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Should Donors Care About Overhead Costs?


Do They Care?

Woods Bowman
DePaul University

This article reports on a theory-based experiment to determine whether there is an observ-


able relationship between changes in charitable giving to an organization and changes in
the proportion of revenue it spends on administration and fund-raising (“overhead
ratio”). This article argues that overhead ratios are meaningless for comparing organiza-
tions, but changes in overhead ratios communicate useful, though incomplete, informa-
tion to donors. Empirical studies have used organization-level data with mixed results.
This research improves on past work by using donor-level information on federal employ-
ees in the Chicago area who donate through the Combined Federal Campaign with ready
access to information on the overhead ratios of all participating charities. Donations are
aggregated by charity and compared over time. Statistical tests give evidence of an
inverse relationship between changes in overhead ratios and changes in giving that are
robust with respect to model specification; however, collectively other factors are much
more important.

Keywords: overhead; administrative costs; fund-raising costs

Between 1994 and 1998, U.S. charities allocated 87% of their spending to
programs, with the balance going to general management and fund-raising
(General Accounting Office [GAO], 2002, p. 8).1 This figure, which is based on
self-reported information, may not be accurate because most charities, large and
small, assign a low priority to measuring functional expenses and allocate costs
among categories in a variety of ways (Wing & Hager, 2004). In any case, it is an
average; some charities spend a trivial amount on programs. Two examples:

Note: I am grateful to Ms. Jan Stinson, executive director of the Chicago Federal Executive
Board, and Mr. Tony Padgett, then of the United Way of Chicago, for their assistance in provid-
ing data used in this study, also to Dolores Kalayta for programming assistance, and Rich
Steinberg, Mark Hager, Wes Lindahl, Dan Tinkelman, and an anonymous referee for reading an
earlier draft and making helpful observations. I alone am responsible for remaining errors of
omission and commission.

Nonprofit and Voluntary Sector Quarterly, vol. 35, no. 2, June 2006 288-310
DOI: 10.1177/0899764006287219
© 2006 Association for Research on Nonprofit Organizations and Voluntary Action

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The James Beard Foundation, a prestigious culinary charity named after


the renowned chef whose bequest established it, had U.S. $4.7 million in rev-
enue in 2003 but spent only $29,000 on scholarships, “one of the primary
aspects of its mission.” In addition, thousands of dollars were unaccounted
for. Donors, believing that most of their money financed scholarships, were
shocked to learn that the foundation’s scholarship program was virtually
nonexistent (Moskin, 2004).
Commercial solicitors working in Illinois for Telemarketing Associates
told prospects that a “significant amount of each dollar donated would be
paid over to VietNow,” a charitable veterans assistance organization. In fact,
the contract provided for paying only 15% to VietNow, which spent only 3%
of its $1.1 million share on charitable programs (Madigan v. Telemarketing
Associates, Inc., 2003).2
These extreme situations prompt a question: Why would anyone give to
organizations with such high overhead ratios, that is, high general adminis-
tration and fund-raising expenses divided by total revenue?3 Keating,
Parsons, and Roberts (2003) proposed that such donors are either ill informed
or so moved by an organization’s mission that they do not care about its over-
head ratio. A very different possibility is that overhead ratios are meaningless
(Steinberg, 1986b, 1994), and rational donors should not care about them. The
first section of this article surveys current theory on the question of whether
donors should care. The second section offers a new view of how overhead
ratios are relevant to donors. The third section briefly surveys the literature
on the question of whether donors, in fact, care about overhead ratios and
discusses a hypothesis based on the theory presented in the previous section
and two exploratory hypotheses. The fourth section discusses how the
Combined Federal Campaign (CFC) works, explains how data were col-
lected, and describes their limitations. The fifth section presents and dis-
cusses the results. The experiment reported here improves on past work by
using multiperiod donor-level information on a group of federal employees
who donate at work through the CFC, which informs them of the overhead
ratios of all participating charities. A final section draws conclusions.

SHOULD DONORS CARE? EXISTING THEORY

Different organizational characteristics and circumstances imply different


costs for one component of overhead—fund-raising (Hall 1996, pp. 35-36).
The New York Attorney General speculates that fund-raising expense as a
proportion of total expenses could differ among organizations because

[1] Identifying new donors may be more time consuming and thus
more expensive than contacting previous contributors. [2] An organi-
zation may conduct a telemarketing campaign simply to test-market
new fundraising ideas without any certainty that its campaign will
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290 Bowman

prove efficient and productive. [3] An organization may also achieve goals
other than raising funds—such as public education or recruitments of
volunteers—at the same time that it is conducting a fundraising cam-
paign. Those other benefits will not be reflected in the revenue received by
the charity. [4] A newly created charity or one advocating new programs
or new ideas may experience greater fundraising costs without any cer-
tainty that its campaign will prove cost effective. (Spitzer 2001, para. 11;
numbers in brackets added)

No one has written more often or more forcefully arguing the irrelevance
of fund-raising ratios than Steinberg (1983, 1986a, 1986b, 1988-89, 1990, 1991,
1992, 1994). He pointed out that optimizing donated funds requires balancing
costs and returns at the margin, whereas a fund-raising ratio (fund-raising
expense divided by total expenses) is an average that provides donors with
no useful information about marginal costs and returns. He (1994) illustrated
with the following example of alternative solicitation budgets:

The first budget of $10,000 will produce $50,000 in donations and pro-
vide a 500 percent ratio return ($40,000 actual net return). The second
budget of $100,000 will produce $200,000, a 200 percent ratio return
($100,000 actual net return). If a charity wished to maximize the rate of
return on its fund-raising investment, it would choose the first budget;
if it cared about maximizing its resources for providing charitable ser-
vices, it would choose the second. . . . Except by an incredible coinci-
dence, the level of solicitation that best supports service provision is
different from the level that maximizes the ratio of return or the level
that minimizes the fundraising cost ratio. (p. 14)

Steinberg (1986b) also argued that when the marginal contribution is very small
relative to total contributions, 100% of a marginal dollar will be spent on
programs, independently of the overhead ratio. Finally, as a technical matter,
large gifts and bequests cause volatility in aggregate contributions and, hence,
in overhead ratios. Coupled with a significant time lag between fund-raising
activity and receipt of a large gift, researchers should expect difficulty in detect-
ing a relationship between fund-raising expenses and giving (Lindahl, 1994).
Practitioners and scholars also caution against judging efficiency from
administrative expenses. The Maryland Association of Nonprofits asserted
that

larger nonprofits often benefit from an economy of scale on management


and fundraising expenses and can direct a larger percentage of money
raised to program. However, a smaller organization may deal with
an issue we are passionate about, may be located in our neighborhood,
and may have helped a family member or us.” (Maryland Standards for
Excellence, n.d., para. 12)
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Donors and Overhead Costs 291

Rooney, Hager, and Pollak (2003) gave evidence that (a) administrative costs
are inversely related to organizational size; (b) as organizations grow older,
their administrative expenses rise relative to total expenses; and (c) increas-
ing dependence on government grants as a source of revenue similarly
increases administrative expenses relative to total expenses.

SHOULD DONORS CARE? ANOTHER VIEW

The overhead ratio affects the price of buying a dollar of charitable out-
put, that is, price of giving (Callen, 1994; Okten & Weisbrod, 2000; Posnett &
Sandler, 1989; Tinkelman, 1999, 2004; Weisbrod & Dominguez, 1986). The
price of giving is typically defined as

price of giving = (1 – MTR)/(1 – OR),

where MTR is the donor’s marginal tax rate and OR is the overhead ratio for
the receiving charity, namely the sum of its fund-raising and general admin-
istrative expenses divided by its total revenue.4 However, comparing prices
of anything—whether commodities or giving to charity—is frustrating and
pointless. Debate over the overhead ratio recalls the classic question from the
early days of economics: Why are useless diamonds so expensive while nec-
essary water is so cheap? As with this example, there are many good reasons
why the price of one commodity might differ from another (e.g., diamonds
are scarce, water is plentiful); however, at the margin the quantity demanded
of any normal product or service always falls when its price rises, and vice
versa, other things being equal. It should be the same with charity.
Assume rational prospective donors consider the balance (trade-off)
between overhead ratio and absolute yield when they choose between two
charities. In equilibrium, for idiosyncratic reasons, some donors give to one
charity and some to the other. Now assume the two charities increase their
fund-raising budgets by the same amount. Their overhead ratios will change
relative to each other, except in the unlikely event that both raise money
in exactly the same proportion as before. Donors who find the trade-off in
the new equilibrium acceptable will continue to donate as before. Other
donors—marginal donors who just barely accepted the trade-off between
rate of return and absolute yield before the change—will switch to a less
“expensive” charity with a similar mission.
Researchers should be very cautious interpreting the results of cross-
sectional studies comparing donations to various charities with their overhead
ratios. Such comparisons are like comparing the prices of different goods such
as diamonds and water. Because administrative costs are inversely related
to organizational size (Rooney et al., 2003), an observed inverse relationship
between overhead ratios of various charities and their total donations may
simply be the result of scale economies in producing charitable services.
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292 Bowman

On the other hand, a person who knows nothing of a charity’s finances


except its overhead ratio can draw inferences relevant for her decision to
donate by observing it increase or decrease relative to the overhead ratios of
other charities. The argument depends on several economic assumptions.

1. Prospective donors are rational and risk averse. This is the standard
model of an economic decision maker.
2. Donors, in the aggregate, have more information about any given
charity than a single individual, and their knowledge can be inferred
from their collective behavior. This assumption is borrowed from the
rational expectations model of securities pricing.
3. Charities solicit donations from various prospect pools in descending
order of their likely productivity. This is equivalent to assuming
diminishing returns to fund-raising expenses.
4. For any given level of programming there exists a unique optimal level
of administration. The assumption of an optimal level of administrative
cost is novel and requires explanation. There are two views of adminis-
trative costs. One view is that they are wasteful—featuring excessive
salaries, numerous perquisites, and unnecessary staff. Thirty-six per-
cent of the public strongly agrees or mostly agrees with the statement
that charities are wasteful.5 Another view holds that administration
enhances organizational capacity, which is a good thing. Chang and
Tuckman (1991) argued that robust administrative expenses enhance
the viability of organizations by giving them a cushion in case of fiscal
adversity. There is evidence that, on average, charities do not increase
marginal spending on programs when resources increase; however,
when resources decrease, charities cut programs (Roberts, Smith, &
Taranto, 2005). This is consistent with charities operating with a subop-
timal level of administrative capacity. These opposing views of admin-
istrative overhead imply the existence of an optimal level of spending
on administration relative to programs between the extremes—a level
that likely differs from organization to organization. Below the optimal
level of spending on administration, increased spending causes increas-
ing returns in organizational effectiveness, whereas above the optimal
level, increased spending is accompanied by diminishing returns in
organizational effectiveness. It is reasonable to suppose that changes in
effectiveness would be observable.

Whenever a charity increases spending on overhead (fund-raising plus


administrative expenditures) relative to programming, there are three possi-
bilities:

1. In Situation #1, donations fall, causing the charity’s overhead ratio to


increase sharply. Its marginal fund-raising and/or administration are
counterproductive. The fund-raising message it is communicating to
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Donors and Overhead Costs 293

prospects dissuades existing donors from contributing. Alternatively,


additional administration degrades organizational effectiveness, which
shows up in less service or lower quality, and drives donors away.
A rational donor should withhold support in this situation.
2. In Situation #2, donations grow proportionally or more slowly than
overhead expenditures. The charity’s overhead ratio either remains con-
stant or increases more slowly than in Situation #1. This is an ambiguous
situation. Observationally, without additional information, Situation #2
is indistinguishable from Situation #1. A rational, risk-averse prospective
donor without other current knowledge about a charity should play it
safe and withhold support while seeking more information.
3. In Situation #3, donations grow more rapidly than expenditures. Now,
the charity’s overhead ratio decreases. Because the assumption of dimin-
ishing returns excludes the possibility that the charity is reaching previ-
ously untapped high-productivity prospect pools, it is reasonable to
conclude that the message the charity is communicating to new prospects
is more powerful than past messages. Marginal donors may be receiving
information our hypothetical rational donor missed. Alternatively, addi-
tional administrative expenditures are improving organizational effec-
tiveness, which is noted by others who increase their support. A rational
prospective donor should feel comfortable contributing too.

In each situation, an increase in the overhead ratio causes a person who is


rational and risk averse to withhold support, whereas a decrease encourages
support. It is easy to recast these situations in terms of decreases in overhead
spending with the same results.

DO DONORS CARE? SOME HYPOTHESES

When asked what proportion of spending by charities should go to


programs, 78% of Americans say 70% or higher (Princeton Survey Research
Associates, 2001, p. 5). This is consistent with earlier surveys by Roper and
the Hudson Institute (Silvergleid, 2003). On the other hand, just because per-
sons have an opinion on the proper proportion does not mean they care very
much when it comes to their own giving. Only one third of Americans actu-
ally seek information on organizational finances (Princeton Survey Research
Associates, 2001, p. 20). Administrative efficiency is not a major concern in
Australia either (Berman & Davidson, 2003).
Numerous studies have attempted to detect a relationship between actual
giving and overhead ratios, with inconclusive results. Steinberg (1983, 1986a,
1986b), using a first-difference specification to control for omitted variables
that are constant over time, reported no statistical association between fund-
raising overhead and donations. Callen (1994), Okten and Weisbrod (2000),
Posnett and Sandler (1989), Tinkelman (1999, 2004), and Weisbrod and
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294 Bowman

Dominguez (1986) analyzed cross-sectional data using models with different


log-linear specifications and found an inverse relationship between dona-
tions and the price of giving.6 Frumkin and Kim (2001), using organization-
level, pooled cross-sectional and time series data, found no statistically
significant negative correlations between overhead and contributions for
nonprofit organizations; however, in five of six subcategories of nonprofit
organizations, fund-raising expenditures exerted a significant positive effect.7
Results have been sensitive to model specification. Furthermore, all stud-
ies have used organization-level data from IRS Form 990, which implicitly
assumes that donors know the overhead ratios of the charities to which they
give, and the overhead ratios of competing charities. Given the results of the
Princeton survey (Princeton Survey Research Associates, 2001), it strains
credulity that a preponderance of donors would do the necessary research
on a charity’s cost structure before writing a check, although the information
for many charities is readily available online through GuideStar. Most per-
sons probably trust their instincts because they know the organization, or
have heard about its work.
Nevertheless, several charity “watchdogs” have adopted standards for
program spending.8 Silvergleid (2003) used multiple regression to analyze
the relationship between lagged donations to a charity and its rating by the
American Institute of Philanthropy. After controlling for size, year, subsec-
tor, and organizational characteristics, he found that neither rating nor a
change in rating had a statistically significant effect on donations. He found
some evidence that giving to regionally focused charities in Minnesota
responded to whether they met the standards of the local Charities Review
Council (CRC); however, his Minnesota sample consisted of only 125 chari-
ties, of which 86% received perfect evaluations across all 4 years in his study,
so it is a suspect result.
Based on theory presented in the second section, we have

Hypothesis 1: Assuming donors have information concerning the overhead


ratios of all alternative charities, the number of contributions to any
given charity should decrease when its overhead ratio rises relative to
the others, and increases when its overhead ratio falls, other things
being equal.

This hypothesis is couched in terms of first differences, similar to Steinberg’s


tests (1983, 1986a, 1986b). As he noted, this method controls for omitted vari-
ables that remain roughly constant throughout 24-month intervals. This is a
stringent test because he is one of the few researchers who found no relation-
ship between overhead ratios and contributions. In preparation for this test,
assume a zero marginal tax rate for individuals and convert each overhead
ratio to a price of giving according to the conventional formula given above.
A dummy variable indicating that a charity operates only within the local
area is included as a control variable in tests of this hypothesis. Its coefficient
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Donors and Overhead Costs 295

will capture the differential drift in favor of local charities. In other words,
when the total number of dollars contributed increases, as it does in each of
the years studied, a positive coefficient on the local dummy indicates local
charities are capturing more of the additional dollars on average, and a neg-
ative coefficient indicates they are capturing fewer.
Intuitively, large donors should be more careful and more responsive to
changes in overhead ratios because they have more money at risk. Tinkelman
(1998) found this to be true for corporate and foundation philanthropy.
On the other hand, individuals may act differently from corporate entities.
People who give a lot of money to a particular organization may be strong
boosters, uninterested in overhead ratios. A new study, based on focus group
research, by Public Agenda (Arumi, Wooden, & Johnson, 2005), concluded
that “most small donors appear to base their giving on a gut-level interest in
a cause and a faith in the people involved. Very few of those interviewed care-
fully researched their giving decisions” (p. 5). Donor interest in overhead
ratios was not specifically plumbed; however, it would seem that small
donors especially rely on trust and instinct rather than objective metrics.
Without theory as a guide, it is an empirical question.
The exploratory hypothesis is stated in the positive; the null hypothesis is
that there is no relationship.

Exploratory Hypothesis 2: Responsiveness to changes in overhead ratios


increase with size of contribution.

The same equations can be used to test this hypothesis as to test Hypothesis 1,
but with the universe restricted to large donors. If they are more responsive,
the absolute value of the coefficient on the price of giving in these regression
equations will be larger than corresponding coefficients in the full sample.
Unfortunately, with the CFC data, it is impossible to control for donor’s
income and marginal tax rate, so small differences may be masked by the
error term. Furthermore, the amount that nearly all donors give is very
small. It is possible that at very low levels of giving people care little about
organizational financial details such as overhead ratios. This experiment will
use a threshold for large donors of $500 (the 97th percentile).
Another question that these data might shed light on is whether local char-
ities have any special advantage because of their proximity to donors. To par-
ticipate in the CFC, local charities must document a substantial presence in
the local campaign area, whereas national and/or international charities need
have active programs in only 15 states, which may not include Illinois, the site
of the current experiment. During the study period, the number of local char-
ities participating in the Chicago CFC fluctuated between a high of 530 and a
low of 383, whereas the number of national and/or international charities
remained fairly close to 1,300. There are two possible proximity effects. On
the one hand, “[d]onors may have alternative means of monitoring local
organizations, as their service efforts may be more visible” (Tinkelman, 1999,
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296 Bowman

p. 140), which should make them more sensitive to changes in the price of
giving of local charities. In this case, the coefficient on the price of giving
when the sample is restricted to local charities should be larger in absolute
value than the coefficient on price of giving when it is restricted to national
and/or international charities. On the other hand, commitment to a local
charity might be stronger a priori because the donor may know the founder
or executive director, or because it is the only organization with a narrowly
defined mission that the donor cares about deeply. In other words, a donor
may be in a better position to monitor but may not have the inclination, and
so would be less responsive to changes in the price of giving local charities.
Again, theory provides no guidance, so this research resorts to the exploratory
hypothesis that there is a positive effect.

Exploratory Hypothesis 3: Donors are more responsive to changes in the


overhead ratio of local charities.

If this is true, the coefficient on the price of giving in a sample of local charities
should be less in absolute value than the coefficient on the price of giving in a
sample of national/international charities. The null hypothesis is no difference.
Finally, by drawing on other data sources, it is possible to explore the
question of whether other characteristics of a charity influence giving.
Theory is meager; however, Weisbrod (1988) proposed that total donations
are a metric for the output of public goods.9 People might feel more inclined
to donate to organizations that produce public goods because they are more
likely to experience some benefit. On the other hand, the free-rider effect
might be stronger, which would imply that they would be more likely to
withhold support. People might have a preference for large organizations
because they feel safety in numbers, or they might prefer small organizations
because their donation will have greater impact. Because theory does not
favor any particular option, the exploratory hypothesis is that organizational
characteristics exert a positive effect. This is difficult to test because major
variables such as mission, total donations, and size change over long peri-
ods, but very little from one year to the next. The best the current research
can do is to examine whether average changes in donations vary by organi-
zational characteristic, holding changes in the price of giving constant.

THE EXPERIMENT

The CFC is a coordinated group of local workplace giving campaigns con-


ducted in 376 federal administrative regions under the aegis of Local Federal
Coordinating Committees (LFCCs), which bring together top local officials—
military, civil service, and postal service leaders in each region (Bowman,
2003).10 These committees implement the law and regulations promulgated
by the Office of Personnel Management (OPM). The Office of Personnel
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Donors and Overhead Costs 297

Management determines which national and international charities are eligible


to participate, whereas each LFCC determines eligibility of local charities. To
participate, an organization must be a 501(c)(3), must formally apply, submit
audited financial statements, and provide proof that not more than 80% of its
funding comes from government sources. In theory, only charities with over-
head that is less that 25% of revenue are eligible.
During an annual campaign, each employee receives a Donor Guide (the
Guide), which provides important information on every participating char-
ity: its name, a campaign identification number, telephone number, Web
address, federal Employer Identification Number, a 25-word description of
its mission, its overhead ratio,11 and whether it is local, national, or interna-
tional. Donors do not have the option of ignoring the Guide. Each donor must
consult it to find the campaign identification number of the charity, which she
must then write on a form authorizing a payroll deduction. The Guide flags
charities whose overhead ratios exceed the 25% ceiling with an asterisk keyed
to the following footnote: “This organization has administrative and fund-
raising expenses above 25%, and is taking the steps necessary to bring these
expenses below the 25% level.” In the years studied, 1999 to 2001, between 6%
and 7% of participating charities exceeded the nominal 25% ceiling, with the
highest above 40%. At the other extreme, only 2% to 3% of charities reported
suspiciously low overhead ratios of less than 1% in any year.
Researchers who use organization-level data from IRS Form 990 are forced
to assume that donors seek out the relevant information; the current study
makes the far weaker assumption that donors use information they are given.
The source of the overhead ratio information is the IRS 990 form, which was
also used in previous research. Whatever the limitations of IRS data, it would
be natural for federal employees to assume that the CFC has vetted the over-
head ratios it publishes in the Donor Guide—especially because it makes a
point of announcing that 25% is the maximum allowable overhead ratio for
participating charities. On balance, it is unlikely donors in other experiments
have actual knowledge of overhead ratios, whereas CFC donors are likely to
see the published overhead ratios, and to regard them as reliable.
The data for the current study come from the 1999, 2000, and 2001
Chicago Area CFC. Prior to 1999, the Chicago Area CFC covered a much
smaller area and fewer employees, and after 2001 a new third-party admin-
istrator conducted the campaign. The years 1999 to 2001 covered by the cur-
rent study are the only ones with the same campaign boundaries and same
third-party administrator. A short time period is actually advantageous
because it minimizes the effects of changes in popularity over time.
In CFC parlance, donations are called designations and charities receiving
donations are called designated charities. Employees may designate up to five
charities through a single payroll deduction. They also have the option of
making a lump-sum contribution by writing a personal check. Initially, infor-
mation for the current study resided in two files: (a) a donor file and (b) a char-
ity file, which were combined into a merged file for analysis.
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298 Bowman

DONOR FILE

In 1999, there were 38,845 designations, 37,333 in the following year, and
35,824 in 2001. Because employees may make multiple designations, the
number of designations in any year exceeds the number of donors by 10,000
to 15,000 (see Table 1). Each record contains (a) an encoded donor identifica-
tion number to preserve anonymity while providing consistency over time,
(b) year of designation, (c) a code indicating lump-sum or payroll deduction,
(d) an account number for the designated charity, (e) the name of the desig-
nated charity, (f) a location code, and (g) the amount of the designation.
Unfortunately, the file has no demographic data about donors. According to
Table 1, in 1999 the average designation was $113, in 2000 it was $120, and in
2001, it was $129. There are major outliers, including several designations
exceeding $1,000 with one as high as $4,000. Many designations cluster
around $2. Because the smallest payroll deduction is one dollar per pay
period, the smallest designations were either lump-sum payments or partial-
year payments from newly hired or departing employees.
Account numbers associated with each charity were used to consolidate
the donor file, resulting in an almost unduplicated count of 2,095 designated
charities during 3 years. It is “almost” unduplicated because 31 charities had
multiple account numbers, such as the American Cancer Society, which had
four; multiple accounts were consolidated for analysis. If a charity partici-
pated in the campaign but received no contributions (i.e., it was not desig-
nated) in a given year, it was absent from the donor file for that year but may
have participated in subsequent campaigns.

CHARITY FILE

There is no information in the donor file about overhead ratios, so a second


file was created on all participating charities by manually keying from the
Donor Guides for 1999 to 2001 (a) the year, (b) the charity’s name, (c) its over-
head ratio for that year, and (d) a code indicating whether it was local,
national, or international. This file contains a duplicated count of 5,467 partic-
ipating charities, identified by name and the year in which they took part.
Using charity identification numbers as a means of keeping track of how often
each charity participated, and manually adjusting for multiple account
numbers, it appears that 1,259 charities participated in all three years, another
550 participated at least twice, and 590 participated only once. Comparing the
number of designated charities with the number participating for each of the
3 years (Table 1) shows that the number of undesignated charities (those
receiving no money) ranged from a low of 222 in 1999 to a high of 291 in 2000.
Notice that the overhead ratios of designated charities are, on average, lower
than those of participating charities generally.
It is striking that many charities received no designations, and many
others received only one. In the Year 2001, these groups together made up
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Table 1. Summary Data for the Chicago Area Combined


Federal Campaign (CACFC), 1999-2000

% Change
1999 2000 2001 1999-2000 2000-2001

Employeesa 61,407 61,606 60,177b 0.3 –2.3


Donorsa 23,493 27,380 20,613 16.5 –24.7
Designations 38,845 37,333 35,824 –3.9 –4.0
Dollars, pledgeda $4,446,801 $4,621,240 $4,735,780 3.9 2.5
Dollars, collected $4,370,715 $4,494,992 $4,615,793 2.8 2.7
Dollars per designationc $112.52 $120.40 $128.85 7.0 7.0
Localc $118.10 $125.76 $134.74 6.5 7.1
Otherc $110.91 $117.98 $127.85 6.4 8.4
Donors designating 409 447 462
$500 or more
Participating charities, totala 1,812 1,911 1,745 5.5 –8.7
Local 499 530 383 6.2 –27.7
Other 1,313 1,381 1,362 5.2 –1.4
Participating charities, 14.1% 14.0% 13.9% –0.7 –0.7
overhead averagea
Not designated 222 291 224 31.1 –23.0
Designated 1,590 1,620 1,521 1.9 –6.1
charities, total
Locald 419 437 317 4.3 –27.5
Otherd 1,045 1,092 1,121 4.5 2.7
With unmatched 126 91 83 –27.8 –8.8
account numbers
Overhead ratio, designated 14.0% 13.6% 13.6% –2.9 —
charity averagea,d
Designations per charityc 24.4 23.1 23.6 –5.3 2.2
Dollars per designated charityc $2,748 $2,774 $3,034 0.9 9.4

Source: Unless otherwise noted, data are derived from donor records supplied to the author.
a. Data for 1999 and 2000 from CACFC donors guides.
b. Interpolated from 2000 and 2002 data; 2002 data from CACFC.
c. Calculated from data in this table.
d. Excludes unmatched account numbers.

29% of the participating charities. The most popular charity that year was the
United Negro College Fund, which received 2,020 designations. Second was
the American Red Cross with 1,344 designations. Notably, 847 designa-
tions were not for any particular charity, which were the third most-popular
option. In all, $102,691 (2.2%) of collections were undesignated (CFC, 2002).
Undesignated amounts are distributed to charities in proportion to the des-
ignations of all other employees. By not designating the charity to receive
their money, donors are in effect allowing their coworkers to vote on how
their gift should be allocated. However, because campaign costs are paid out
of gross receipts before allocations are made to designated charities, gifts not
designated to a particular charity merely help underwrite the campaign’s
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300 Bowman

cost, which is approximately 13% of collections (Chicago Area Combined


Federal Campaign, 2001, p. 7).

MERGED FILE

Each record in the merged file contains the name of the participating char-
ity, and in each of 3 years its overhead ratio, its number of designations, and
the total amount designated.12 As many matches as possible were made elec-
tronically; however, hundreds of charities remained unmatched and the
account numbers had to be supplied manually by comparing the unmatched
names with charities that had account numbers. This laborious process
resolved more than one half of the unknown accounts. Still, it was impossible
to uniquely identify account numbers for 587 participating charities in the
donor file, even after close inspection described above. An unknown, but
large, number was undesignated and, hence, received no money. Gaps in the
data cause the N in various statistical tests involving the merged file to be less
than the number of designated charities in the charity file alone.
Chicago is the third largest campaign in the continental U.S. outside of
greater Washington, D.C., area.13 Table 1 gives summary data on the 1999, 2000,
and 2001 Chicago Area CFC campaigns. Although the number of employees
solicited declined between 1999 and 2001,14 the size of an average designation
climbed steadily from $113 to $129, which pushed up total collections. Year-
over-year differences between mean overhead ratios for participating charities
and designated charities are not significant at the p = .05 level.
The charity file contained no information on the National Taxonomy
of Exempt Entities (NTEE) categories, so I drew a 25% sample and manually
added to each record an NTEE code and data from GuideStar on total expen-
ditures and donations. Table 2 shows the codes of those charities that make up
at least 2% of designated charities. Advocacy and legal organizations, which
are 11% of designated charities, have the highest average overhead ratios
(15%). The most popular designated charities are either disease-related or
human services, comprising 30% of designated charities, 36% of the designa-
tions, and 35% of the dollars contributed. There is no relationship between the
overhead ratio and popularity, as measured by the number of designations.
Ranking the NTEE categories on these variables gives a Spearman rank order
coefficient that is statistically indistinguishable from zero (t = .32), which is
consistent with the proposition that the level of the overhead ratio (as opposed
to changes in the ratio) is not a critical factor in a typical decision to give.

RESULTS AND DISCUSSION

The first analysis (Tables 3a and 3b) counts the cases in each cell of a 3 x 3
matrix where the rows indicate whether the number of designations to a
charity increased, stayed the same, or decreased, and the columns indicate
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Donors and Overhead Costs 301

Table 2. Distribution of Charities, Designations, Dollars, and Overhead by National


Taxonomy of Exempt Entities (NTEE) Category, 2001 (based on a 25% sample)

% of % of % of Mean
NTEE Purpose Designated Charities Designationsa Dollars Overhead in %a

G Diseases 16.3 19.5 19.0 14.7


P Human services 14.5 17.1 16.1 12.1
D Animal related 8.4 8.4 7.1 13.4
Q International relief 6.8 3.2 4.7 9.1
R Advocacy 6.8 1.8 1.7 15.3
B Education 5.0 2.5 2.3 9.9
C Environment 4.7 2.3 2.0 13.4
H Medical research 4.7 9.4 8.5 12.4
O Youth development 4.2 3.1 3.4 12.3
I Legal related 3.9 2.0 1.9 15.4
E Health 3.7 3.5 3.6 12.6
X Religion 3.2 1.5 1.8 11.1
F Crisis intervention 2.6 0.7 0.7 11.5
Total 85.0 75.1 72.8

a. Spearman rank order correlation coefficient is .10, t = .32; insignificant at p = .10.

whether the charity’s overhead rate went down, stayed the same, or went
up. Rows and columns are arranged so that a negative relationship between the
corresponding variables is displayed by a preponderance of cases arranged
along the principal diagonal (northwest to southeast). Fortunately for
hypothesis testing, there is considerable year-to-year variation in overhead
ratios. The correlation between changes in overhead ratios for the years 1999
to 2000 and for 2000 to 2001 is –.341, which is significant at the p = .01 level
(two-tailed test). In other words, if a charity’s overhead ratio went up in a
given year, it was likely to go down the next year, which is an expected out-
come. Otherwise, overhead ratios would tend to be bimodally distributed.
If overhead rates were the only thing that mattered to donors, and theory-
based Hypothesis 1 is true, cells on the principal diagonal would be the only
ones populated; however, because the total number of designations declined
in both periods, there will be a bias toward the top row of the tables. If the
overall reduction in designations is concentrated in just a few charities, the
bias will be slight. Although only 44% of the cases in Table 3a and 50% in
Table 3b behave according to theory, the principal diagonals in both tables
are strong enough to produce negative correlations significant at the p = .01
level (−.12 in Table 3a and −.22 in Table 3b). There appears to be a bias toward
the top row in Table 3a, but not in Table 3b.
Next in importance to the principal diagonals are the central column and
row on each table. The central column shows all cases in which the overhead
ratio was constant. Nevertheless, about 8% of the charities experienced
changes in the number of designations without apparent stimulus. The center
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302 Bowman

Table 3a. Number of Designations Versus Overhead Ratio,


1999 to 2000 (cells contain count of cases)

Change in Overhead Ratio

Increase None Decrease Total

Decrease in designations 298 57 257 612


No change 77 9 100 186
Increase in designations 150 34 218 402
Total 525 100 575 1,200

Pearson χ2 = 20.0**
Spearman correlation = −.115**

**p = .01 (two-tailed).

Table 3b. Number of Designations Versus Overhead


Ratio, 2000 to 2001 (cells contain count of cases)

Change in Overhead Ratio

Increase None Decrease Total

Decrease in designations 288 50 148 486


No change 72 11 64 147
Increase in designations 192 48 279 519
Total 552 109 491 1,152

Pearson χ2 = 59.0**
Spearman Correlation = −.224**

**p = .01 (two-tailed).

row displays counts of charities receiving a constant number of designations


year-to-year, regardless of changes in the overhead ratio. Fifteen percent of
charities in Table 3a and 12% of charities in Table 3b showed no change in the
number of designations in response to either a decrease or increase in their
overhead ratios. Clearly, overhead ratios are only one of many influences res-
ponsible for the changes in number of designations. This effect is brand loyalty,
consumer ignorance, the result of offsetting changes in omitted variables, or a
statistical anomaly.
In the first pair of regressions (Table 4a), the dependent variable is the first
difference in the number of donors to a charity, and the independent variable
is the first difference in the price of giving. It is included in the analysis to test
robustness with respect to the logarithmic transformation used in the second
pair of equations. In the second pair of regressions (Table 4b), the dependent
variable is the first difference of the natural logarithm of the number of donors
to a charity, and the independent variable is the first difference in the natural
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Donors and Overhead Costs 303

Table 4a. Ordinary Least Squares (OLS) Linear First


Difference Model: Change in Number of Designations

1999-2000 2000-2001

Coefficient SE Coefficient SE

Constant –0.14 .0** 0.11 .0**


Change in price of giving –1.54 .3** –2.08 .3**
Proximity (local = 1) –0.09 .1 –0.33 .1**
Adjusted R2 .020 .059
F statistic 11.46 37.12**
Total df 1,021 1,151

**p = .01 level (two-tailed).

Table 4b. Ordinary Least Squares (OLS) Log-Linear First


Difference Model: Change in Natural Log of Number (LN) of Designations

1999-2000 2000-2001

Coefficient SE Coefficient SE

Constant −0.10 .0** 0.09 .0**


Change in LN price of giving −1.58 .3** −1.86 .3**
Proximity (local = 1) −0.04 .0 −0.17 .0**
Adjusted R2 .030 .049
F statistic 17.01** 30.53**
Total df 1,021 1,151

**p = .01 level (two-tailed.)

logarithm of the price of giving. Both specifications include a dummy variable,


which equals 1 for local charities. Double log is the preferred specification
because data span two orders of magnitude, and cumulative distributions of
gift size and number of designations per charity are normally distributed
between the 15th and 85th percentiles. At the high end, there are more donors
than a normal distribution implies, and fewer at the low end. Sparseness at
the low end is probably the result of a minimum size payroll deduction
($1 dollar per pay period), and partial year contributions by new or departing
employees.
The results are robust with respect to specification: In all regression equa-
tions the price of giving coefficient is negative, larger than 1 in absolute value,
and significant at the p = .01 level, which supports the theory as expressed
by Hypothesis 1. The adjusted R2 is quite small—less than .05—although the
F statistic is significant at the p = .01 level (two-tailed). These results may
mean that donors do care about changes in the overhead ratio; however, other
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304 Bowman

factors that influence their giving decisions are much more important in the
aggregate. Signs on the dummy variable for local charities, used as a control
variable, tend to be negative; however, only one half are significant.
Tables 5a and 5b show estimates of the demand for charitable giving, as
measured by the total number of dollars designated to a charity, in each of the
two time periods. First differences in total dollars designated and the price of
giving are in Table 5a, whereas in Table 5b the first differences are between
the natural logs of total dollars designated and the price of giving. Again, the
preferred specification involves logarithmically transformed variables. In all
four equations, the price of giving coefficient is negative and significant at
the p = .01 level, offering further support for the theory as expressed by
Hypothesis 1. The price of giving coefficient in the transformed equations is
the elasticity of demand for charitable giving. In all cases, demand is highly
elastic, meaning that a change of 1% in the price of giving causes total desig-
nated dollars to change in the opposite direction by more than 2%. This effect
is caused, in part, by incumbent donors changing the level of their giving, but
also by marginal donors switching to “lower priced” providers of similar
charitable services. Signs on the dummy control variable for local charities are
negative only in the double log specification, one of which is significant.15
Because the corresponding price of giving coefficients on Tables 4b and 5b
are dimensionless, they can be compared without having to adjust for dif-
ferent scales. The average designation changed 70% between the years 1999
and 2000 in response to change in the price of giving.16 This is a large effect.
Because donors who give above-average amounts would have the most
impact, an effect of this size hints that above-average donors might be more
sensitive to changes in the price of giving than other donors, per Exploratory
Hypothesis 2. Unfortunately, this is not a direct test of Exploratory Hypothe-
sis 2 and must be regarded as inconclusive. A direct test of Exploratory
Hypothesis 2 uses a truncated donor file restricted to “large donors”—that is,
donors in the 97th percentile who gave $500 or more to any single charity,
namely about $40 per monthly paycheck or $20 per biweekly paycheck. There
were 409 large donors in 1999, 447 in 2000, and 462 in 2001. The maximum
number of large donors that any charity claimed was 89 in 1999, 64 in 2000,
and 82 in 2001. The average number of large donors per charity was between
two and three for all years (excluding those with 0) with standard deviations
near 5. Again, the dependent variable was the difference in the natural log of
number of designations, and the independent variable was the difference in
the natural log of the price of giving. The price of giving coefficient was –.69
for the period 1999 to 2000 and insignificant (t = 1.10), and .04 for the period
2000 to 2001 and insignificant (t = .05). Adjusted R2 were negative in both
cases. Perhaps large donors have strong personal reasons and are unaffected
by information about overhead ratios, or perhaps their incomes are suffi-
ciently high that $500 is of little consequence, or maybe the sample size is too
small and the error term is too large. In any case, a direct test does not support
Exploratory Hypothesis 2, so the regression results are not tabulated.
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Donors and Overhead Costs 305

Table 5a. Ordinary Least Squares (OLS) Linear First


Difference Model: Change in Dollars Designated

1999-2000 2000-2001

Coefficient SE Coefficient SE

Constant 36.85 85.8 453.35 137.7**


Change in price of giving −2,717.0 888.3** −2,565.0 1,347.3*
Proximity (local = 1) 6.25 183.0 356.17 289.7
Adjusted R2 .007 .003
F statistic 4.70 2.53
Total df 1,021 1,151

*p = .05 level (two-tailed). **p = .01 level (two-tailed).

Table 5b. Ordinary Least Squares (OLS) Log-Linear First


Difference Model: Change in Log of Dollars Designated

1999-2000 2000-2001

Coefficient SE Coefficient SE

Constant −0.042 .034 0.210 .033**


Change in natural log of
number (LN) price of giving −2.241 .045** −2.544 .420**
Proximity (local = 1) −0.013 .073 −0.227 .071**
Adjusted R2 .022 .037
F statistic 12.43 23.13
Total df 1,017 1,146

**p = .01 level (two-tailed).

To test Exploratory Hypothesis 3, the sample is split into local and


national and/or international and estimated the price of giving coefficient in
a double-log, first-difference specification (without the local dummy, of
course). In 1999 to 2000, the price of giving coefficient was –2.427 (SE = .687)
for local charities and –2.179 (SE = .549) for national and/or international
charities. Given their standard errors, there is no significant difference. In
2000 to 2001, the price of giving coefficient was –1.650 (SE = .799) for local
charities and –2.734 (SE = .486) for national and/or international charities.
This difference is not significant either. These results do not support
Exploratory Hypothesis 3, and are therefore not tabulated.
To see if other organizational factors might cause shifts in demand for giv-
ing, I used a 25% sample with additional data on NTEE category, total dona-
tions, and total expenses extracted from GuideStar and added manually to
estimate a demand equation with the first difference in the natural logs of
the dollars designated as the dependent variable and the first difference of
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306 Bowman

the natural logs of price of giving as the dependent variable with control
variables for size of organization and donations as a percentage of total rev-
enue. Total expenditures and donations were entered as a series of dummy
variables indicating the quartile to which a charity belonged (omitting the low-
est quartile) to detect possible nonlinearities. When parameter estimates were
calculated stepwise, only the price of giving coefficient entered in the period
1999 to 2000 and the price of giving coefficient and local dummy entered in
2000 to 2001. The adjusted R2 did not materially improve. Consequently, the
results are not tabulated.

CONCLUSIONS

Donors should care about changes in overhead ratios. A change in a char-


ity’s overhead ratio correlates positively with a change in the price of giving,
which, like any price, contains useful information for consumers. And, yes,
donors do care about changes in overhead ratios, but only as one of many
things, and collectively other factors are much more important. Adjusted R2
are very low, which suggests that the importance of overhead ratios in the
larger context of public policy is easily exaggerated. There is emphatically no
objective basis for saying that a particular ratio is too high. Although, the
Beard Foundation, VietNow, and their ilk raise disturbing questions, the
important issue in these and all such cases is whether fund-raising materials
and solicitors misled donors. Deception in any form is intolerable. One
hopes that courts will take a hard look at representations made by solicitors
(see endnote 2).
This experiment reveals that the demand for charitable giving (measured
by total dollars designated) changes by a greater percentage than the price
of giving changes, and in the opposite direction. The ratio of these two quan-
tities (the price elasticity of giving) is stable over time and robust with
respect to model specification. Evidence on whether large donors are more
sensitive to changes in the price of giving than other donors is inconclusive
at best. Evidence on the sensitivity of donors to changes in the price of giving
among local charities is mixed.
The negligible adjusted R2 demand attention. Some unexplained variance is
because of the assumption that marginal tax rates were constant for all donors;
however, this cannot be the whole story. In market transactions, price is
a major consideration for consumers, but apparently not so in this experi-
ment. This could be because of the fact that most donors are contributing
small amounts and may not care about price of giving (i.e., overhead ratios).
Although this database contained some large donors, the average payroll
deduction was small. Further experiments with a greater range of variation in
gift size are needed to determine if donors are less sensitive to information
about charities when they have very little money at stake. This experiment
uncovered two tantalizing observations that invite further inquiry. First, for
many charities, the number of designations did not change when the overhead
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Donors and Overhead Costs 307

ratio changed. This could be brand loyalty, consumer ignorance, the result of
offsetting effects of omitted variables, or just a statistical anomaly. Second, the
popularity of the “not-designated” option hints that people give just to be giv-
ing, not necessarily to support a particular mission. Perhaps, as Andreoni’s
(1990) “warm glow” theory suggests, the act of giving itself increases a donor’s
utility, independent of the use to which his or her gift is put. Alternatively,
social pressure may be responsible.17 More research is clearly needed.
Organization characteristics, like size and reliance on donations, appear
to be largely irrelevant. However, what is relevant? Do donors use informa-
tion on overhead ratios they are given? If not, why? Did these donors have
prior association with the charities they designated to receive their gifts?18 If
so, what kind? Were they influenced by marketing campaigns that targeted
federal employees during the CFC campaign? If so, what techniques were
particularly successful? Why? More research is needed on these questions.
We have probably gone as far as possible with data in the public domain.
Further progress in our understanding of these issues requires custom tai-
lored experiments that probe how donors form their perceptions of charities,
what information is most relevant to giving decisions, under what circum-
stances donors explicitly seek information, where they search, and how far
in advance of making a gift they begin their search.

Notes

1. GAO is now termed the Government Accountability Office.


2. When state courts dismissed the case on First Amendment grounds, Attorney General
Madigan appealed to the U.S. Supreme Court, which remanded the case to the trial court for a hear-
ing on its merits, ruling that the First Amendment does not protect willful misrepresentations of
fact. The outcome hinges on the actual representations that Telemarketing Associates made to
prospective donors and its intent. In earlier charitable solicitation cases, the U.S. Supreme Court
decided in Schaumberg v. Citizens for a Better Environment (1980), and in Secretary of State of Md. v.
Joseph H. Munsen Co., (1984) that capping fund-raising costs violated the First Amendment. It also
held in Riley v. National Federation of the Blind of N.C., Inc. (1988) that requiring solicitors to announce
the percentage of donations going to fund programs also violated the First Amendment.
3. There are various ways to calculate an overhead ratio. Using expenses in the denomina-
tor would produce a ratio that is less volatile because large gifts and bequests occasionally boost
revenues. However, the available dataset dictated the choice to use revenue here.
4. To see how the formula works, imagine overhead expenses are 0. Then all gifts are spent
entirely on programs, and the price of buying $1 of charitable output is $1. As overhead
expenses become an increasingly large fraction of total expenses, gifts are increasingly spent on
overhead and less on programs, causing the price of giving to approach infinity. Weisbrod and
Dominguez (1986) divided the sum of administrative and fund-raising cost by donations,
whereas the CFC divides by total revenue.
5. Calculated by author from the Independent Sector’s 1996 Giving and Volunteering survey
data.
6. In this article, the marginal tax rate for each donor is unavailable. I assume it is constant
for all donors in the Chicago CFC, and by inference that all variation in price of giving is due to
variation in overhead ratios.
7. More precisely, they used a logarithmic transform of total contributions as the dependent
variable in a generalized least squares model, and for independent variables they used lagged
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308 Bowman

logarithmic transform of fund-raising expenditures and the lagged ratio of administrative costs
to total costs.
8. Charity “watchdogs” (e.g., American Institute of Philanthropy, Wise Giving Alliance,
Charity Navigator, Maryland Association of Nonprofits) do not agree on a method of calculation.
See Bowman and Bies (2005, p. 43).
9. A pure public good is one that is nonrival and nonexcludable. Nonrival means that more
than one person can consume the good without interfering with anyone else’s enjoyment of the
same good at the same time. Nonexcludabilty means that a person cannot be excluded from con-
suming the good if they do not pay.
10. In 28 large cities that have Federal Executive Boards, it wears the mantle of the Local
Federal Coordinating Committees (LFCC). Chicago is one of these cities.
11. The organizations themselves develop this information subject to LFCC verification
using IRS 990 informational returns. Although eligible charities are required to submit audits,
these documents are not used in verification.
12. Account codes in the donor file were not the same as charities’ identification numbers
published in the Donor Guide, which complicated the process of merging them. An attempt was
made to merge based on charities’ names; however, it was not effective because of multiple
account codes (see Donor File above), and minor differences (e.g., and in one file, & in another).
Furthermore, the donor file contained only the first 40 characters of a name, and different char-
ities might have the same first 40 characters; this was a frequent source of confusion between
national/international charities and their local chapters.
13. The greater Washington, D.C., area consists of the Capital Area Campaign plus cam-
paigns in eastern Virginia and central Maryland. Other campaigns larger than Chicago’s are San
Diego and San Antonio.
14. The number given for 2001 in the Detail Location: Combined Federal Campaign (CFC) Results
(Combined Federal Campaign, 2002) is incorrect according to Jan Stinson, executive director of
the Chicago Area Federal Executive Director, who recommended averaging the 2 years adjacent
years (personal communication with author, February 24, 2006).
15. Experiments measuring demand should hold the conditions of supply constant; how-
ever, if we are willing to assume that the Chicago CFC contributes only a small portion of the
income of all participating charities, then receiving charities can expand their output at nearly
zero marginal cost, which is equivalent to holding conditions of supply constant. Under these
conditions, the estimated price of giving parameter measures only demand effects, and is not
distorted with supply effects.
16. Let total dollars designated to a charity be D = NG, where N is the number of designations
and G is the average size of designation. If we let ∆ indicate a change in a variable, then ∆D/D =
∆N/N + ∆G/G. Dividing this equation through by ∆P/P, gives the price of giving coefficient on
Table 5b ([∆D/D]/[∆P/P]) on the left and, on the right, the price of giving coefficient from Table 4a
([∆N/N]/[∆P/P]) plus (∆G/G)/(∆P/P). Thus, (∆G/G)/(∆P/P) = 1.54 – 2.24 = –.70. The percentage
change is found by multiplying the decimal fractions by 100.
17. “Warm glow” is simply a name Andreoni (1990) gave to a mental state to explain why
donors might gain utility without reference to the impact their gifts are likely to have on the
beneficiaries. In mathematical terms, social pressure serves the same function as warm glow.
18. Brown and Lankford (1992) showed that donations of money and time are complementary,
which implies that, other things being equal, volunteers are more likely to give than nonvolunteers.

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Woods Bowman, an associate professor in the graduate program in Public Services Management at
DePaul University, is an economist.

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