Association for Public Policy Analysis & Management

Charity Navigator recommends that nonprofit organizations should not spend more than 25% of their budget on overhead (Charity Navigator, n.d.). Such guidelines have manifested donors’ unrealistic expectation that nonprofits should run on low overhead exacerbating an alarming phenomenon in the sector known as the “nonprofit starvation cycle.” The cycle suggests that underfunding overhead can have detrimental effects on nonprofits’ program outcomes and overall effectiveness. Existing evidence supporting those effects (e.g., Gregory & Howard, 2009; Wing & Hager, 2004); however, remains largely anecdotal.

We address this distinct gap in the literature through an empirical examination of the impact of overhead spending on program outcomes using longitudinal data of arts and cultural nonprofits from 2008 to 2016 with a final sample size of 34,506. The dependent variable is in-person attendance, a measure adopted from several previous studies (Carman, 2010; Charles & Kim, 2016; Kim, 2016; White & Simas, 2008). We test the effect of overhead spending on program outcomes in three different ways: total in-person participation (paid and free), paid participation only, and free participation only. The primary independent variable is overhead cost ratio and its quadratic term. It is the sum of administrative and fundraising expenses divided by the total expenses.

This study focuses on the arts and cultural subsector where the dynamics of the starvation cycle are particularly evident because people relegate art appreciation to secondary importance relative to more pressing services such as health and education. However, arts organizations need overhead to ensure program quality and to attract new patrons. Limited overhead spending could greatly compromise art-goers’ experience and hinder the development potential of organizations, both of which lead to a decline in attendance. Therefore, we hypothesize that nonprofits that spend more on overhead costs have better program outcomes than otherwise comparable organizations. However, allocating too many resources towards overhead could effectively weaken the quality of programs. Therefore, we also hypothesize that excessively spending on overhead costs could negatively influence the program outcomes of a nonprofit.

The preliminary findings confirm our hypotheses. As organizations spend more on overhead, their program outcomes improve. However, it declines after a certain point, suggesting that excessively spending on overhead could ultimately compromise program outcomes. Specifically, in terms of total in-person participation, spending up to 31% of total expenses on overhead can help organizations enhance program outcomes. The turning points for total in-person participation, free participation, and paid participation are 31%, 30%, and 37%, respectively.

The findings of this study contribute to altering the expectations of donors and watchdogs that nonprofits should operate on unrealistically low levels of overhead. Donors should give nonprofits flexibility in using resources towards overhead with necessary accountability checks. Watchdogs should put less emphasis on using overhead cost ratio as a determinant of efficiency and effectiveness. Further, senior management should not be afraid of disclosing how much they spend on overhead or starting a conversation with donors about their overhead needs. These steps are necessary for breaking the starvation cycle and changing the dynamics in the nonprofit sector.