Why Nonprofits Can’t Pay Their Executives As Much as For Profit Companies

Today’s Managing Health Care Costs Indicator is $11 million

 There has been a lot of angst, and frankly pretty awful press, about executive compensation at nonprofit health care organizations over the past month.

In Massachusetts, this started with reports of the $11million severance and final year package for Cleve Killingsworth, the deposed CEO of Blue Cross Blue Shield of Massachusetts.   This was only a few years after the previous long-term CEO had cashed out with a $16.4 million package.  BCBSMA board compensation quickly came under the glare of the public spotlight; one board member received compensation of almost $90,000.  

The New York Times expanded the scrutiny to the Bronx, where the CEO of Bronx Lebanon Hospital earned  $4.8 million in 2007 and $3.6 million in 2008.   In Manhattan, the CEO of the much larger New York Presbyterian earned $9.2 million in 2007 and $2.8 million in 2008.

These compensation numbers, of course, aren’t what drives health care to be increasingly unaffordable.    Killingsworth’s entire exit package would be 30 cents per BCBSMA member per month, a very tiny fraction of the amount of premium inflation each year.  Much of this package was compensation for services in previous years that Killingsworth deferred at the time. 

Nonprofits live in a world where they have to compete for talent at all levels with for-profit organizations.   Hospitals and health plans are complicated organizations – and getting the best executives to run them is critical to achieving their important public missions.

Still, payouts like this from organizations receiving the tax subsidization through not-for-profit status feel wrong.   I think there is a good reason high compensation seems disreputable in a health care nonprofit –while it doesn’t feel wrong in a for-profit company.

A nonprofit hospital must pay its executive salaries from revenue – that’s fees paid by health plans, patients, and the government.  If an executive is paid more, the revenue must cover this.   Nonprofits are making resource allocations all the time; Bronx Lebanon has been cutting its money-losing home services even while it pays a stratospheric salary to its top executive.

When for-profits offer especially generous pay, that pay is usually a combination of salary and stock options.  So – a CEO of a for-profit hospital chain might make $10 million in a year – but usually a small minority of that is salary which comes from operations.  If a CEO gets an $8 million stock grant, the shareholders of the for-profit company are essentially giving her an ownership stake in the company - thus diluting their own investment.  If shareholders of a for-profit publicly-traded company want to give a CEO some shares of the company they own – well – it’s their business! 

This is very different than a nonprofit Board of Directors granting a CEO a very high salary, where the organization will have to charge patients (or health plans or the government) more money to support this high pay.  There is no financial tool for nonprofits to transfer wealth to their top executives without raising their prices (or selling some of their valuables, or failing to make appropriate investments in improving their facilities).

I’ve worked at nonprofits and for-profit organizations, and each can do important work in financing or delivering health care.   Nonprofits are granted a substantial competitive advantage by not having to pay taxes, and some are able to receive charitable donations as well.   With those advantages comes a potential competitive disadvantage – nonprofits cannot use their stock to inflate the salaries of their top executives.  

Health care nonprofits can attract business-savvy, mission-driven chief executives without paying the all-in compensation numbers offered by some for-profit companies.  The damage to public trust with high executive payouts is much larger than the impact on health care costs.