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Non-Profit Agencies Following Corporations' Lead In Paying Executives

By: Bruce Muphy,

Tom Hefty became state deputy insurance commissioner in 1979 at an annual salary of $36,600.

Had Hefty stayed on that job, he would be earning about $94,000 today. But Hefty transferred to the not-for-profit field in 1982, earning $60,000 as a vice president with Blue Cross Blue Shield. He quickly rose to chief executive officer in 1986, at a time when executive salaries were beginning to explode. His salary rocketed from $75,000 in 1987, to $426,320 in 1990 and to $534,964 in 1993.

In the late 1990s, Hefty spearheaded a plan to turn the not-for-profit health insurer into a for-profit called Cobalt Corp. As a result, his compensation once again leaped, rising from $694,920 in 1999 to $2.2 million in 2002.

Hefty, who now is an attorney with the Reinhart Boerner Van Deuren law firm, did not respond to repeated requests for an interview. The two-decade rise in executive compensation he earned personifies the growing synergy between the non-profit and for-profit worlds. Cobalt was not the only for-profit company formed from a non-profit during the last decade, and such switches came at a time when major non-profits were also emulating for-profit companies in how they awarded executive salaries.

Last year, Ed Howe, head of the non-profit Aurora Health Care, earned $2.9 million, 108 times more than the average worker in America.

This was still well below the compensation of top executives at for-profit companies, who earned 301 times more than an average worker in 2003. But it was $500,000 more than Howe made just one year ago, and all but unimaginable compared with what top non-profit executives earned in the early 1990s.

Annual surveys of the Chronicle of Philanthropy found that the highest paid non-profit executive in 1991 earned about $509,000. By last year, the top-paid person, Harold Varmus, president of the Memorial Sloan-Kettering Cancer Center, earned $1.7 million.

The Chronicle found 18 executives who earned at least $1 million last year, and that sampling (of 215 executives at organizations that raised the most money from private sources) did not even include others such as Howe and his $2.9 million.

This rise in salaries has generated controversy because non-profits are essentially subsidized by taxpayers. They are exempt from property, sales and income taxes, and also benefit from tax-deductible charitable donations from individuals and corporations.

In the wake of hearings held in June by the U.S. Senate's Finance Committee, which examined abuses by non-profits, the Internal Revenue Service has announced a project that will investigate the "seemingly high compensation" paid to executives at some tax-exempt organizations.

"I think charity is being used to enrich some individuals," said H. Art Taylor of the Better Business Bureau's Wise Giving Alliance, a national organization, in reference to the rise in non-profit salaries.

Competing with for-profits

The vast majority of non-profit leaders do not earn huge salaries, and many are underpaid, said John Vogel, a business administration professor at Dartmouth College and an expert in non-profit management.

A 2003 survey by the Non-Profit Times found that the average non-profit executive nationally earned just under $84,000. In Milwaukee, a study done for the Nonprofit Center of Milwaukee surveyed a range of 117 non-profits and found that the average salary for executive directors was $86,000. But at the larger non-profits, especially hospitals, foundations and private universities, and as well as at public universities, executive salaries have been rising much faster than inflation.

The Chronicle of Philanthropy, whose annual survey concentrates on the larger non-profits, found a 36% increase in average executive salaries from 1996 through 2002.

"The non-profit world loves to wrap itself in the mantle of virtue and serving the public," noted Rutgers University professor of public policy John Van Til, who has done research on non-profit management. That makes the rise in executive pay "controversial stuff," he said.

Vogel said non-profits are competing with for-profit businesses for executive talent, which would help explain the rise in salaries. Non-profits such as hospitals are fighting for market share and becoming increasingly business-like in their orientation.

"The job of running non-profits is becoming more difficult and more complex," Vogel noted.

But Van Til said the non-profit world also is mimicking the business world by creating the same kind of "iron triangle" of chief executive, board of directors and compensation committee. These insiders make decisions that drive salaries skyward, he argued.

"Businesses are manipulating salaries through that iron triangle, and the non-profits are following like lemmings," he said.

As they do for private companies, consulting agencies such as Towers Perrin provide experts who advise non-profits on how much to pay executives.

Stock options, which fuel executive salaries, aren't available for non-profit leaders. Noting this, consultants suggest other compensations, including bonuses, free use of an automobile, deferred compensation, interest-free loans, housing allowances, executive expense accounts and severance packages.

Deferred compensation has become particularly popular. John Miller, president and CEO of Goodwill Industries Southeast Wisconsin and Metropolitan Chicago Inc., who earns a salary of about $260,000, was given a new contract in 1999 that gives him $120,000 in deferred compensation annually through 2008. In addition, he was given $60,000 in deferred compensation to pay him for sick days he never used.

With interest earned, Miller said he expects to have $2 million in a deferred compensation account by 2008. In addition, he is building up money through a 401(k) plan with Goodwill.

Goodwill Chairman Charles Wright said the board made this decision because the national Goodwill organization based in Maryland was interested in hiring Miller in 1998. "So we decided we would try to tie him into a long-term contract," Wright said.

Wright noted that the Milwaukee Goodwill, which took over the Chicago-area Goodwill, has become the largest such organization in the country. But while Miller's compensation increased after the 1998 merger, it has not gone down as the organization's budget declined from $161 million to $129 million over the last three years.

Wright, who is also chairman of the Mequon-based Fall River Capital, conceded that the board considered the pay offered at for-profit companies when it created Miller's contract.

"The organization works best if it's run like a business," Wright said. "If you looked at a $150 million corporation, he'd probably be paid two to three times what he's getting. And there's no stock options," Wright noted.

Goodwill also emulated for-profit companies by hiring a compensation consultant. Miller's combined salary and deferred compensation "comes in somewhere in the 50th to 75th percentile range," Wright said.

'Salaries will keep climbing'

Twenty years ago, there were few surveys or sources of information available on non-profit salaries, said Paul Dorf, managing director of Compensation Resources Inc. But now there are many such consultants, and they find that non-profits, much like for-profits, do not want to pay below-average salaries.

"Most want to be at the 50th percentile or higher," Dorf noted.

If so few organizations want to pay below the average, Vogel noted, "salaries will keep climbing up."

That's how it has worked for Jon Vice, president of Children's Hospital of Wisconsin in Wauwatosa since 1984. Vice, who declined to be interviewed, earned about $227,000 in 1990. Today, his salary is just over $641,000, the organization's federal tax filing shows.

"Jon has been right around the 50th percentile almost every year," said William Abraham, a member of the hospital's board of directors and its compensation committee.

The situation is similar on the boards of three corporations that Abraham, a Foley & Lardner lawyer, serves on.

"In general, on the corporate boards I serve on, most of the people believe in being above average," Abraham said.

Hospital mergers have increased the size of medical care organizations, which has helped drive up the pay of executives, experts say. Perhaps nothing better illustrates this revolution than St. Mary's Hospital. Sister Renee Rose took a vow of poverty and was paid nothing by the hospital during the years she ran it.

Today, she is a board member of the merged hospital Columbia-St. Mary's hospital system , and heads up the compensation committee, which has pegged the salary for president Leo Brideau at just over $561,000.

A consultant from Towers Perrin advised the hospital, said Sister Rose. "We shot for the 50th percentile or a little above it," she said.

Performance not key

In reaction to the rise in non-profit salaries, a 1996 law gave the Internal Revenue Service the power to fine or revoke the tax exemption of non-profits whose executives get excessive compensation. But the law gives groups a "safe harbor" if they have a written opinion from an outside expert justifying the pay. The IRS has also advised that salaries at comparably sized profit-making companies can be used as a guideline.

The ironic result of this law may have been to push non-profits to rely on compensation experts and salary surveys, just like in the for-profit sector. And in doing so, the salaries all rise together at rates that far exceed what an average worker could ever get.

University professors Peter Frumkin of Harvard and Elizabeth Keating of Northwestern studied more than 6,000 non-profits over a three-year period. Their 2001 study found that executive compensation is not significantly related to performance, as measured either by improved administrative efficiency or improved fund-raising.

Rather, the study found, "CEO compensation is significantly higher in the presence of free cash flows," where organizations are flush with revenue. That was particularly true of the health care field, they found.

Consider the case of Froedtert Memorial Lutheran Hospital in Wauwatosa, where the president's salary quadrupled in 14 years, jumping from $157,709 in 1988 to $596,648 in 2002.

"I believe executive pay is climbing because the marketplace recognizes a person who takes a job to run a hospital doesn't want to be on the bread line," said Dorf.

Van Til scoffs at that notion.

"You could advertise the job at about one-third the salary and still get lots of good candidates," he said. "Salaries in the $600,000 range and above are not only an embarrassment but are throwing away money."

The Chronicle of Philanthropy's 2004 survey of top-paid executives at some of the biggest medical care organizations in the country shows that salaries range widely, from as low as just under $200,000 to the $1.7 million earned by Varmus. Those at the low end included Michael Friedman, CEO at the City of Hope hospital in Duarte, Calif., who earned $198,077 last year, and Lewis K. Molnar, chief operating officer at Shriners Hospital for Children in Tampa, Fla., who earned $247,522.

"I think it's reasonable to question the high salaries," said Marcus White, executive director of the Interfaith Conference of Greater Milwaukee. "It erodes community trust and puts some non-profit directors out of sync with the communities they're serving."

Public and private universities are also seeing salaries for presidents rise much faster than inflation. The Chronicle of Higher Education's 2003 survey found that 39 university presidents are paid more than $500,000, and four got more than $800,000. As recently as 1996, just one president was paid more than $500,000, the Chronicle found.

Back in 1990, University of Wisconsin-Milwaukee chancellor John Schroeder earned just $108,000. Since then, the pay has risen four times faster than inflation. Today, the new chancellor, Carlos Santiago, gets $270,000, which includes a $20,000 supplementary payment from the UWM Foundation.

Robert Atwell, a former college president and retired president of the American Council on Education, said college president pay is rising not because of market factors, but is being influenced by the huge increase in compensation for chief executives in the business world.

"A lot of the people on the governing boards of colleges are CEOs out of the business world. I think they see their president as another CEO, so they want to reward him or her accordingly," Atwell said.

Atwell has served on executive search committees of a number of universities, and said he was convinced there was "no shortage" of good candidates and that compensation is not the major factor in decisions by presidential candidates.

Some evidence for that was found in the Chronicle of Education's survey, which found that presidents of 469 of 595 colleges and universities earned less than $300,000 in total salary and benefits.

As for those who earned more, Atwell said this is causing a growing gap in pay between the president and faculty at some universities.

"We're getting out of whack with what faculty members make. I think that is contributing to divisiveness between president and faculty members."




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