be governed by boards consisting of economic elites. Salamon (1995) argues that philanthropic paternalism is problematic for clients because elite-dominated boards fail to represent client interests. Salamon’s paternalism argument suggests that when a large proportion of the board consists of economic elites, such as lawyers, business entrepreneurs/executives, and financial experts, nonprofits may be more likely to adopt an instrumental orientation. Heavy representation on the board by economic elites may serve as a mechanism through which business sector values become embedded in a nonprofit organization’s values and priorities.

Moreover, research conducted by Daley and Marsiglia (2001) suggests that economic elites acting as board members prefer the status quo in their governance authority and are somewhat resistant to increasing board diversity. These authors studied five United-Way funded organizations that had boards consisting largely of White, male, business professionals and found that members were mostly resistant to the idea of increasing social diversity on the board. Study participants perceived board diversi- fication as burdensome, and were frustrated at the lack of expertise that “diverse” members bring to the tasks of policy setting and fundraising. Board members in the Daley and Marsiglia study tended to assume a lack of competence among prospective board members who met one or more of the following descriptions: low-income, clients, young, those without prior board experience, and “new” board members. Daley and Marsiglia (2001) conclude,