Do Donors Care? Some Australian Evidence

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Voluntas: International Journal of Voluntary and Nonprofit Organizations C 2003) Vol. 14, No. 4, December 2003 (°

Do Donors Care? Some Australian Evidence Gabrielle Berman1 and Sinclair Davidson1,2

It is commonly believed that individuals would donate more to charity if they were assured that the funds would not be “wasted.” This is a common answer to survey type investigations into charitable giving. In this paper we adopt a law and finance approach to investigate the validity of this contention in the Australian context. We develop an Accountability Rights variable and relate that variable to charitable donations. The relationship between the two is statistically weak and not robust. KEY WORDS: charities; fund-raising; legislation; Australia.

THE ISSUE As with all organizations, charities suffer from a corporate governance problem. Shleifer and Vishny argue that “corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment” (Shleifer and Vishny, 1997, p. 737). In the for-profit organization corporate governance is well recognized as being a complex issue. In nonprofit organizations the situation is somewhat more complex. While shareholders and bondholders may have well-defined objectives, it is not immediately clear why individuals and corporations donate funds to charity. In short, in the absence of a clearly defined objective function, it is difficult to determine whether charities use their funds wisely. It is not clear what donors are investing in, let alone how to evaluate the return that they receive as a consequence of providing funds to charities. According to Hansmann (1980), however, it is this very criteria (i.e., the lack of an objective function in the form of a profit motive) that effectively engenders trust in these organizations and establishes the rationale for the nonprofit form. 1 School

of Economics and Finance, RMIT University, Melbourne, Australia. should be directed to Sinclair Davidson, School of Economics and Finance, RMIT University, 239 Bourke Street, Melbourne 3000, Australia; e-mail: [email protected]

2 Correspondence

421 C 2003 International Society for Third-Sector Research and The Johns Hopkins University 0957-8765/03/1200-0421/1 °

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Hansmann (1980) argues that private for-profit provision arises when three conditions are satisfied: when customers/clients can make quality and price comparisons; when they can enter into agreements; and when they can evaluate firms on their adherence to these agreements. Nonprofit provision is said to arise when these conditions are not satisfied, as is the case with donational financing. The nonprofit form is said to limit opportunistic behavior (quality deficiencies and overpricing) that may arise with profit maximizing behavior. Hence the nonprofit form will have a competitive advantage as a result of increased levels of trust afforded by the nonprofit distribution constraint. Under these circumstances the profit distribution constraint would suffice as an indicator of trust, eliminating or minimizing the requirement for reporting and monitoring. If we assume, however, that the Hansmann (1980) theory does not wholly hold true and that donors provide funds to charity in the hope that some “worthy cause” (however defined) is promoted, it would seem plausible that they would engage in monitoring behavior to ensure their funds are used appropriately (Jensen and Meckling, 1976). Similarly, it might be expected that charities themselves would engage in bonding behavior, that is they would engage in some form of implicit agreement with donors to monitor and report outcomes achieved through donational financing. Conversely, however, if donors simply provide funds to charity in the hope of self-appeasement or being a responsible (corporate) citizen, then little monitoring or bonding would occur. Their objective is met by the act of giving, not the eventual usage of the funds. In Australia, charitable organizations are, in part, regulated in terms of how and when they may raise funds and how they communicate that usage to the general public, under the various state fund-raising laws. Mandatory reporting is, in essence, a subsidy to donors and investors who are thereby required to expend fewer resources to information acquisition. To the extent that a donor wishes to allocate a fixed portion of his/her total budget to charity and is concerned about the eventual usage of the funds, lower monitoring costs will increase the cash flow to charities. On the other hand, to the extent that the donor is unconcerned about the eventual usage of funds, mandatory reporting will have little or no impact on funds being allocated to charities. An alternate approach, however, would be to argue that donors “trust” charities and consequently are concerned about eventual usage but do not monitor that usage. This would suggest that donations are “endogenous” to the level of trust within society (and towards the charitable sector) and would be unresponsive to subsidized monitoring. If this argument is correct, however, there is no basis for governmental action or regulation of the sector. To the extent, however, that the trust may be undeserved, most particularly when it is not earned but rather a product of the “halo effect” of the perceived sanctity of charities (McGregor-Lowndes, 1994), a public policy role may remain in that the donating public expect the state to regulate and monitor charities. This already occurs in some sectors of the economy, e.g., the banking sector.

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Public policy towards donations seems to be predicated on the notion that donors are concerned about eventual usage of funds. For example, the (Australian) Industry Commission proposed that “increased confidence that funds are used appropriately can potentially increase the overall fund-raising to the sector” (Industry Commission, 1995, p. 221). Survey results in Australia and the United Kingdom indicate that donors are interested in ultimate usage of funds (Charity Commission of England and Wales, 1999; IOOF & ASSIRT, 1997). In particular donors are concerned about the proportion of funds used to finance the day-to-day activities of the charities, i.e., funds not directly allocated to the welfare function of the charity. This paper uses the Australian environment to determine whether donors are willing to donate more in an environment of “increased confidence.” Unlike the Corporations Act 2001, which is uniform across Australia, the regulation of charities is not. The regulatory regime that governs charities is determined by their choice of incorporation. Charities may take the form of an unincorporated association, an incorporated association, or a company limited by guarantee. Other charities are established by their own Act of Parliament, by Royal Charter, or by State Trust. The basic reporting requirements of these associations are determined by the form of association. Only Companies Limited by Guarantee are required to file annual reports with the Australian Securities Commission, a federal regulator, while the reporting for incorporated associations will be determined by the State Incorporations Acts. The Charitable trusts form carries few external reporting requirements while the nature of reporting for those established by their own Acts of Parliament and by Royal Charter, is determined by their individual Act. In short, charities may be governed by a combination of both Federal and State laws or by one or the other. In addition, each state has its own laws about soliciting funds from the public. These laws are also of varying antiquity. For example the laws governing charities in Victoria were promulgated in 1998, while the South Australian law was promulgated in 1939. La Porta et al. (1997) have investigated the impact of law, law enforcement, and legal tradition (family) on the ability of firms’ to raise capital. This paper follows that approach. While legal family and law enforcement is uniform within Australia the rules governing charities are not. Given the antiquity of some rules and the varying regulations that apply across states and the sector, it is possible, using an approach similar to that of La Porta et al. (1997) to test whether the rules and regulations that apply to charities (increased confidence) actually impact their ability to raise funds. Much as La Porta et al. create their antidirector rights variable so we create an accountability variable by examining the various rules that apply to charities. Unfortunately the data we have relate to the 1996 financial year, so we are unable to test changes to the Victorian legislation in 1998. The structure of the paper is as follows: first we set out the rules that apply to charities; proceed to describe our data and results; and then offer some conclusions.

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REGULATION OF CHARITIES In order to determine the regulations that apply to charities, the legislation governing charities in each state was examined. Legislation that pertains to the manner of fund-raising for each state was examined. Those issues that pertain to greater accountability were identified and an interstate comparison made. Table I sets out differences between the fund-raising requirements. An examination of the legislation highlights the inconsistencies in the definition and regulation of charities. There is little consistency across states, and within each state the various forms of association (Unincorporated Association, Incorporated Association, Company Limited by Guarantee, Royal Charter, Own Act) determine the form of regulation. This disparity in the form of governance may also occur within an organization if that organization has offices in several states. In these instances it is common to create a central company limited by guarantee that presides over the independent incorporated associations regulated by their respective state legislation (Fitzgerald, 1997). The Company Limited by Guarantee is the only organizational form for which legislation is consistent across the states. This consistency is the result of a Federal as opposed to State regulatory body, in the form of the Australian Securities and Investments Commission. The fund-raising legislation also suffers from similar disparity. Furthermore, in the Australian Capital Territory, South Australia, and Western Australia fundraising legislation has not been substantially altered since 1959, 1939, and 1946, respectively, resulting in the imposition of less rigorous reporting requirements for these states. This is further compounded by the differing exemptions in each state. New South Wales, Queensland, and Victoria effectively exempt religious organizations from many of the reporting requirements. To the extent that donors are concerned about ultimate usage and monitor charities, these regulations and especially the variation in regulation can be expected to result in systematic variation of fund-raising. DATA AND RESULTS La Porta et al. (1997) create an index of “anti-director rights” and “creditor rights” similarly we create an index of “accountability rights.” Following La Porta et al. (1997) we assign numerical values to the variables in Table I, Y = 1 and N = 0. We aggregate the values to derive a final index. La Porta et al. (1997) measure firms’ fund-raising ability by the ratio of external capital to GDP ratio, we employ funds raised (donations). Data for this variable are collected from the annual financial statements of a sample of charities for the financial year 1996. The sample of charities employed is all those charities that are concerned with human welfare (e.g., the Smith Family, but not the Royal Society for the Prevention of Cruelty to Animals) and for which we could acquire the data. We sent out 600 letters

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Table I. Summary of Accountability Requirements Across States Requirement A person/organization conducting a fund-raising appeal must keep records sufficient to enable a true and fair view of the income and expenditure relating to the appeal. The person/organization conducting the appeal must keep records of all assets and funds received as a result of the appeal; full details of what happened to those funds and assets; the amount applied to the purposes or objects of the appeal and how it was distributed. The person/organization conducting the appeal must ensure that the records are kept in a way that enables them to be audited. The minister may direct the person/organization conducting the appeal to submit to the minister an auditor’s report on the accounts and records kept in relation to the appeal. Any person may inspect the accounts or the audited accounts at any time after a copy has been given to the minister. Any person/organization conducting the appeal must ensure that any money received in the course of the appeal is deposited in an account that is used exclusively for money received from the appeal. If clothing bins are used in the course of a fund-raising appeal a written record is kept detailing the total amount of funds raised, what percentage of the clothing was made available for sale, what percentage was sold as scrap and to whom, and if any person was paid for collecting, processing, or selling the clothing what proportion of total proceeds was paid to this/these persons. Paid phone canvassers, or paid collectors must explicitly indicate that they are being paid for their services either by stating that they have been retained on a commercial basis on the phone prior to seeking the donation, or by displaying clearly on a badge that they are “paid collectors.” Collection receptacles are to be secured, numbered, and labelled etc. The use and emptying of receptacles to be properly supervised in a way that ensures that all the donations are collected and properly supervised. In conducting an appeal a person must not make or give any oral or written statement in relation to the appeal that misleads or deceives.

VIC

NSW

QLD

SA

WA

ACT

Y

Y

Y

Y

N

N

N

Y

N

Y

N

N

N

Y

Y

Y

N

N

Y

Y

Y

Y

Y

N

N

Y

Y

N

N

N

N

Y

N

N

N

N

N

Y

N

N

N

N

Y

Y

N

N

N

N

N

Y

Y

Y

N

N

N

N

N

N

N

N

Y

Y

N

N

N

Y

Notes. The Victorian data relate to the 1984 legislation. If the 1998 legislation were used all of the variables would have been “Y .” No legislation has been passed with respect to fund-raising in Tasmania and the Northern Territory.

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requesting copies of financial statements and received 184 responses (30.7%). This does introduce some bias into the results as those charities that did not provide data are perhaps less likely to raise vast amounts of funding from the public. In addition, many charities associated with religious organizations are not required under state legislation to produce publicly available financial information and are thus underrepresented in our sample. The data available is further limited to that subset of charities that included aggregated fund-raising data in their annual report for the 1996/97 financial year. In total there are 135 observations. Gross State Product for the financial year 1996/97 is employed as a control variable. Other variables that La Porta et al. (1997) employ, such as legal tradition and rule of law are likely to display little or no variation across the states and territories (and in any event we have no data) and are not included in the analysis. Summary statistics are shown in Table II. The data are segmented by state and the analysis assumes that the donations are attributable to the state in which a charity is registered. Given the unambiguous demarcation of (Australian) metropolitan areas in their respective states this assumption seems reasonable. Table II indicates that Victorian charities constitute the largest subset of charities within our sample. Charities are also more likely to be Incorporated or Company’s Limited by Guarantee than have their own Act of Parliament or Royal Charter. We have no data for charities in the Northern Territory and only one for Tasmania (which was eliminated from the sample). What is important for our purposes is that there is no obvious relationship between Donations and Accountability Rights. In order to further investigate any relationship between Donations and Accountability Rights we estimate a series of OLS regressions. Results are shown in Table III. Gross State Product is used as a measure of relative wealth in the state

Table II. Summary Statistics State

Account Rights

Donations

Assets

Incorp

Own/ Royal

Com

N

Year

ACT NSW QLD SA VIC WA

1 10 4 5 3 1

2,174,021 15,341,623 37,930,881 11,008,869 247,861,257 3,819,509

11,929,903 131,379,120 142,511,141 191,886,322 1,021,604,412 62,512,411

3 5 5 8 38 4

0 6 2 1 7 0

1 25 7 1 20 2

4 36 14 10 65 6

1959 1991 1966 1939 1984 1946

Notes. “Account Rights” is the sum of legal requirements that apply fund-raising within each state/territory. Victorian data relate to the pre-1998 legislative position, Account Rights would now be 11. Donations and Assets refer to the sum of donations and assets within each state/territory for which we have data. Incorp indicates the number of charities in our data set that are incorporated. Own/Royal indicates the number of charities that are established either by their own Act of Parliament or by Royal Charter. Com indicates the number of charities that are company’s limited by Guarantee. N is the total number of charities in our data set. Year refers to the year in which the act relating to fund-raising was promulgated in each state.

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427 Table III. Regression Results for Log(Donations)

C Log(Assets) Log(GSP)

1

2

3

4

5

1.0735 (0.7387) 0.7455 (0.0000) 0.0588 (0.8264)

1.8385 (0.1383) 0.7252 (0.0000)

5.8362 (0.0543) 0.6444 (0.0000) −0.1889 (0.4350)

3.5101 (0.2687) 0.7298 (0.0000) −0.1728 (0.5360)

6.8137 (0.0333) 0.6429 (0.0000) −0.2895 (0.2638)

0.1017 (0.0784) 0.3979 30.7340 0.0000

0.3274 (0.4314) −1.0184 (0.0347) 0.0438 (0.4873) 0.4419 22.3794 0.0000

ACT

0.3577 (0.7180) 0.5968 (0.1381) 0.3916 (0.4618) 0.2120 (0.7450) 0.0370 (0.9612)

NSW QLD SA WA Company

0.3144 (0.4297) −1.0037 (0.0297)

Incorporation Accountability Adjusted R 2 F-statistic Prob(F)

0.3892 45.9263 0.0000

0.3822 15.5402 0.0000

0.4369 28.3547 0.0000

Notes. Log(GSP) = the natural logarithm of Gross State Product for 1996/97. Company is a binary variable = 1, if the charity is a company limited by guarantee and = 0 otherwise. Incorporated is a binary variable = 1, if the charity is incorporated and = 0 otherwise. Accountability is the “Accountability Rights” index. p values are in parentheses.

and Assets are a proxy for charity size. Our base case is shown in column 1 of Table III. It is clear that there is a size effect in charities abilities to raise funds. The relative wealth in the state, however, has no effect. In column 2 we augment our model with state dummy variables. The base case here is Victoria. As none of the dummy variables are statistically significant we are able to conclude that donations are not systematically different across the various states of Australia. In column 3 we introduce incorporation regimes. The dummy variables indicate whether a charity is a company limited by guarantee or whether it is an incorporated association. The large, negative, and statistically significant coefficient on Incorporation indicates that those charities that are incorporated association have, ceteris paribus, fewer donations. This is consistent with the notion that a lack of uniform regulation does have an impact on the fund-raising capabilities of charities. Column 4 includes our accountability rights variable in the basic equation. It is statistically significant at the 10% level and the impact of the coefficient is potentially large. For example, in the case of Victoria where the accountability rights variable increased to 11 in 1998 expected donations, based on this result,

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would double. This result, however, is not robust and disappears in column 5 when we include the incorporation variables. This finding supports the idea that donors are concerned primarily with the donative act rather than the usage of funds. A different interpretation may be that the Hansmann (1980) explanation for the nonprofit nature of donative organizations (independent of legal identity) largely holds true. Thus the restriction on distribution of funds provides a sufficient indication of trustworthiness such that donors are largely indifferent to legal form and in turn to the effective regulation of these organizations. The negative and significant coefficient on Incorporation, however, undermines this explanation.

CONCLUSION This paper has adopted a law and finance approach to evaluate the question of whether donors “care” about increased accountability for charitable organizations. Following La Porta et al. (1997) we have formulated an accountability index and evaluated its impact on donations. It appears that the accountability index has a weak impact on charities ability to raise funds from the public. In short, it would appear that donors do not care about the usage of funds. It is premature, however, to draw such strong conclusions. Size is a significant determinant of donations. To the extent that size is a proxy for reputation donors may care about fund usage. This, however, does not modify the conclusion that increased regulation and accountability will not necessarily increase charitable donations. A number of other caveats are also in order. The nature of our data collection includes strong self-selection bias in that many organizations chose not to provide us with their financial statements. Assuming that these charities are less “accountable” this would bias the empirical test towards the results that we actually found. In addition, the power of the test may be low and the definitions of the accountability variable imprecise. Nonetheless, we are unaware of any other test of this nature that does not rely on survey instruments that suffer from stated preference bias.

REFERENCES Charity Commission of England and Wales (1999). A Survey of Public Attitude and Knowledge Conducted by Market and Opinion Research International (MORI). www.charitycommission.gov.uk/mori.htm Fitzgerald, E. (1997). Structuring and Restructuring Non-Profit Associations, Working Paper Series No. 7, Program on Non-Profit Corporations, Queensland University of Technology, Queensland. Hansmann, H. (1980). The role of non-profit enterprise. Yale Law Journal 89, 835–901. Industry Commission (1995). Charitable Organisations in Australia, Australian Government Publishing Services, Melbourne.

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IOOF & ASSIRT (1997). Australians and Their Money: How Generous Are Australians? IOOF & ASSIRT, Melbourne. Jensen, M., and Meckling, W. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics 3, 305–360. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., and Vishny, R. (1997). Legal determinants of external finance. Journal of Finance 52(3), 1131–1150. McGregor-Lowndes, M. (1994). Halos, Fractures, Rigour Mortis, Cloning, External Instruments and Companies Limited by Guarantee, Working Paper Series No. 42, Program on Non-Profit Corporations, Queensland University of Technology, Queensland. Shleifer, A., and Vishny, R. (1997). A survey of corporate governance. Journal of Finance 52(2), 737–783.