The microfinance site Kiva entices lenders with a promise that every dollar will go directly to the small business that the lender chooses. It’s a powerful strategy: people have funded more than $1.6 billion in loans through the site. As for raising money to administer the loans, Kiva makes that feel like an afterthought. Lenders are asked to tack on a donation to contribute to Kiva’s operating costs—and they’re welcome to decline.
Chicago Booth’s Canice Prendergast looked into why not-for-profit organizations emphasize alluring projects while downplaying their core operational needs. He finds that charities, cultural groups, and other nonprofits distort their priorities in ways that wouldn’t happen at for-profit corporations, usually to please marginal donors—people who give only to projects they care about.
Such donors are often motivated by the sense that their donation will make a difference. The nonprofits end up prioritizing projects that aren’t central to their mission but seem more likely to attract revenue.
Because of the divergence between what donors want and what organizations need, nonprofits also can wind up investing more in their worst projects, Prendergast finds. Cultural organizations such as art museums and theaters, for example, often spend huge amounts on new buildings, hiring high-profile “starchitects” to convince donors that they are contributing to something memorable. At the same time, those organizations might pay most of their staff poorly and have them work in dilapidated offices.
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How Charities Can Get an Edge“Often, the desire to attract funders causes organizations to contort themselves in ways they would not do otherwise,” Prendergast says. “They invent projects. They try to make existing projects sexier. What that means is that other stuff gets ignored, such as doing routine maintenance or keeping staff. All of the kinds of things donors think the organization is going to do anyway, donors have no interest in.”
Another challenge nonprofits face is that donors can penalize them for spending too efficiently. This might come as a surprise, given the host of websites that rank charities based on responsible spending. But Prendergast used a model to demonstrate that marginal donors can feel that an efficient organization will stretch its resources and that their contributions aren’t needed.
Prendergast says his findings may validate the experiences of people who run nonprofit organizations and are well aware of these dynamics. The findings could also help fundraisers justify to certain donors why they should pay for administrative expenses.
“From a practical perspective, you should not think that the ways nonprofits are designed should look the ways for-profit companies are,” Prendergast says. “There’s a strong tendency among people in for-profit sectors to criticize nonprofits because they look different. They automatically assume that they don’t know how to calculate net present value, or that they have workers who are lazy. Most of those things are totally wrong. A lot of the constraints that face a not-for-profit or mission-based organization come from the outside.”
Ultimately, Prendergast says, he aims to develop a full framework for when an organization should incorporate as a nonprofit and when it should not, based on the unusual incentives that are created by the need to appeal to donors.
Canice Prendergast, “Organizational Design for Making a Difference,” Journal of Public Economics, February 2023.
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