Corporate Governance in Private and Not-for –Profit Organizations

1. Corporate Governance in Private and Not-for –Profit Organizations Chapter XIII

2. Chapter Objectives: • Discuss the purpose and roles of NPOs. • Evaluate SOX and its potential application to private companies and NPOs. • Present the corporate governance principles, mechanisms, and functions found in public companies in a comparable structure for use in private companies and NPOs. • Elaborate on the duties of the audit committee of NPOs. • Reiterate the importance of an effective internal control structure for entities of all types and sizes.

3. Key Terms Articles of Incorporation charter Development/fundraising committee Executive committee Finance committee Nonprofit Integrity Act of 2004 Not-for-profit organization Personnel committee Program committee Society of Corporate Secretaries and Governance Professionals Whistleblower programs

4. Types of NPOs There are a variety of NPOs created for philanthropic purposes. State and Local Governments Health Care Organizations Colleges and Universities Charitable Organizations

5. Purpose and Characteristics of NPO The primary purpose of NPOs is to serve the public rather than earn profit. Characteristics of NPOs are: (1) they do not attempt to make a profit and are often exempt from income taxes; (2) they are owned collectively by their constituents, where ownership is not evidenced by equity shares that can be sold or traded; (3) their policy and operating decisions are normally made by majority vote of an elected or appointed governing body

6. Public Trust in NPO NPOs, particularly charities, have been under extensive scrutiny regarding their governance, financial integrity, stewardship of resources, and appropriateness of their compensation. schemes. The IRS has also increased its efforts in reviewing about four hundred foundations regarding their tax-exempt status and compensation decisions. Example: According to California’s Nonprofit Integrity Act require charities reporting more than $2 million in revenue to have audit committees and their financial reports audited.

7. Governance of NPOs Emerging corporate reforms, rules, and regulations are having significant implications for the governance and accountability of NPOs such as higher education institutions, charities, and churches. Many provisions of SOX are applicable to NPOs, even though these provisions were intended for public companies. Provisions of SOX that would be appropriate for NPOs are: establishing an audit committee composed solely of independent directors, prohibiting the shredding of records, establishing whistleblower programs, establishing codes of ethical conduct.

8. Governance Structure of NPOs

9. Oversight Function of NPOS NPOs are typically organized as nonprofit corporations with either a board of directors or board of trustees, or as trustees or foundations with a board of trustees.

10. Oversight Function of NPOS (Cont) 1. Establish the organization’s mission and goals. 2. Develop strategies to achieve these goals 3. Establish appropriate board committees 4. Appoint officers and executives to run the organization. 5. Determine the compensation of executives, oversee their work, and evaluate their performance. 6. Review the organization’s programs and services. 7. Oversee financial reporting, internal controls, and audit activities. 8. Oversee compliance with applicable laws. 9. Promote ethical behavior and accountability. 10. Ensure adequacy and effective use of resources. 11. Evaluate the board’s performance. 12. Approve director/trustee compensation, if any. 13. Assess board vacancy and recruit new board members. 14. Ensure executives and staff provide the board with relevant and timely information to effectively carry out its fiduciary duties. 15. Set an appropriate “tone at the top” 16. Establish fair whistleblowing policies to encourage employees to come forward in reporting wrongdoing without the fear of retaliation.

11. Attributes of Board Members The effectiveness of the organization’s board depends on the attributes, personal integrity, competence, dedication, insight, and professional qualifications of its members. Important qualities of an effective board member are: Vision Leadership Stewardship Skill Diligence Collegiality

12. Best Practices The suggested corporate governance best practices for NPOs consists of the following checklist of elements for good governance: Make ethical behavior central to a board’s culture Strengthen internal controls Review bylaws Use board committees Use the Internet to inform the public Review investment and spending policies Perform board training and evaluation

13. Internal Control in NPOs Internal controls pertaining to compliance with applicable regulations are essential in an NPO to ensure continuation of tax-exempt status. Governance documents of NPOs consist of four major documents: two organization documents (mission statement and code of conduct) and two legal documents (charter and Bylaws: Mission Statement Code of Conduct Charter Bylaws

14. Conclusion • Many private companies will eventually enter the public markets, and thus, their corporate governance practices will be publicly scrutinized. • There are a variety of NPOs for philanthropic purposes. • The primary purpose of NPOs is to serve the public rather than maximize shareholder wealth through earning profits. • The Panel on the Nonprofit Sector was organized to demonstrate the role of charitable organization. • Many provisions of SOX are very applicable to private ns companies and NPOs, including requirements for (1) more vigilant and independent directors, (2) audit committees, (3) improvements in the financial reporting process, (4) risk management and internal controls, (5) audit quality, (6) codes of conduct, (7) whistleblower programs, and (8) prohibition of document destruction.

15. Conclusion (Cont) • Corporate governance measures are as important and relevant to NPOs as to business firms. Specifically, some NPOs often use public funds, contributions, and grants, and are tax exempt. They must be monitored closely to ensure their budgets are spent on the intended philanthropic purposes. • Corporate governance principles of fairness, transparency, responsiveness, accountability, resilience, communication, and disclosures discussed in Chapter 2 for public companies are also relevant to private companies and NPOs. • NPOs must rely primarily on internal governance mechanisms to assess performance, reward good performance, and discipline poor performance. The primary governance mechanisms of NPOs are their governing and advisory boards.

16. Conclusion (Cont) • Directors and trustees of NPOs have three major fiduciary duties: duty of obedience, duty of care, and duty of loyalty. • The important qualities of an effective board member are vision, leadership, stewardship, skill, diligence, and collegiality. • ICFR, operations, and compliance with applicable laws and regulations, particularly the tax exempt status of many NPOs, are important internal governance mechanisms.