Members of Congress Don’t Understand What Good Grant Making Takes

Legislation recently introduced in the House of Representatives would bar private foundations from counting administrative expenses, such as salaries and rent, toward the minimum 5 percent of assets they must distribute annually. The result would be at least $1-billion more in annual grants, surely a good thing for charities in these lean times. For those concerned with the effectiveness of the nonprofit world, however, the long-term harm of the proposal would far outweigh its short-term benefits.

It is easy to confuse volume with effectiveness. More grants are certainly better, but what should matter to society — and therefore to Congress — is the social benefit those dollars bring. Like it or not, the ability to direct dollars to where they will do the most good depends entirely on administrative expenses.

Some may believe that all nonprofit organizations are equally effective and all grant proposals equally good. In that case, foundations could eliminate virtually all overhead by using a lottery to select the grant requests they support. Even the largest foundation could be run with only a computer, printer, and stack of blank checks.

But if one accepts that grant requests, and even grantees, have different degrees of merit and operate with different degrees of effectiveness, then the benefit to society depends not just on the volume of dollars flowing into the nonprofit world, but also on the impact achieved by those dollars. That, in turn, depends on how the allocation decisions are made, and on the resources dedicated to formulating strategy, evaluating grantees, and managing the foundation’s non-grant-making activities — all administrative expenses.

Of course, some administrative expenses are bad. Many of the costs involved in applying for or making a grant result from inefficiency and bureaucracy. They are mere transaction costs necessitated by foundation policies and procedures that do nothing to create greater social impact. There are very few checks on the bureaucratization of grant making, and the operating procedures of most foundations that I have encountered could be significantly streamlined. Grant applicants must often needlessly contort their requests to fit complex and irrelevant application forms. Program officers, having already investigated and decided to support a grant proposal, still spend hours writing it up for the board, so that it can be routinely approved without exception. These administrative costs are pure waste.

But other administrative costs create tremendous value for society and the nonprofit world. One of the best examples is at the Charles and Helen Schwab Foundation. Its staff members discovered several years ago that they didn’t have time to stay abreast of developments in their major grant-making programs on learning disabilities, poverty prevention, homelessness, and substance abuse. They decided that they needed a librarian — imagine the overhead — to conduct research and circulate weekly e-mail messages related to each program, summarizing and linking to significant news developments around the world.

Schwab program officers say this service has enabled them to be more effective. It turns out that many other people and organizations — staff members of other foundations, nonprofit groups, associations, public-interest groups, and even government agencies — have the same need to stay informed but no budget for such a luxury. The e-mail updates are now provided directly to 1,000 such professionals each week, and excerpts of the learning-disability updates go out to an additional 23,000 parents of children with learning disabilities, all without charge.

In a recent survey of the 1,000 professionals, 96 percent considered themselves better informed because of these e-mail updates, 79 percent said the updates saved them time, and 70 percent said the updates made them more effective in their jobs. Doing the math, if the Schwab effort saved these professionals even a half hour a week, assuming an average cost of salary and benefits at $60,000 per year, the nonprofit world might be saving as much as $600,000 per year because of the modest additional administrative costs borne by the foundation.

Other examples abound: The Robert Wood Johnson Foundation has 35 communications officers on its payroll. Those officers have worked in highly effective ways to manage campaigns against teenage smoking and to enroll uninsured children in Medicaid. The Edna McConnell Clark Foundation spends more than 200 hours investigating potential grantees, then many hundreds of hours more working closely with those that the foundation supports to develop business plans. This approach seems to be working. During the past three years, when many other charities were shrinking, nearly all of the organizations that Clark supports have doubled or tripled in both the number of clients served and the money raised from other sources.

Of course, the proposed legislation would not eliminate administrative expenses, but merely prohibit foundations from counting them to meet federal payout requirements. Foundations would be free to spend as much as they like on administrative costs above the 5-percent floor. However, the prevailing attitudes and practices in the field today suggest that the foundation staff members and trustees would sooner eliminate or disguise administrative expenses than increase their annual payout.

Many foundations boards are already obsessed with minimizing administrative expenses to the point of undercutting their own effectiveness. Rightly or wrongly, 5 percent is widely viewed as the danger point beyond which spending might lead to an eventual dissolution of the foundation. The proposed legislation would force a choice between administrative expenses, already misunderstood and disliked, and the zealously defended perception of 5 percent as the limit on sustainable spending. The result is sure to be overwhelming pressure for expense reductions. Perhaps such pressure would force out wasteful and inefficient spending, but more likely it would inadvertently disguise and multiply it.

After all, administrative expenses can be magically transformed into grants merely by delegating them to a nonprofit organization, whether a nonprofit advisory firm such as the Philanthropic Initiative, a community foundation, or a large national charity. During the rapid growth of the 1990s, many foundations — precisely because of the need to meet payout requirements and keep overhead low — made lump-sum grants to other organizations with instructions for the recipient to regrant the money according to certain guidelines. Nonprofit groups are only too happy to oblige such requests, inflating their fund-raising results, covering their own overhead with administrative fees, and gaining stature among their peers for having money to spend.

The proposed legislation might well create foundations with virtually no administrative expenses, paying out a full 5 percent of assets each year in grants, but paying it to a small industry of nonprofit intermediaries that redistribute the funds in place of foundation-hired personnel. Unfortunately, the net costs to society would only increase for having added another layer of overhead, and the extra billion dollars in grants would be largely illusory. Worse, the already limited accountability of foundations would be further attenuated as they become removed from the ultimate allocation decisions.

Whether Congress should increase the minimum payout rate or set guidelines for executive compensation are separate questions. But if it acts, it must do so directly. Distinguishing between administrative expenses that create social value and those that uselessly increase transaction costs requires a line that is much too subtle for Congress to draw.

The challenge for foundations is to reduce costs without reducing their effectiveness. That depends not on legislation, but on better public information, greater accountability, and a deeper understanding of the ways to measure philanthropic effectiveness.

Mark R. Kramer is a founder and chairman of the Center for Effective Philanthropy, a nonprofit research organization, and managing director of the Foundation Strategy Group, an international consulting firm. He is a regular contributor to these pages. His e-mail address is kramercap@aol.com.