How Boards Can Confidently Assess Executive Pay

One of the chief responsibilities of a nonprofit board is to determine executive compensation. But fulfilling that responsibility can be challenging.

Boards must contend with a variety of factors, from applicable state and federal laws to the nonprofit’s financial constraints to competitive pay practices to organizational values and the salaries of the rest of its staff.

The responsibility is also an opportunity.

Recently, NPQ spoke with Casey Williams, a nonprofit business and employment attorney at Liebert Cassidy Whitmore, who frequently advises nonprofit boards on issues around compensation and the roles and responsibilities of boards in determining executive compensation.

These considerations all boil down, Williams explained, to the same point: A board is responsible not just for setting executive pay but for doing so justifiably—and that means carefully weighing many things at once.

But the responsibility is also an opportunity for boards to get it right, as best they can, and create an executive compensation package that will hold up under stakeholder and public scrutiny, and will allow the organization to thrive in its work.

Key Takeaways: 

• It’s the board’s job to approve a compensation package that is “reasonable and not excessive.”
• It is highly recommended that boards achieve this by conducting a robust and well-documented investigation using comparability data.
• Boards should consider internal, external, and stakeholder perceptions of executive compensation and be prepared to justify compensation decisions.
• A board’s responsibilities around executive compensation extend beyond the approval of a compensation package to monitoring changes in compensation, changes in market conditions, and executive expenses.

Williams noted that getting compensation right requires balancing objective considerations like the law, finances, and comparable salaries elsewhere, as well as subjective ones like how an executive’s compensation will affect how the nonprofit is perceived, both internally and among external stakeholders.

“It’s not just from an ethical or budgetary perspective that people don’t want to be paying excessively.”

Whatever decision a board makes, Williams pointed out, will eventually become public knowledge and will be subject to public examination.

“The scrutiny exists, whether it’s right or wrong,” Williams said. “Nonprofit boards need to be prepared to respond to it by justifying where they land [on executive compensation] and explaining why it’s ‘reasonable’ in the context of the geographic market and comparable organizations.”

Learning the Law

A healthy board process of considering executive compensation, according to Williams, should begin with robust training in the laws around nonprofit executive compensation.

“It starts with just literally understanding that it’s not just from an ethical or budgetary perspective that people don’t want to be paying excessively,” Williams said. “There’s also literally a law within the Internal Revenue Code that prohibits it. And I think a lot of boards operate without understanding that.”

“Directors on nonprofit charitable boards need to know that at the federal level, the IRS regulates how much executives can be paid,” Williams added. “And that doesn’t mean they say…executives need to be paid between X and Y amount.”

Instead, the IRS sets a standard of executive compensation that is “reasonable and not excessive.”

In its guidance on executive compensation practices, the National Council of Nonprofits states:

The board of directors is responsible for hiring and establishing compensation (salary and benefits) for the executive director/CEO that is “reasonable and not excessive,” but is also enough to attract and retain the best possible talent to lead the organization.

It’s up to nonprofit boards to not only make their own determination as to reasonable executive compensation but also to be prepared to justify that determination to stakeholders, the public, and the IRS.

For boards to avoid excessive compensation, proper training is key.

“One of the key things we talk about in that kind of governance training is their legal responsibility to protect against excessive compensation,” said Williams, “And then we explain how to do that.”

Protecting against “Excessive” Compensation

Because the IRS does not assign numeric values to the concepts of “reasonable” and “excessive” compensation, it’s up to nonprofit boards to not only make their own determination as to reasonable executive compensation but also to be prepared to justify that determination to stakeholders, the public, and the IRS.

A properly led board process in determining executive compensation should create what is known in legalese as a “rebuttable presumption” that the compensation provided is indeed “reasonable and not excessive.”

Williams advises that most nonprofit boards undertaking this work engage in a three-pronged process laid out by the IRS:

• Have an independent body approve the compensation package: “That means that if the CEO is also a [board] director, they’d need to exclude themselves,” Williams said. “It also means that if a family member of the executive is on the board, they need to exclude themselves.”
• Approval of a compensation package must be based on “appropriate comparability data,” Williams said, such that the board can determine that a given compensation package “is within the range of what a comparable organization is paying for a functionally comparable person.” Making this analysis requires board members to either parse such data themselves or engage a third party to conduct the analysis.
• The entire process needs to be thoroughly documented through contemporaneous notes, said Williams. That means that board decisions around what comparability data to use, whether to hire professional assistance, whom to hire if so, and so on—all must be documented as the board moves forward in its process. Any and all votes by the board regarding an executive compensation package should be documented as well, including any objections or abstentions.

Continuing Responsibility

A board’s duties around executive compensation don’t end with the approval of a compensation package, Williams emphasized.

“The board is expected to continue to provide an oversight role, and that means regularly vetting the performance of your CEOs; it also means doing things like continuously overseeing business expenses, reimbursable business expenses like meals and flights,” noted Williams.

While such expenses incurred by non-executive staff are typically vetted by a CEO or CFO, Williams added that “the whole board is who is above the CEO. And so the board has that oversight role as well, and they need to be making sure those are legitimate business expenses, but also reasonable expenses—not just in terms of how the IRS might perceive that, but, again, how public perception might perceive it, whether right or wrong.”

The bright side of doing a thorough job, Williams emphasized, is confidence in moving forward with the organization’s ambitions.

“I think there’s a lot of space for boards to say, ‘No, those expenses are reasonable, considering what we’re doing and how important the work we’re doing is,’” Williams said, “But again, [the board] wants to be able to say they looked at it, thought about it, and came to an articulable justification for it.”