A Little ‘Creative Destruction’ Is Good for Foundations

To the Editor:

Surprise, surprise. Two recent reports by investment companies recommend giving away only the current required minimum amount of 5 per cent of assets (“To Live Forever, Foundations Should Give Away the Minimum, Reports Say,” November 18).

The primary purpose of foundations should be to act as talent scouts to efficiently distribute funds to deserving non-profit organizations, not to grow the endowment. The concern over the possibility of shrinking total foundation assets is the most overblown fear since fat-free potato chips threatened to take over the supermarkets. The only fact certain about investment performance is that the next 50 years’ experience will be different from the past 50.

Since 1980, the number of grant-making foundations has doubled, from 22,000 to over 44,000. Total foundation assets have grown from $74-billion in 1984 to over $282-billion in 1997. Looking ahead to the not-too-distant future, we can see that the science and technology heroes in California will soon be creating huge foundations that will rock the non-profit world.

Not only should the minimum payout amount be raised from 5 per cent to 6 per cent, but newly created foundations should be voluntarily encouraged (by their peers) to set term limits of 25 to 30 years on their existence. This will result in the immediate distribution of more money to non-profit groups. It will also lessen the problems of ignoring original donor intent and will help bring a sense of urgency to this field.

Who wins when the minimum foundation payout remains low? Money-management firms, non-founder professional staff members, and some consultants.

Who loses? Foundation founders, deserving non-profit organizations working on present-day problems, and the American public.

Let’s give future generations a little more credit than we have in this debate. I think with their brains, resources, creativity, and intuition they should be able to handle some of their own unique problems. They will probably be wondering why we didn’t spend more money on certain problems, where clearly money was the solution.

A little “creative destruction” can be good, even for foundations.

Craig H. McCoy
Financial Planner
Minnetonka, Minn.

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To the Editor:

The current debate over raising the payout rate on foundation assets is framed incorrectly. The reports by DeMarche Associates and Goldman Sachs Asset Management, as described in The Chronicle, argue that foundations should not pay out more than the legal minimum of 5 per cent of their assets for fear of eroding their asset base, while others suggest that foundations can raise their levels of giving to 6 per cent or more without decreasing the real value of their assets.

However, these arguments over whether to set the payout rate at 5 per cent or 6 per cent or more miss the point. These are arbitrary numbers unconnected to the benefits that foundations seek to produce with their expenditures. The 5 per cent minimum payout, for example, is a legal requirement that has little relation to a sensible policy for foundation giving. Rather, it is a politically determined standard to insure that foundations do not accumulate their assets — and hence their power — without limit.

What foundations need to do is to think through how their spending relates to accomplishing their missions. The question of whether they can afford to spend 6 per cent rather than 5 per cent in order to preserve their assets and maintain themselves in perpetuity should not be the guiding principle.

A simple exaggerated example will illustrate the point. If a foundation could spend down all its assets on a project that would assure the elimination of AIDS or create an effective early-warning system for earthquakes, it would be justified in doing so even if it meant going out of business. The present value of future benefits of such expenditures — lives saved, medical expenditures reduced, added value of future productive work by those helped — would likely exceed any alternative stream of benefits produced by keeping the foundation in business. A 5-per-cent or 6-per-cent rule has no relevance to such a calculation.

Under what circumstances, then, should a foundation seek to preserve the real value of its assets? In many cases, it may be required to do so by virtue of donor intent. But aside from legal constraints, the touchstone for this decision should be mission. For some missions, it may indeed make sense for a foundation to stay in business forever. Perhaps poverty will always be with us, or science will always hold the promise of new and useful discoveries. The environment may always need conserving. Foundations dedicated to clear, ongoing goals may justifiably decide to be permanent.

But other missions may be time limited or may hold some promise of being accomplished in shorter order with larger current expenditures that reduce the foundations’ asset base. Naturally, there is always uncertainty surrounding such decisions, and foundations may wish to hedge their bets, but it should not be assumed a priori that expenditures should be limited by the foundations’ ability to stay in business indefinitely.

Economists make another argument that also casts doubt on imposing a ceiling on foundation spending. Preserving assets in an endowment favors benefits to future generations relative to the current generation. But if the economy continues to grow, future generations will be richer than ourselves and perhaps more capable of solving certain problems. Does it always make sense to favor the future when current problems are so severe? Moreover, by solving problems now, we are less likely to allow the costs of these problems to balloon upward for future generations.

This may be particularly true in areas such as education and health, where deficits in the current population can project themselves through many future generations. Foundations need to look at their expenditures as investments in the future, not as ongoing salves constrained by what is possible within the limits of asset preservation.

What foundations require is not a specific guideline on the percentage of their assets that they should be spending. What they need is a sensible cost-benefit calculus that relates the value they produce to the expenditures they make within the context of their missions. This requires a much more sophisticated approach to foundation decision making that might lead in many cases to spending substantially more than foundations now do.

Of course, the approach I am suggesting will rub against the grain of human behavior. Foundations with employed staff are organizations with natural instincts for survival. Understandably, they don’t want to shrink or go out of business. Moreover, donors often seek immortality with their gifts. But a version of the philosophy of Andrew Carnegie — “he who dies rich has failed” — applies to foundations: The foundation that hoards its wealth rather than distributes it wisely is a failure.

I have recently been involved in forming a new organization called the National Center on Nonprofit Enterprise whose mission is to help non-profit organizations make wise choices in economic decisions such as these. The determination of foundation spending and many other such decisions by non-profit organizations require more than simple rules of thumb. They deserve sophisticated consideration to insure that non-profits use their resources as effectively as they can to address their social missions.

Dennis R. Young
Professor
Case Western Reserve University
Cleveland

Mr. Young also is current president of the Association for Research on Nonprofit Organizations, founding editor of the journal Nonprofit Management and Leadership, and chief executive of the new National Center on Nonprofit Enterprise.

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To the Editor:

What moves me to write is your recent uncritical report on the yet-to-be-issued study by DeMarche Associates, which purports to correct my study on foundation giving, “Spending Policies for Foundations” (“Playing the Percentages,” October 21) without in fact addressing a single one of the issues I raised.

DeMarche presumes that the primary objective of foundation spending policy is to perpetuate each foundation (each one of the 44,000 and counting) into the infinite future, and even to grow the assets each one has under management. This is something that needs argument, but no argument is provided. Grant this presumption, as DeMarche would have you do, and the result follows easily that foundations should pay out as little as possible, which means the minimum allowed by law. Question the presumption, as I have done, and the result comes into question as well.

I conduct my analysis on the alternative presumption that the primary objective of foundation spending policy should be to give money away — to make a difference, not a profit. This is arguably the objective that Congress thought it was furthering when it provided special tax-favored status for foundations, but there is no need for us to read the mind of Congress. The question presents itself to us as citizens: What kind of foundations do we want? Answer that question, and the payout question will answer itself.

Perry Mehrling
Chair
Economics Department
Barnard College
Columbia University
New York