Program Ratio Bias

Abstract

A not-for-profit organization's reported ratio of expenditures on program services to total expenditures is a key performance metric for many donors, which may lead the manager of a not-for-profit organization to manipulate this ratio. This paper presents a theoretical model to examine when and how this ratio is likely to be manipulated. We show that program ratio manipulation is executed through a combination of misreporting and real activities manipulation. This manipulation leads to inefficient donation choices and free riding among donors. Given these detriments, we examine whether three costly signaling mechanisms --- voluntary auditing, leadership giving, and overhead-free giving --- could help lessen the prevalence of program ratio manipulation.

Keywords: Nonprofit organizations, Philanthropy, Auditing

JEL Classification: D64, L31, M41, M42