At a conference last night, you were swayed by an emotional speech from the CEO of a prominent charity for impoverished children, and you decided to donate $1,000. You wire the money in the morning, feeling a certain sense of warmth. Then you head to the airport for your flight home. When you check in, you’re still feeling pretty good. You walk through the doorway of the plane and look for your economy-class seat. As you’re making your way down the aisle, you pass someone familiar sitting in first class. It’s the CEO of the charity you just donated to. How do you feel?
After seeing the CEO sitting in first class, you’d probably feel resentful and maybe a little mad. You might even regret sending that check, because you feel like all you did was help pay for the CEO’s first-class seat. You’re not alone. Many people don’t like charities with high levels of overhead costs—expenses that aren’t directly attributed to the primary objective, including the CEO’s travel expenses.
With a tunnel vision on overhead costs, we often don’t think about how effective the donation will be to the cause when making the decision to donate. With little time and energy for research, we base our decision largely on one question: What percentage of my donation will go to overhead? This concern highlights another question: Why are people so averse to paying overhead costs in the first place?
Philanthropy has always emphasized the enormous potential and impact of giving. Many of us believe in the power of giving to create meaningful change. In the United States alone, individuals donated close to $300 billion to charity in 2019. Even in the market of good intentions, however, it’s important to provide some economic incentives to drive organizations.
In a 2013 TED Talk, the activist and fundraiser Dan Pallotta called out the double standard that drives our broken relationship with charities. He argued that when it comes to nonprofits, we equate frugality with morality—we closely scrutinize nonprofits’ spending, rewarding them for how little they spend instead of what they get done. We seem to have one rulebook for the nonprofit sector and another for the rest of the economic world. We don’t judge CEOs of regular companies by how modest they are in their spending but by outcomes, such as the company’s profit. This rulebook discriminates against the nonprofit sector and keeps nonprofit organizations from realizing their full potential, Pallotta argued.
The double standard is especially prevalent in employee compensation. Making millions of dollars selling books or weapons in the private sector is okay, but if you made millions in personal income through your nonprofit trying to cure cancer, you’d be vilified and chastised from all sides. In the general population’s view, an MBA graduate making $400,000 a year working at a bank is okay, but the CEO of a charity making that much? No way—completely unacceptable. This skewed public perception drives talent away from the field of charity. People who could make a huge difference in the nonprofit sector end up choosing the for-profit sector because they’re unwilling or unable to make this lifelong economic sacrifice.
We seem to have one rulebook for the nonprofit sector and another for the rest of the economic world. We don’t judge CEOs of regular companies by how modest they are in their spending but by outcomes.
Back to overhead aversion—one of the reasons I like this topic is that as an economist, I understand that when giving, I should care about the overall impact of my dollars and not the overhead of the charity. However, as a human being, I would feel bad passing the CEO in first class on the way to my economy seat. In other words, although I understand that I should care about impact rather than overhead, in practice, I care about both. And I’m certainly not alone: studies have shown that donors strongly prefer charities with low overhead regardless of cost-effectiveness.
Two reasons are typically used to explain why people don’t like charities with high overhead costs. The first is that high overhead might imply that the organization is inefficient and that the people who run it are bad at their jobs. The second is that high overhead might suggest corruption within the charity, either through high consumption or embezzling. We’ve all heard of examples of these two types of problems in charities. Donors may therefore be wary and use a charity’s overhead spending as a signal of how much the charity is actually doing for its cause.
Although I recognize the first two reasons, I also propose a third one directly related to the donor’s feelings and inspired by our first-class CEO thought experiment: donors want their money to have a direct impact on the cause they support. They might feel that they’ve made a greater impact when they know their contributions went directly toward the kids’ meals as opposed to the CEO’s first-class seat. In other words, thinking their money went entirely to the kids amplifies their self-signal and reassures them that they are good people for helping the needy.
Although I understand that I should care about impact rather than overhead, in practice, I care about both.
Ayelet Gneezy, Elizabeth Keenan, and I asked ourselves: Could this feeling be why people are averse to paying for overhead? Which one of the three reasons just described is the primary driver of overhead aversion? Apart from simple curiosity, we thought a better understanding of the reason behind this overhead aversion might lead to a new way to increase donations. Our idea was motivated by a simple thought experiment: Imagine you are the CEO of a charity who just secured funds from a generous private donor to help launch a new fundraising campaign. How would you use this initial donation as an incentive designed to maximize contributions from other potential donors?
This isn’t just a hypothetical—board members in charity organizations ask this question all the time when they receive large donations. Traditionally, charities have used these initial financial gifts to solicit additional donations in two primary ways: (a) describing the initial donation as seed money (“a generous donor already gave us $10 million for the cause”) or (b) using a matching model in which the charity uses the initial funds to match every new dollar donated. These two uses of initial donations—seed money and matching grants—have been studied and proven to be effective in increasing donor contributions. In our experiment, we wanted to use incentives as a diagnostic tool, offering a new fundraising approach that will reveal why people hate paying for overhead. To do this, we proposed a third alternative incentive: telling donors that their donation would be overhead-free.
Think back to when you walked past that CEO in first class, and imagine instead that at the conference, he and his charity promised you that 100 percent of your dollars would go toward covering meals for the needy kids. Someone else had given the nonprofit the money necessary to cover all the overhead expenses, including compensation, travel, and other administrative costs. Now when you pass the CEO in first class, you don’t feel quite as bad—it wasn’t your money that put him there. Your money was put directly to good use. Would that knowledge help alleviate your negative emotions?
Seed money and matching grants have been proven to be effective in increasing donor contributions … We proposed a third alternative incentive: telling donors that their donation would be overhead-free.
We thought it would. We tested this idea with a foundation specializing in education. The foundation purchased the right to send a one-time donation-request letter to forty thousand potential U.S. donors who had donated to similar causes in the preceding five years. All participants were informed about the foundation’s new initiative, were told that the cost of the new program was $20,000, and were asked to donate toward this goal.
Together with the foundation, we secured the funds needed for the incentives and created four different groups; each received a different type of incentive to donate. Specifically, each group, consisting of ten thousand individuals randomly sampled from the list of forty thousand past donors, was sent one of the following incentives:
- Control group: No additional incentives were offered.
- Seed group: Participants were told that the foundation had already secured $10,000 for the project from a private donor.
- Match group: Participants were told that the foundation had already secured $10,000 for the project from a private donor that would be used as a matching grant. This grant would match every dollar donated up to $10,000.
- Overhead-free group: Participants were told that the foundation had already secured $10,000 for the project from a private donor that would be used to cover all overhead costs. Thus, every dollar collected would go directly toward the program.
This field experiment allowed us to learn more about what dissuades donors from making charitable contributions to companies with large overhead costs: Is it the size of the overhead cost that turns donors off, or is it who pays for it? It’s important to diagnose the root cause of overhead aversion before we rush to come up with a solution. We hypothesized that if we covered all the overhead costs associated with the project, we would incentivize donors to give, because they would have the assurance that every dollar they give would go directly to the cause.
The figure below presents the overall donations collected from the ten thousand appeals in each of the four groups. The seed and match treatments were effective in increasing the donation amount above the control, but the overhead treatment proved to be even more effective.
The result was mainly driven by the fact that more people were convinced to donate in the overhead-free group. Incentivizing potential donors by informing them that overhead costs would be covered by an initial donation significantly increased the number of people deciding to donate and the total donation amount compared with the seed and matching incentive approaches.
These results helped us diagnose the reason behind overhead aversion; they showed that the alternative explanation was important: donors care not only about helping the cause but also about how doing so makes them feel. Understanding the reason behind overhead aversion is not just a theoretical exercise; it can also help increase giving. One approach would be to “educate” small donors who give $100 on why they shouldn’t care about overhead and instead concentrate on impact. However, given that there are typically many small donors, this approach would be very challenging. Furthermore, measuring a charity’s impact is hard.
Informing potential donors that overhead costs would be covered by an initial donation significantly increased the number of people deciding to donate and the total donation amount compared with the seed and matching incentive approaches.
Imagine instead that, as the person in charge of development in a hospital, you are facing a big donor who is about to give $5 million to your institution. You could tell the donor how the money will be used—on a new building or some state-of-the-art machines. Alternatively, you could try to convince the donor to use the donation to cover the overhead costs of raising money for hospital development. This conversation may allow the hospital to offer an overhead-free campaign for the smaller donors, all of whom care about whether they’re giving directly to the cause. Our research suggests that this approach—using the donation as an incentive in the form of overhead-free donations for smaller donors—may help increase the number of donations and the total donation amount. By allotting the money to cover overhead, the $5 million could go much further than if it were simply put toward a new building.
A prominent example of this approach at work is a nonprofit called charity: water, which splits into two separate organizations: “charity: water,” which accepts donations that go entirely to the cause, and “The Well,” which consists of a dedicated group of private donors who pay for all the overhead expenses.
The relative efficiency of paying for overhead demonstrates how important it is to control the framing of the story. The three incentives we tested in this field experiment were exactly the same from a traditional economic point of view. However, the source of overhead aversion is not just worrying about corruption, inefficiencies, and overspending. Emphasizing donors’ personal impact is important. Find the frame that people care about, and your incentives will go further than ever.
Excerpted from Mixed Signals: How Incentives Really Work by Uri Gneezy. Published by Yale University Press. Copyright © 2023 by Uri Gneezy. All rights reserved.