Corporate Ownership & Control / Volume 4, Issue 2, Winter 2006-2007 83 THE MECHANISMS OF GOVERNANCE IN NONPROFIT ORGANIZATIONS Cláudio Antonio Pinheiro Machado Filho*, Adalberto Fischmann**, Luciana Rocha de Mendonça***, Sandra Guerra**** Abstract This paper discusses the governance issues in nonprofit organizations (NPO). The theoretical framework of agency theory is used to analyze the relationship between agents and principals (donors and volunteers) in such kinds of organizations. Similarly to the for-profit organizations, the mechanisms of incentives and monitoring are crucial to the alignment of interests among principals and agents. However, considering the NPO’s intrinsic characteristics, due to the difficulty to implement external and internal governance mechanisms, the challenges of alignment are far more complicated. The NPOs are idiosyncratic, being in many situations complex to establish performance comparisons with similar organizations. Keywords: governance, NPO, agency theory *Professor at the School of Economics, Business and Accountancy of University of São Paulo e-mail: capfilho@usp.br **Professor at the School of Economics, Business and Accountancy of University of São Paulo e-mail: aafischm@usp.br *** Phd candidate at the School of Economics, Business and Accountancy of University of São Paulo e-mail: lurocha@usp.br **** Corporate Governance Consultant, e-mail: sandraguerra@bettergovernance.com.br 1. Introduction What parameters can the donors use to monitor the effectiveness of social projects implemented by a nonprofit organization? How can these parameters be unfolded in efficiency indicators in the allocation of the donated resources? What is the role of governance mechanisms faced with these demands? These questionings are more and more frequent in the nonprofit organizations (NPO). The nonprofit organizations, more specifically those included under the third sector framework, are constituted by organizations which belong neither to the State nor to the market. They are nonprofit and nongovernmental organizations. According to the BNDES (2000), the third sector is defined as: “The group of private activities with public purposes and nonprofit purposes, composed by civil (of any origin) - religious, community institutions, institutions of workers, institutes and corporate foundations, nongovernmental organizations and others - differing from the government's strict logic (public with public purposes) and of market (private with private purposes)”. Just as in the for-profit organizations, in the nonprofit organizations the implementation of incentive mechanisms and monitoring over the management are crucial for the organization’s effective performance. Zylbersztajn (2003) supports this verification, questioning the still incipient discussion of the governance theme in nonprofit organizations. Regarding its scope it becomes very important to understand the governance dimension of nongovernmental organizations, due to its growth and enlargement of the focus on the social capital. The concept of Corporate Governance is based on the principles of transparency, equity, accountability and ethics. The Brazilian Institute of Corporate Governance (IBGC) defines it in the following way: “They are practices and the relationships among the shareholders / stockholders, board of directors, management, independent auditing and fiscal council with the purpose of optimizing the company’s performance and facilitate access to the capital." (IBGC, 2001)”. According to Zylbersztajn (2003), in its most basic form the problem of corporate governance appears when a shareholder wants to control making decisions which differ from the directors of an organization. In the heart of governance practices is the need to reduce the "Agency Costs", in a way to search to reconcile the undertaking’s long-term interests. From the seminal work of Spence and Zeckhauser (1971) and Ross (1974), the scholars of the science of organizations started giving more attention to the development of "Theory of Agency" developed later by Jensen and Meckling (1976), Fama and Jensen