Navigating the Notches: Charity Responses to Ratings

This paper studies both donor and nonprofit responses to the star rating system designed by Charity Navigator. Using IRS Form 990 data from 2002 to 2019, I find that an increase in a charity’s rating from 3to the highest 4-star rating is associated with a 6% rise in contributions, with larger effects among smaller charities. Some charities respond to the incentives by changing their behavior to try to get themselves above the star thresholds, leading to “bunching” at the thresholds. This response is equal to the effect of charities halving spending on administration. I find that some of the response is due to misreporting of expenses in order to achieve a higher star rating. The analysis suggests that a notched rating system induces greater behavioral change than a continuous measure, but affects a smaller number of charities. Which rating system is preferred depends on the relative value placed on these effects. ∗Email: jenmayo@umich.edu. I am grateful for advice from Ashley Craig, Jim Hines, Nirupama Rao and Joel Slemrod, and for comments from Charlie Brown, Adam Cole, Vera Eichenauer, Edward Fox, Teresa Harrison, Stephanie Karol, Laura Kawano, Paul Kindsgrab, Shawn Martin, Jonathan Meer, Dylan Moore, Michael Murto, Andrew Simon, as well as seminar participants at the University of Michigan, WZB Berlin, the Online Public Finance Seminar, the 76th Annual Congress of the IIPF, and the NTA Annual Conference 2020.