`

Risk in the charitable sector: An

analytical framework
Voluntary Sector and Volunteering
Research Conference 2014

Diarmuid McDonnell, University of Stirling

Introduction
Risk is an everyday part of charitable activity. Charity trustees are responsible for
managing risk to ensure that their charities achieve their objectives and protect the
organisations funds and assets. In Scotland, the Office of the Scottish Charity
Regulator (OSCR) has responsibility for implementing The Charities and Trustee
Investment (Scotland) Act 2005, and ensuring that charities and their trustees comply
with the law. One of the challenges for the regulator is ensuring that their action is
appropriate, and that they balance enforcement of The Act against placing an undue
burden on charitable organisations.
Charities operate in dynamic organisational, political and social environments. The
funding landscape has shifted in recent years, with more focus on temporary, project-
specific support rather than strategic, core funding from government (Kiviniemi,
2008). This reflects changes in the compact between the state and the charitable
sector. The perception and utilisation of charities by the state has evolved; they are
now seen as an extension of the public sector in terms of service delivery, rather than
providers of supplementary services (Panel on the Independence of the Voluntary
Sector, 2014; Cornforth, 2011). They are also subject to unique pressures according
to their field of activity and beneficiary groups; for example, recent high-profile
regulatory investigations and reviews of fee paying schools and care homes. These
developments in the charitable sector have occurred against the backdrop of
increasing public scrutiny and accountability of institutions (Power, 2009; Rothstein et
al, 2006). Consequently, charities and the institutions tasked with their oversight are
under increasing pressure to demonstrate their legitimacy. Charities capacity to be
resilient in the face of these challenges (and others) is crucial to ensuring they
continue to deliver public benefit, meet the needs of beneficiaries and remain
accountable to relevant stakeholders.
This working paper seeks to develop an analytical framework for researching the
nature and understanding of risk in charitable organisations. The paper begins by
drawing on multidisciplinary literature on the concept of risk, with a particular focus
on sociological definitions and applications. The charitable form of organisation is
then defined as part of a critical discussion of economic and sociological theories of
nonprofit formation and behaviour. The previous discussions are followed by a
consideration of the concept of risk as it applied to organisations. Finally, an analytical
framework is developed by synthesising core theoretical and methodological
constructs from the preceding literatures.
Risk theory
The term risk is ubiquitous in modern society. As an illustration, one may think of
how risks related to food, drugs, infectious diseases, climate change, and financial
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crises have steadily been penetrating all conditions of life in recent times. (Alemanno
et al, 2003: 1) Though it is difficult to assign an origin for either the word or concept,
one of the first uses of the term was as means to understand the uncertainty or
danger of maritime explorations. Applications were soon found for the concept in the
provision of insurance and other financial services. As probability theory became more
sophisticated and robust from the early eighteenth century onwards, the application
of the concept spread rapidly, both within existing sectors and to new ones such as
health care, environmental protection and crime (Taylor-Gooby & Zinn, 2006).
The concept of risk has received comprehensive treatment in multiple disciplines,
ranging from economics, public health, environmental sciences and sociology to name
a few (Riesch, 2012). Risk has been defined as an unwanted event that may or may
not occur (Rosa, 1998), the cause of said event (Moller, 2012), and as simply the
probability of the unwanted event occurring. A well-known utilised definition of risk
grounds it in a decision-making framework, arguing that a risk is the fact that a
decision is made under conditions of known probabilities (Knight, 1921). Perhaps the
most common definition, and certainly the one that is adopted frequently for
technical risk assessments, is risk as the expectation value of a harmful event that may
or may not occur (Campbell, 2005). In the sociology literature, Rosa (1998, 2003)
defines risk as a situation or event where something of human value (including
humans themselves) is at stake and where the outcome is uncertain. In this definition,
risk is a state of the world and is independent of perception and subjectivity. For
example, a risk to human well-being is lung cancer; the cancer itself is the risk and
there is uncertainty around its likelihood and consequences. Though commonly
referenced in the theoretical discourse on risk, Rosas definition suffers from its
abstraction from modern applications of risk analysis; that is, the operationalization of
risk as the probability of an event multiplied by its impact (Aven & Renn, 2009). Aven
& Renn (2009) sought to amend Rosas conceptualisation of risk by grounding it in
standard risk analysis terminology without losing its conceptual rigour. Their definition
is as follows: Risk refers to uncertainty about and severity of the consequences (or
outcomes) of an activity with respect to something that humans value. (Aven &
Renn, 2009: 2) Uncertainty and severity remain the core dimensions of the concept
of risk, with probabilities often used to express uncertainties. While risk analysis using
this definition is often applied to real events, the concept of risk is no longer a state
of the world as it is not independent of the assessor: Uncertainty is not real, it is a
construct of human imagination to cope with potential future outcomes that can
become real. (Aven & Renn, 2009: 8)
Risk society
In Becks influential contribution to the sociological literature, risk is no longer
conceptualised as a matter of fate or an unavoidable consequence of material and
technological progress (Beck, 1992). In the risk society, the relation between wealth
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production and risk production is reversed. The production of wealth is now
overshadowed by the production of risks. The risks produced have lost their
delimitations in time and space and consequently can no longer be seen as latent
side effects afflicting limited localities or groups. (Lidskog and Sundqvist, 2013:
1012) Hutter (2006: 208) echoes the argument of Beck and describes the
characteristics of risk in modern western societies: First, they [risks] are manufactured
as opposed to natural. Second, they transcend social and national barriers and may be
global in their effects. And third, these modern risks are closely but ambivalently
associated with science which is seen as responsible for the creation and definition of
modern risks but is also seen to have failed to control these risks, thus leading to the
emergence of a risk society characterized by global risk situations. From a risk society
perspective, technology, industry and science are creating risks that are difficult to
perceive or assess from a non-positive perspective (Kurian & Wright, 2010). People
are concerned with the impact of scientific and technological developments on their
lives, society and environment. This increased awareness of risk in modern society has
implications for those tasked with risk analysis. As a result of the incongruity between
expert and lay understandings of risk, its management is becoming increasingly
contentious. Renn (1998: 49) highlights the influence of large-scale and dangerous
incidents on public perception of risk, in particular how they have gained much public
attention and have given rise to a growing discontent between the publics desire to
see risks reduced and the actual performance of risk management institutions.
Institutions tasked with managing risk must consider some of the following questions
relating to the aforementioned concerns (Roeser, 2012): how do you incorporate
scientific assessments of risk with public perception and tolerance? Should the public
only be involved in decisions relating to risk management and not assessment? How
do you weight scientific or technical assessments with more qualitative or values-
driven perceptions?
Methodological and conceptual challenges
A robust and universally-applicable measurement of risk is difficult to develop.
Assigning a probability can often be a matter of judgement rather than mathematical
certainty; severity also needs to be measured in a meaningful and comparable
manner. The theoretical issues of comparing harms and assigning probabilities do not
only constitute a problem for proponents of the expected value notion of risk, but for
any account that, while objecting to the expected value interpretation as such, still
takes severity of harm and probability as basic aspects of risk and safety. (Moller,
2012: 64) As well as dealing with probability and severity, Taylor (2012: 446) argues
that there are factors over and above those in place today which can lead to the
mismeasure of risk: unknown unknowns, model risk, thresholds for acceptable levels
of risk, trade-offs of risk against rewards, and the inadequacy of single measures.
Finally, there is an element of judgment to reflect factors outside the models which
may increase risk. Determining what is an acceptable risk is also an important
4
consideration. A technical risk assessment may reveal a quantitatively-derived level of
risk that should be tolerated for a particular activity. However, those tasked with
managing the risk may be dissuaded from adopting this level due to pressure from
stakeholders subject to the risk (Hansson, 2004). This is especially relevant in light of
the increasing prominence of risk in modern society, where those risks are often
global, involuntary and inequitable in their distribution.
Nonprofit formation and behaviour
In Scotland, a charity is defined (under statute) as an organisation that is listed in the
Charity Register maintained by the Office of the Scottish Charity Regulator (OSCR).
Therefore, to be registered as a charity, an organisation must demonstrate that it
satisfies a number of conditions (OSCR, 2012):
It must have only charitable purposes;
The organisation must or intend to provide some form of public benefit when
determining public benefit, OSCR must consider how private benefit is
balanced against public benefit, whether there is any disbenefit to the public,
and whether there are any undue restrictions to accessing public benefit;
The organisation must not allow its assets to be used for non-charitable
purposes, be governed or directed by non-Ministerial individuals, and not be a
political party.
Despite their distinct branding in terms of legislation and public consciousness,
charities embody and operationalise characteristics from a wider domain of activity
known, variously, as the voluntary/nonprofit/third sector. In keeping with the
nomenclature of the theoretical contributions, the term nonprofit will be used as a
proxy for charitable organisation for the remainder of the paper.
Definition
One of the most parsimonious and utilised definitions of nonprofit enterprise was
proposed by Hansmann (1980; 1996); he defines a nonprofit firm as one that is not
free to distribute profit to its owners, board or managers. Termed the
nondistribution constraint, it provides a clear distinction [from forprofit firms] that
affects how the organization obtains resources, how it is controlled, how it behaves in
the marketplace, how it is perceived by donors and clients, and how its employees are
motivated. (Steinberg, 2006: 118) Anheier & Salamon (1997) take a broader view of
nonprofit distinctiveness and propose the Structural-Operational definition, where
nonprofits are defined by the following characteristics:
Organised;
Private;
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Autonomous;
Non-compulsory (that is, voluntary);
Non-profit distributing.
Formation
The economic theories of nonprofit organisations rest on four theoretical "legs"
(Wallis, 2006). Demand-side theories focus on the motivations of individuals to
interact and contract with nonprofit organisations (Wallis, 2006). The first of these,
Weisbrod's (1975) public goods theory, contends that nonprofits surface to fulfil
unsatisfied needs for public goods. Heterogeneous demand for public goods, in terms
of quantity and quality, cannot be fully satisfied by the state, resulting in space in which
nonprofits can arise to satisfy niche or overlooked needs. Therefore, nonprofit
organisations arise when private demand for public goods is unmet by the state. The
second significant demand-side theory seeks to explain why there are non-market
rather than market responses to public goods provision. Hansmann's contract failure
theory (1980) postulates that, owing to the nondistribution constraint, nonprofits
address information asymmetries that exist between producers and consumers
regarding the quantity, quality and costs of goods and services. In such circumstances,
a for-profit firm has both the incentive and the opportunity to take advantage of
customers by providing less service to them than was promised and paid for. A
nonprofit firm, in contrast, offers consumers the advantage that, owing to the
nondistribution constraint, those who control the organization are constrained in
their ability to benefit personally from providing low-quality services and thus have
less incentive to take advantage of customers than do managers of a for-profit firm.
(Hansmann, 1987: 29)
Steinberg (2006) elaborates on the means by which nonprofits address contract
failure:
The nondistribution constraint performs a sorting process, where
entrepreneurs whose values are not aligned with the nonprofit sector do not
enter it;
Many founders or managers of nonprofits are demand-side stakeholders (for
example, parents founding a nonprofit childcare facility);
Nonprofits are immune from financial takeovers, promoting stability;
Spillover benefits to competitors; that is, the presence of a nonprofit
incentivises forprofit organizations to become more trustworthy.
Supply-side theories are concerned with nonprofit entrepreneurship and giving. Rose-
Ackerman (1996) posits that nonprofit organisations attract founders and leaders that
are altruistically motivated, rather than purely driven by rent-seeking behaviour.
Structural differences between public agencies, private firms and NPOs [non-profit
6
organisations], including the non-redistribution constraint, as well as selection and
screening procedures, ensure that a sorting process takes place that results in the
motivational segmentation of leaders according to sector. Thus, wealth-maximizing
executives will be attracted to the private corporations, power-seeking administrators
will tend towards public agencies, and altruistic leaders will gravitate to the voluntary
sector. (Wallis, 2006: 961) This theory complements Hansmann's focus on the role
of trust in nonprofit organisations and addresses his assumption that the motivations
and values of board members and managers are aligned with those of the
organisation. As Young (2001) contends, this sorting of altruistic entrepreneurs and
leaders into the nonprofit sector signals that the organisations they participate in are
trustworthy. Other supply-side theories focuses on the motivations and incentives of
individuals to give time, money and other resources to nonprofit organisations (see
Andreoni, 1990).
Behaviour
Primarily in response to the nondistribution constraint, nonprofits rarely seek to
maximise profits; therefore, theories of non-profit behaviour often seek to
understand other maximands (Hansmann, 1987):
Quality and/or quantity of service;
Budgets;
Some other socially-optimal objective.
The purpose of the nonprofit organisation, as expressed in its mission statement, is
crucial to understanding its behaviour. The functions and values of nonprofit
organizations find their expression in missions, or, more precisely, in mission
statements. The mission is the principal purpose of the organization, and the very
reason for its existence. (Anheier, 2005: 176) Missions can be vague and intangible,
resulting in low-specificity goals and impacting on the delineation of tasks and
organisational structure (Anheier, 2005). A nonprofits mission can both constrain
and enable activities, and is a crucial driver of behaviour. Sociological perspectives on
behaviour have also posited that nonprofits are sources of innovation and diversity in
society, campaigning for and promoting social change in many cases, and developing
innovative responses to the needs of marginalised groups in others (DiMaggio &
Anheier, 1990; Kramer, 1981)
Nonprofit behaviour has also been studied from the perspective of their perceived
and actual failures. Contributions to voluntary failure theor critique the nature of
nonprofits in relation to their organisational weaknesses (Anheier, 2005):
i

resource inadequacy;
particularism;
7
paternalism;
amateurism.
Often these failures are addressed by forming partnerships with state organisations,
which can provide a more stable stream of resources, set priorities through a
democratic process, discourage paternalism by [for example] making access to care a
right and not a privilege, and improve quality of care by setting benchmarks and
quality standards. (Anheier, 2005: 131) This symbiotic relationship between the
nonprofit organisations and the state has significant implications for oversight and
monitoring. Nonprofit organisations monitor government provision (and
underprovision) of services and undertake advocacy roles to ensure service delivery. In
this way the nonprofit sector overcomes its resource insufficiency and particularism
failures. In turn, government would rely on nonprofits as its preferred agent in the
delivery of many of the services it funds. Government would also monitor and
regulate the operations of nonprofits to foster accountability and good management
practices and to prevent abuse and harmful paternalism. (Wolpert, 2003: 178)
Summary
Nonprofit formation and behaviour theories do not claim to have universal
explanatory power. Often they are better utilised as heuristic devices, guiding research
rather than structuring it. In the context of the study of risk, the theories reviewed in
the previous section possess important contributions and insights. Issues surrounding
the role and salience of trust in nonprofit behaviour are important considerations for
risk research. The nonprofit organisation, though it signals some degree of
trustworthiness through organisational type, is not sufficient by itself to guarantee
behaviour that provides public benefit. The nonprofit organisation eliminates some
incentives to exploit information asymmetries (Hansmann, 1996) but this presumes
that such an agreement is enforced by someone. If enforcement is lax, then the
advantages of the nonprofit firm disappear. (Krashinsky, 2003: 133) Hansmann
(1987) corroborates Krashinksys concern, highlighting Issues with donor or patron
monitoring of a non-profit (Hansmann, 1987):
Difficult to detect managerial malfeasance;
Often dont have voting rights in the organisation;
No market for organisational control (for example, stock markets).
Their thinking converges on the need for effective monitoring and oversight to
ensure nonprofits provide public benefit and act in a trustworthy manner.
Consequently, regulatory regimes were formed in recognition of the importance of
protecting public confidence in the nonprofit sector.
Risk and organisations
8
Much of the forprofit literature on risk emphasises the role risk analysis can play in
optimising decision-making and operations (see Rothstein et al, 2006). As such, risk
management methods are widely promulgated as efficient, rational and universally
applicable means for challenging organisational practices in ways that manage their
inevitable downsides without stifling entrepreneurialism. (Huber & Rothstein, 2013:
652). Risk analysis can also be an effective tool for demonstrating accountability to
relevant stakeholders (Rothstein et al, 2006). Structured risk analysis frameworks, such
as Enterprise Risk Management (ERM), have been embraced by forprofit
organisations due to its congruence with easily defined financial metrics and goals,
effective monitoring by principal, and competition (Chen & Bozeman, 2012).
A major criticism of these highly formalised risk analysis frameworks is their focus on
rules-based compliance (Power, 2009). Huber & Rothstein (2013: 668) echo similar
concerns, positing that risk analysis can become an exercise in organisational
legitimacy and can reflect rather than challenge engrained organisational
preferences. Organisations can become myopic and inward-looking in their focus,
relying on box-checking and internal controls rather than creatively conceptualising
and identifying new risks. This can have the perverse effect of making organisations
risk-averse (Huber & Rothstein, 2013). While many risk and compliance people at
the operational level prefer this less ambiguous and more rule-based world, it is also a
rather dangerous generalised and standardized orientation for organizations,
regulatory bodies and societies (Power, 2009: 852) As a consequence, much of the
systemic risk in the sectors organisations operate in remains poorly understood or
measured; there is a disconnect between risk management at the organisational level
and the interconnectedness of the sector or society in which the organisations
operate (Power, 2009). Finally, Goble & Bier (2013: 1947) consider the inherent
limitations in the applicability of risk analysis for organisations, arguing that the most
pernicious problem with the use of risk assessments can be overreach, for example,
failure to acknowledge the limitations of an assessment, or attempts to suppress
legitimate concerns. Such failures have in many cases seriously eroded public trust.
The nature of risk in nonprofit organisations is broad: Financial, personnel, program
and capital expenditure decisions all entail risk because they involve interactions with
changing, complex, volatile or intrinsically stochastic economic, political and social
environments. (Young, 2009: 33) Contributions from the fields of economics and law
have theorised that nonprofit firms are poor bearers of risk, relative to owned
enterprises. They do not possess the ability to diversify their risk through raising equity
for instance, and tend not to invest in risky projects relative to other firms. Moreover,
the managers of nonprofit firms, lacking a class of owners to whom they are
responsible, have unusual autonomy and thus are unusually free to indulge their
personal aversion to the risk that the firm might fail, costing them their jobs.
(Hansmann, 1996: 242) Nonprofits also exhibit some similar traits to forprofit
organisations with respect to risk, such as the effect of competition on organisational
sustainability. Uncritically importing a forprofit perspective on risk however, fails to
9
take account of the distinct nature of nonprofits, especially with respect to: the role of
profit in the organisation; mission objectives; societal expectations; and accountability
to wide set of stakeholders (Chen & Bozeman, 2012). Despite these applicability
concerns, Young (2009: 34) advocates for the adoption of risk analysis approaches by
nonprofits, especially in relation to strategic decisions; otherwise, nonprofits may find
themselves making unduly conservative decisions that fail to achieve as much impact
as they might, or in some cases taking unreasonable amounts of risk for a low return.

10
Analytical framework for the study of risk
Deriving an analytical framework for the study of risk in the charitable sector must
give due consideration to the epistemological, theoretical and methodological
concerns delineated throughout this paper. In particular, the nature of risk must be
understood with respect to the following propositions:
The role of risk as an organising idea for decision-making;
The influence of risk analysis in demonstrating organisational legitimacy;
The salience of trust and accountability for nonprofit organisations; and
Potential incongruity between public, regulatory and nonprofit
conceptualisations of risk.
The analytical framework presented below incorporates these concepts and others,
and is an adjusted version of Anheiers (2005) framework for studying nonprofit
activity more broadly:
11


Organisation
Understanding
Values
Behaviour
Risk factors
Organisation
Understanding
Values
Behaviour
Risk factors
Organisation
Understanding
Values
Behaviour
Risk factors
Sector
Sector
Sector
12
Organisational level
Understanding An analysis of risk should take account of a nonprofits
understanding of core concepts and terminology, with due consideration of the
potential for varied and fuzzy conceptualisations in the sector.
Values Research should consider the importance and values attached to risk in
the organisation, in particular the boundary work that may be conducted by
those tasked with managing risk (Gieryn, 1999). Attention should be paid to
core risk components such as risk tolerance or appetite, ownership and
measurement.
Behaviour Is risk an organising concept for charities, both in terms of its
strategic objectives and everyday activities? In particular, research should seek to
understand how decisions are made in relation to risk management strategies
such as risk reduction and mitigation.
Risk factors charities should be asked to communicate what they perceive as
significant hazards and threats to their organisational stability.
Examining risk at this level is crucial in the context of regulatory activities that are
focused on communicating best practice and guidance with respect to effective and
compliant governance.
Sectoral level
The heterogeneous nature of the sector necessitates the use of a classification system
to properly understand and contextualise risk factors in relation to individual charities.
Operational and external risk factors as they relate to different types or sectors of
charities are of particular relevance. Delineating the framework in this way also
acknowledges the distinct circumstances charities operate in across different sectors;
for example, charities operating in the care sector face regulatory oversight and
monitoring from the Care Commission.
Societal level
Attention here should focus on the structure and content of the regulatory and
legislative environments. The influence of the publics conception of and expectations
for charities should also be captured. Of primary concern is the way in which the
regulatory agency defines, measures and communicates societal risks to the charitable
sector. Societal risks are understood as relating to overall public confidence in the
charitable sector, the accountability of the sector to the public and other key
stakeholders, and the effect the often contentious relationship between the publics
conception of charities and their activities. The role of the regulator in terms of
managing institutional risk should also feature prominently in any analysis of risk in the
sector. One of the most significant risk factors in charities is not understanding the
13
role risk plays in shaping organisational survival and impact. The ability of the regulator
to communicate the benefits of risk analysis can also have a powerful and useful
effect on reducing risks in and of themselves. In fact, risk communication can help to
reduce risk even without a direct link to risk management (Goble & Bier, 2013:
1948) In order for the regulator to undertake their activities effectively, a common
risk language must be adopted, at the very least at a conceptual level.

14
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ii
Note that some of these failures are only so from an instrumental (i.e. economic) perspective.
Particularism could be a success when viewed from an expressive or advocacy perspective for instance.]
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