Corporate governance remains an important issue on the national domestic agenda. It began in 2001 with the Enron scandal. Enron's fraudulent accounting practices and executive enrichment shook investor confidence in the markets and resulted in one of the largest corporate bankruptcies in the history of our country. But it is the fact that the spotlight has not dimmed in the intervening years — with additional corporate scandals, criminal and civil suits, newspaper reports, legislative and regulatory responses and the media with an intense appetite to be critical of corporate America — that has cause good corporate governance practices to become ingrained as part of our values.

Nonprofit organizations have not been immune from their share of scandals, particularly with respect to whether they are sufficiently charitable, misuse of the tax deduction for charitable gifts, self-dealing by insiders, conflicts of interest, and compensation-related issues, including excessive compensation, loans, spousal travel, and personal use of organization assets.

At the heart of the scrutiny of nonprofits is compensation. There is some limit to what constitutes reasonable compensation, even where the total amount is properly reported as compensation. Second, process is at least as important as substance with respect to executive compensation. In this regard, cases such as the New York Stock Exchange (May 2004) reminds us that:

• All factors relevant to the compensation determination need to be disclosed to a Compensation Committee;
• The compensation consultant on which the Compensation Committee relies must be privy to all relevant facts and must disclose all pertinent facts in its report;
• The "comparables" that are to be relied upon must be truly comparable and valid; and
• All decision makers need to understand the actual amounts that are at issue (and not simply formulas).

The IRS announced in May of 2004 that it has an initiated a Tax-Exempt Compensation Enforcement Project. This project is resulting in reviews of varying intensity with the compensation paid to officers and other insiders and the processes employed in establishing the compensation, for approximately 2,000 exempt organizations. The goals of the IRS are to address compensation of specific individuals or instances of questionable practices, to increase awareness of IRS interest in compensation and the processes by which it is determined, and to help the IRS learn more about how exempt organization compensation is set and reported.

To reduce a nonprofit's exposure in applying Sarbanes-Oxley reforms, a compensation committee composed solely of independent directors should be formed. The committee would determine the compensation of the Chief Executive Officer and determine or review the compensation of other executive officers and managers, and ensure that compensation decisions are tied to the executive's performance in meeting predetermined goals and objectives. The committee should:

1. Use objective, comparable data for executive and other compensation determinations. The Compensation Committee should be responsible for determining the need for and selecting compensation consultants to provide comparable information and assist in crafting an overall compensation package that includes appropriate executive incentives tied to articulated performance goals. Such compensation determinations may be done annually or as part of a multi-year employment agreement.
2. Compensation Committees also should conduct an overall performance evaluation of the Chief Executive Officer, although such responsibility may be exercised by the Board itself or delegated to another Committee. In making compensation decisions, such Committee needs to consider the degree to which the executive satisfied prior performance goals. The Compensation Committee or another Committee may also be charged with responsibility for ensuring that a succession plan is in place for the CEO and other executives, with procedures for development of potential future leaders from within the organization.
3. The Compensation Committees of nonprofit Boards should verify the compensation (salary, bonuses and other payments made to executives) are based on an analysis of compensation received by executives at comparable organizations (including applicable for profit corporations) and are reasonable with respect to the organization's revenues, assets and complexity, and that any incentive portions of executive compensation are tied to the accomplishment of organizational or executive performance goals. Unlike for profit businesses, the goals set for a nonprofit executive may focus more on mission-related accomplishments rather than financial results.

In summary, nonprofit organizations need to learn from the Sarbanes-Oxley reforms and structure the necessary committees and processes to reduce vulnerability.

Article Submitted by Bill Ford, SESCO Management Consultants

About the Author: Bill Ford is President & CEO of SESCO Management Consultants, the oldest human resource consulting firm in the country. SESCO specializes in conducting comparable surveys, developing and implementing executive compensation and performance management systems. SESCO is AAHSA's retained human resource consulting firm. Bill can be reached at 800-764-4127, bill@sescomgt.com, or you may review SESCO's website at www.sescomgt.com.