Nonprofit Corporate Governance: The Board’s Role

In the nonprofit setting, misconceptions about corporate governance abound. Are board members primarily fundraisers? Cheerleaders? A rubber stamp to legitimize the actions and decisions of the executives? Do they run the organization to the extent staff is unable? Are they window-dressing to spruce up the organization’s letterhead? If they are rich or famous, must they attend board meetings? How do they know whether they are doing a good job, or when it is time to go? Despite nonprofit and for-profit corporations’ common ancestry and legal underpinnings, nonprofit corporate governance places heightened demands on trustees: a larger mix of stakeholders, a more complex economic model, and a lack of external accountability. This post, excerpted from Lesley Rosenthal‘s Good Counsel: Meeting the Legal Needs of Nonprofits and originally appearing in the Harvard Corporate Governance Forum, explores how substituting a charitable purpose for shareholders’ interests affects the board’s role.

In organizations of all kinds, good governance starts with the board of directors. The board’s role and legal obligation is to oversee the administration (management) of the organization and ensure that the organization fulfills its mission. Good board members monitor, guide, and enable good management; they do not do it themselves. The board generally has decision-making powers regarding matters of policy, direction, strategy, and governance of the organization.
The board of a well-governed nonprofit organization, like the board of a well-governed profit-making company, will do all of the following:

  • Formulate key corporate policies and strategic goals, focusing both on near-term and longer-term challenges and opportunities.
  • Authorize major transactions or other actions.
  • Oversee matters critical to the health of the organization— not decisions or approvals about specific matters, which is management’s role—but instead those involving fundamental matters such as the viability of its business model, the integrity of its internal systems and controls, and the accuracy of its financial statements.
  • Evaluate and help manage risk.
  • Steward the resources of the organization for the longer run, not just by carefully reviewing annual budgets and evaluating operations but also by encouraging foresight through several budget cycles, considering investments in light of future evolution, and planning for future capital needs.
  • Mentor senior management, provide resources, advice and introductions to help facilitate operations.

Similar to for-profit corporations, the power to control and oversee the management of the affairs and concerns of a nonprofit corporation is set forth in its corporate charter. Generally speaking, state law permits both kinds of corporations to self-direct significant allocations of power and responsibility, and then requires them to follow their own corporate governance and operational policies. The familiar fiduciary duties of care, loyalty, and – sometimes – obedience, undergird these requirements in both sectors.

In a well-governed organization of either the for-profit or nonprofit kind, the board does not permit executives to run and dominate board meetings, set agendas, or determine what information will be provided to board members. Under the leadership of an active and functioning board chair, there is adequate opportunity at board meetings for members to receive and discuss reports from not only the chief executive, but also, as appropriate, directly from other executives, in-house and outside professionals, and independent consultants if necessary. Time should be reserved for executive sessions, at which management should be excluded so that its performance may be fully and freely discussed.

Mission is what distinguishes nonprofits from their for-profit cousins: Nonprofits have missions instead of owners or shareholders. While the prime directive for board members of for-profit organizations is to ensure the highest possible value for owners, by contrast, nonprofit board members’ prime directive is mission fulfillment.

Board independence and board attention are of paramount importance in good nonprofit governance. The independence of the board is key because of the non-distribution constraint – nonprofits exist to serve the public interest, not to benefit owners or other private parties. Business or family relationships between the organization or its executives and a board member or her firm are frowned upon and should be strictly scrutinized under a conflict of interest policy administered by independent directors. Even absent outright business or family relationships, a common shortcoming of nonprofit boards is that they are too small, too insular, or too deferential to the founder or chief executive.

Another frequent error of nonprofit boards is inviting new members because of their marquee name within a certain field of endeavor (e.g., a famous dancer on the board of a dance organization) or their means and inclination to donate, without due consideration to the person’s ability and availability to fulfill fiduciary duties, providing the critical oversight function. The governing body of a nonprofit must be made up entirely of people in a position to govern it—setting the strategic direction of the organization and overseeing management’s execution of the mission. Wealthy or prominent persons— donors, artists, scientists, public officials, and others—with an interest in the organization’s program but lacking the time, availability, or expertise to provide meaningful oversight may serve the organization in a non-fiduciary capacity, such as an honorary or advisory board, donors’ circle, or professional council.

Governance is more complex in charitable nonprofits for a number of reasons. Public charities (501(c)(3) organizations) are intended to serve a public purpose, and the board must bear in mind that broad interest. Depending on its mission, history, and geographic reach, a nonprofit may also have specific stakeholders or different groups of stakeholders, some or all of whom may be represented by categories of board members under the organization’s by-laws. The interests of the organization’s ultimate clients, who may be indigent or otherwise disadvantaged, are another important consideration. The organization’s management and workforce may be paid less than their for-profit peers for similar work – if at all – further complicating the board’s oversight duties. In addition, nonprofit trustees may feel role-strain – or worse – because of real or perceived obligations to interact with, attract – or even be – charitable donors. These additional factors make nonprofit board decision-making arguably a much more complex process than the straightforward mandate of maximizing return.

Moreover, nonprofits’ economic models may be more complex than for-profits’ models, including a dynamic blend of earned revenue (ticket sales for a symphony, fee-for-service billings by a hospital, tuition payments to a university) and contributed income (annual fundraisers, “Friends of” membership groups, end-of-year solicitations, capital campaigns). Wealthier nonprofits with endowments can also count on a stream of revenues from investments. In harsh economic climates, however, there is a high correlation between reduced contributions and weaker investment returns. Compounding the difficulty, hard times on the revenue side often coincide with heightened demand for organizations’ services, particularly social services, increasing expenses and creating cash crunches, trouble balancing budgets, or even persistent deficits. Savvy nonprofits have added “third streams” of revenue to supplement and diversify traditional two sources. Entrepreneurial initiatives may include leveraging real estate or other assets, monetizing treasure troves of intellectual property know-how, or engaging in joint ventures with fellow nonprofits or even commercial entities. In envisioning and evaluating such enterprises, board and management must observe regulatory requirements and consider tax implications. In lean years and in growth years, the board must be deeply engaged in overseeing the organization’s investments, its other sources of revenue and expense, and the planning of new initiatives.

What happens when board members fail? In theory, the mechanism in a for-profit corporation for correcting errant board members is straightforward: if the investors don’t like what the directors are doing, they vote them out of office. But in the absence of investors, nonprofit boards must be self-correcting. No one has ever made a tender offer because a nonprofit was inefficient. Moreover, governmental agencies regulating the sector tend to be small and under-resourced, making it highly unlikely that any but the most obvious misconduct will be detected and corrected from the outside. Unless board members are doing something illegal or are term-limited out of office, they may serve in perpetuity, giving them ultimate power over the organization. In this regard, nonprofit trusteeship is a unique and privileged role.

By a number of measures, nonprofit and for-profit board governance are similar: the board’s oversight role, its decision-making power, its structural place within the organization, and its members’ legal duties. The similarities end, however, where shareholder interest in maximizing returns gives way to mission fulfillment, a multiplicity of stakeholders, more complex business models, and self-accountability rather than external accountability.

Author: Lesley Rosenthal

LESLEY ROSENTHAL is the author of Good Counsel: Meeting the Legal Needs of Nonprofits (John Wiley & Sons 2012). She leads the legal, governance, and compliance functions of Lincoln Center for the Performing Arts, Inc. Since 2005 she has fashioned the legal context for the renowned arts center's world-class cultural and educational offerings, its entrepreneurial initiatives in media, fashion, and international consulting, and the $1.2 billion redevelopment of its iconic physical complex. Rosenthal has served in many roles throughout the nonprofit sector, including for the New York State Bar Association and its Foundation. For 13 years she was in private practice as a business, litigation, and technology lawyer at Paul, Weiss, Rifkind, Wharton & Garrison in Manhattan. Rosenthal graduated from Harvard College and Harvard Law School. The National Organization for Women (NOW-nyc) has named her a "Woman of Power and Influence," and the Association of Media & Entertainment Counsel has named her Counsel of the Year for Excellence in the Arts. Follow her on Twitter @GoodCounselBook or find her on Facebook at facebook.com/GoodCounselBook. Good Counsel: Meeting the Legal Needs of Nonprofits www.goodcounselbook.com goodcounselbook@gmail.com * * * Nonprofit organizations, law firms, bar groups, or universities wishing to inquire about scheduling a book-signing event, training program or conference may contact goodcounselbook@gmail.com.

6 thoughts on “Nonprofit Corporate Governance: The Board’s Role”

  1. Non-profit board members (except in the case of foundations with large endowments) are often expected to personally bring in substantial revenue to the organization, through their direct charity and personal fund raising. This can lead to board members being selected on the basis of wealth and access to wealth, rather than primarily on the ability to perform the roles mentioned by Ms. Rosenthal. The burden of fund raising also can limit the attention that board members give to governance. However, as Ms. Rosenthal suggests, the most common failure of all boards, both business and non-profit, is to be too deferential to management, and this failure is often actively sought by Chief Executives (both business and non-profit).

    1. I need to apologize that I originally missed the paragraph of the post where selection of board members for fund-raising was addressed…

  2. Another thing that (often) distinguishes nonprofit boards from those of for-profit corporations is their size compared to the size (both dollar and staff) of the underlying organization. A for-profit with revenue of a million or two a year is going to have a handful of people on the board, almost all of them directly involved in the day-to-day operation of the business. There will almost certainly be more employees than board members. A small nonprofit, in contrast, may have only one or two employees (or sometimes no paid employees at all) but a board of half a dozen to a dozen people. With only one or two involved in day-to-day operations. You need this kind of superstructure when playing with other people’s money for a supposedly altruistic purpose, but it does make nonprofit boards fundamentally different even if they don’t want to be.

  3. Thanks for tackling such a difficult topic. I’ve served as a board member for private non-profits and I’ve provided legal advice to elected boards that govern bodies politic and corporate here in Massachusetts. The model of a governing board that runs a local housing authority, for example, is desperately in need of redesign. We keep having awful scandals (http://articles.boston.com/2011-11-10/news/30382972_1_housing-officials-public-housing-mclaughlin) and the stories are all the same. In many cases, the board only knows what the E.D. reports, so the notion that the board controls the E.D. is fanciful. In other cases, board members turn housing authorities into their own fiefdoms (http://www.freerepublic.com/focus/f-news/1169930/posts). No easy answers.

    Non-profits are also in need of a different model. The line between micro-managing and oversight can be impossible to discern. It isn’t even clear, much of the time, when a board vote is needed. We muddle along, and as I drive home from board meetings, I am often aware that we’re all just making it up as we go along.

    1. You may want to glance at the third edition (2011)of my book Policy vs. Paper Clips. Listed on Amazon.com. The model has been adopted by thousands of nonprofits and address the issue you have sited in depth.

  4. Often nonprofit Board members are recruited just as for-profit Board members are: with a promise that they won’t have to do any work. Then the Executive Director and staff wonder why Board members never do any work. If we’re clear about our expectations of Board members (which we can be in a relatively simple document outlining their tasks and duties), they will measure up. And I reject as false the dichotomy between Board members who give money and those who give time or oversight: every Board member can do both. What’s really missing in nonprofits is adequate training of Board members, of the kind offered to prospective small business owners by the Small Business Administration. (Apparently the SBA also offers guidance to nonprofits but it’s something of an afterthought.)

    If we’re going to go on having the most important business of society (caring for our sick, educating our children, supporting the arts, etc.) done by agencies whose governors are untrained volunteers, we can’t be surprised if those agencies frequently aren’t up to the task. Volunteers can do phenomenal work, but they have to be shown how.

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