The Organizational Governance Environment

In the last newsletter, I highlighted the fact that good organizational governance is crucial to meeting the challenges of the future.  While that is true, it is more than that.  Good governance is also one of the key determinants of current organizational success or failure.

We can look back to the Enron failure and the failures of other large multinational corporations in the early years of the millennium and to the more recent bank failures and ask, “What were the directors of these corporations thinking and doing?” The answer is clearly that they were not doing their jobs as they should have been.

The problems of poor governance are not limited to the world of big business.  On the national level, Senator Charles Grassley of Iowa severely criticized the board of the American Red Cross in 2005 for the organization’s perceived failures following Hurricane Katrina.  He later expanded his criticism of nonprofit governance to other areas noting, “Among all charities, of those that have failed their mission, I’ve found that poor board governance unites all of them.” (1:xx) On a local note, here in Southern California, I am aware of three news-making organizational scandals that were allowed to happen because the boards of these organizations were not fully exercising their responsibilities.  In one of these cases, the state Attorney General investigated the failure, and there was talk that the Attorney General was considering legal action against the individual members of the board of the organization for failure to carry out their legal responsibilities. As might be imagined, that got a lot of people’s attention – and fast.

Indeed, smaller for-profit corporations and nonprofit corporations may be more at risk for governance issues than the large corporations that retain executive search firms to recruit and screen their potential directors and for whose services they pay handsomely.  Smaller corporations, particularly nonprofit corporations, cannot afford this sort of hiring luxury.  Instead, board members often come from the ranks of organizational members or volunteers who may or may not be experienced as a corporate director.

It is incumbent upon these smaller corporations to make sure that the leadership of their boards understands and carries out the best practices in governance for the sake of the organization and its mission.  Faulty board practices that may have been invisible to the public or other interested stakeholders in the past will not go unnoticed today.  In the for-profit world, there are government regulators, rigorous disclosure requirements, financial analysts and activist investors that are examining and critiquing governance practices and, in some cases, generating positive governance reform.

The nonprofit world also has its watchdogs and critics.  Indeed, as one recent book noted, “U.S. nonprofits are entering an era of the most intense federal and state regulation in history.” (1:33) Congress, and in particular the Senate Finance Committee, has been particularly active in attempting to reform nonprofit governance.  State legislatures have followed the lead of the Sarbanes-Oxley Act (which creates restrictions and other requirements for the for-profit sector) by enacting legislation like the California Nonprofit Integrity Act aimed at more stringently regulating the nonprofit sector.  As well, Attorneys General around the country have begun to take notice of questionable organizational practices in nonprofits that are brought to light by any number of investigative sources.

The Internal Revenue Service (IRS) has also become increasingly mindful of the nonprofit world.  The reason is that this sector of the economy is huge.  Various estimates exist with regard to how many nonprofit entities there are in the country (and the answer can vary depending upon which types of nonprofits are being included in the count), but conservative estimates are that the number exceeds 1.5 million. (1:9) Assets of these nonprofits exceed $2 trillion (1:21), and each year the federal government foregoes about $280 billion in taxes on income earned by tax-exempt nonprofit organizations. (1:ix)  This forgone revenue puts an obligation on nonprofit boards to manage the affairs of the organization in a way that warrants the public trust and tax exempt status.  Those boards failing to do so will find any number of investigative eyes willing to highlight their shortcomings to the public and government watchdogs.

With this governance environment clearly in mind, I will be undertaking a series of articles on good governance practices as well as the common pitfalls that all-too-often plague boards – both for-profit and nonprofit — as they attend to their governance responsibilities.  The purpose of this series is to help organizational leaders – both staff and board leaders – to understand the challenges to good governance that they may face and provide them the tools to overcome these challenges.  I hope readers will find these articles informative and useful.

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1. Jill Gilbert Welytok and Daniel S. Welytok, Nonprofit Law and Governance for Dummies, Wiley Publishing, Hoboken NJ, 2007.