Ethical demands on the third sector

By Patrick McClure

This article was published in Living Ethics: issue 78 summer 2009

The global financial crisis has highlighted the need for regulation and the importance of applied ethics across the economy, writes Patrick McClure. But it has also brought focus to the strong case for an independent regulator of the not-for-profit sector, which faces particular challenges of governance, accountability and transparency.

The not-for-profit or third sector plays a significant role in the Australian economy and society. There are about 700,000 not-for-profit organisations. Of these, 380,000 are incorporated in some form and 41,000 are relatively large; most are small and dependent on volunteers. Altogether they employ 900,000 people and receive $76 billion in income.

They include schools, hospitals, nursing homes, child, youth, family, aged and disability services, international aid, employment and training, culture and sporting organisations as well as small organisations addressing various needs in the community.

In not-for-profit organisations, the need to act ethically in day-to-day operations, and to be seen to be doing so, is greater than ever: to ensure they contribute to a good society, develop well-managed, sustainable organisations, build capacity in individuals and communities across Australia and enhance the reputation of the sector.

Transparency in reporting needs to be enhanced. Choice magazine surveyed its members regarding charities and found that 81% of respondents did not know what proportion of their donation reached the charity’s clients. It compared financial reporting by nine charities and found that fundraising ratios (the percentage of donated funds used for administration) are calculated inconsistently.

For example, in an appeal for homeless people, some people expect all donated funds to reach clients on the streets. However for the not-for-profit organisation, there are administrative costs, such as employing fundraising staff and developing marketing materials. To be effective, services for homeless people also need to pay for skilled frontline staff and provide them with adequate resources. Most donors readily accept this, once it is fully explained to them. To ensure creditability and ongoing trust in not-for-profit organisations, donors need to know how their funds are spent. Agreed standards and greater transparency are required.

This is also true for the level of executive remuneration in not-for-profit organisations. Take the example of the CEO of a large hospital, or employment organisation that competes with commercial companies in a privatised market such as healthcare or employment. The not-for-profit CEO managing a complex organisation is required to achieve similar outcomes to colleagues in commercial companies in the same industry. Should he/she be on a private sector-equivalent package? We need, but lack, published, not-for-profit industry benchmarks as well as a requirement to disclose executive remuneration across the not-for-profit sector, such as already exists for listed companies and universities.

Many small not-for-profit organisations have no compliance or reporting requirements. This is a problem if they are receiving public funds. Management and directors are often not aware of best practice corporate governance principles. There may be no checks and balances to ensure that the organisation is run well and allocates its funds appropriately.

As well as governance and transparency, the not-for-profit sector’s relationship with Federal and State Governments is a major issue. Complex and inefficient compliance obligations often apply to organisations receiving government funding. Reporting frameworks can limit the capacity of not-for-profit organisations to innovate and achieve outcomes for their clients. In addition, in pursuing government contracts, a not-for-profit organisation can lose sight of its original mission and the people it serves. It is important that the current consultation for a National Compact between government and the third sector addresses these concerns.¹

The size and complexity of the sector, as well as the challenges outlined above, point to a strong case for an independent regulator. The Productivity Commission has recommended the establishment of a Registrar for Community and Charitable Organisations. Its functions would include a register of not-for-profit organisations, ensuring compliance with relevant legislation, investigating complaints, implementing standard reporting requirements and advising on governance and practice standards. The test of its success would be greater transparency and accountability in the sector. Without it, we may find ourselves even more vulnerable when the next financial crisis comes around.