Examining the Role of Foundations in a Free Society

Carl Schramm knows a thing or two about private foundations. Schramm is the president of the Ewing Marion Kauffman Foundation of Kansas City, the nation’s largest foundation to focus on entrepreneurship, and has served as a trustee of the Milbank Memorial Fund of New York. In those capacities, he has engaged in the pragmatic, nuts-and-bolts business of managing private foundations.

But Mr. Schramm is also a scholar. With a law degree and a doctorate in economics, he has taught at Johns Hopkins University, lectured around the world, and written for popular and academic publications. No surprise, then, that Mr. Schramm has devoted considerable thought to the deeper issues surrounding the role of the foundation within the free society.

Recently, he drew upon his practical experience and scholarly background to construct a theoretical account of the foundation and its place in American law, culture, and economics. The result is a journal article, titled “Law Outside the Market: The Social Utility of the Private Foundation,” which appeared in the Fall 2006 issue of the Harvard Journal of Law & Public Policy.

The article argues that “the private foundation, [as] an institution of democratic capitalism, exists to strengthen and facilitate the mutually supporting American systems of democratic pluralism and a free-market economy.” Enjoying a singular freedom of action (circumscribed by donor intent), foundations are uniquely positioned to engage in institutional entrepreneurship for the advancement of civil society. The article concludes by proposing the terms of “an informal treaty among founders, trustees, and governmental oversight authority.”

PHILANTHROPY: In your essay, you seek to establish a coherent theory of the role of the foundation within the context of democratic capitalism. Why now?

MR. SCHRAMM: We appear to have reached an inflection point in the history of the American private foundation. New wealth is pouring into the philanthropic sector. New books are attempting to chart a future course for philanthropy. And the Congress is considering proposals to increase its oversight of foundations.

The grantmaking foundation is now about a century old. It grew up in a society and economy very different from today’s. Look at American corporations: the few firms that have survived since the first half of the twentieth century are those that could self-renew and be innovative. As a result, while the corporate form itself persists, today’s firms are far different from those of a century ago. Yet grantmaking foundations have nevertheless maintained the same organizational form, more or less, and, despite the dynamic nature of the environment around them, haven’t really changed the ways they operate. They need to be continuously self-renewing and innovative—not only in what they do, but also in how they do it.

PHILANTHROPY: Then what, precisely, is the purpose of a philanthropic foundation?

MR. SCHRAMM: That might actually be the wrong question, and framing the question that way may help explain why so many earnest attempts to theorize about philanthropic foundations have never really risen above unhelpful rhetoric. Instead of posing the question de novo, we should look at foundations contextually—that is, their relationship to the system of democratic capitalism within which they were created and within which they operate. Now, democratic capitalism has an uncanny ability to generate the institutions it needs to thrive and prosper—institutions like the mass-production factory, the business school, and the venture capital firm. The philanthropic foundation is another such institution.

From Rockefeller and Carnegie to Gates and Kauffman, foundations are the creatures of generous individuals whose wealth was created through entrepreneurship. They created new products, new companies, and, in many cases, new industries. These entrepreneurs wanted their money used into the future to improve human welfare—their foundations are thus a reconstitution of that entrepreneurial wealth to help democratic capitalism expand opportunity, freedom, and prosperity. The vision of the founder should guide the foundation as it seeks to fulfill this role.

PHILANTHROPY: You raise the issue of donor intent. Why, precisely, is donor intent so important to a proper understanding of what a foundation is and ought to be?

MR. SCHRAMM: Since the great era of the establishment of foundations, there’s been much ink spilled over the importance of their professional administration. Implicit within that literature is a desire to quiet the donor’s voice. Now, the donors, in most every instance, led lives that were well-informed about his or her social conditions. They were, in every case, exceptionally smart people; in the majority of cases, they knew full well what they were doing when they created these foundations. (In some cases, they were not very clear, but I argue that we should look to the donor’s life and infer the implicit declarations of intent.) Donor intent is therefore all-important. If we don’t recognize it, we discourage wealthy people from creating foundations in the future.

Which is why this issue is not to be taken lightly. In the world of philanthropy, subsequent managers of the foundations sometimes come to believe that the settlor—the creator of the foundation—was somehow benighted and couldn’t really understand the contemporary world. If he was around today, they say, he wouldn’t think this way. And the net outcome is that we find foundations sometimes pursuing policies that could be seen as counter to the values and achievements of their founders.

PHILANTHROPY: Is there ever a point at which donor intent can become superfluous? Suppose a foundation was established to achieve a certain mission, and that mission is actually achieved. For instance, suppose a foundation was established to cure a specific disease, and a cure is found. What then becomes of donor intent?

MR. SCHRAMM: At that point, the donor can offer no further guidance. If the donor was that specific, and very few are, we are left with the problem of what to do with the asset. It would have to be extremely specific, and it’s actually very uncommon for a donor to say: “Do exactly this.”

However, the question does raise very important considerations for future donors. There are two different types of problems with donor intent: it can be too specific, or it can be too general. To be so specific that the goal could be achieved before the assets are fully spent raises the question: “What to do next?” And that is potentially dangerous, because it invites trustees to behave as if the foundation’s resources are their own.

The opposite danger is to be too general. For example, imagine a foundation established to “improve the social welfare of the population of Kansas.” Some trustees could decide that buying HMO coverage for the uninsured was the best way to do that. Some might say building safer roads was the best way to do that. Others could argue for groundwater cleanliness, or creating jobs. It leaves the trustees particularly directionless, without any roadmap whatsoever. That’s why a clear statement of donor intent, particularly at the formation of foundations, is something that donors need to think long and hard about.

PHILANTHROPY: You describe foundations as “out-market institutions.” What do you mean by that? What advantages—and what disadvantages—does being “all assets and no liabilities” confer upon foundations?

MR. SCHRAMM: When I say out-market, I mean that these institutions are unique in that they are never tested in terms of their relevance. They have no external accountability. Such “blue-sky” freedom is a foundation’s greatest asset, but it can also be its undoing. Think of a university or a hospital. In both cases, they talk a great deal about having to compete, but the fact is, if you’re Harvard University and you have a $30 billion endowment, you don’t have to compete for anything. You can run the risk of becoming totally irrelevant. That is a real, genuine risk. Which is another reason why donor intent is so important: it offers a readily available touchstone for the foundation.

I know I speak quite contrary to a lot of current philanthropic theory here, but often, in an attempt to test their relevance, foundations, both trustees and professional managers, go about the business of identifying constituencies that they want to serve. By doing so, they basically make themselves into political organizations, and they begin to rely on the evaluation of the invented constituency. Its evaluation often becomes the foundation’s source of accountability and its measure of relevance. But, unfortunately, this is essentially a false market, if you will. Had the foundation not developed the constituency, the group would be without judgment as to the relevance of the foundation’s work. And, inevitably, such constituencies will resist future innovation by the foundation because they are vested in the status quo.

PHILANTHROPY: Much of your own personal research—and much of the work of the Kauffman Foundation—centers on how best to foster such an entrepreneurial spirit. In the absence of feedback mechanisms, how can foundations cultivate and maintain an entrepreneurial sensibility?

MR. SCHRAMM: It’s a very difficult question. Peter Drucker discussed the problem in terms of absolute versus relative. What he called “public service institutions”—like foundations—often view their work as absolute missions. Other organizations—like business firms—face external accountability, and must think in terms of relative opportunities. Thinking in absolute terms can foreclose entrepreneurial thinking.

At the Kauffman Foundation, we have to face the challenge of dual stewardship. Our founder, in his declaration of intent, instructed us to support entrepreneurship, and he also told us to behave like an entrepreneurial, risk-taking organization. We have to focus on the creation of new solutions. We have to advance new initiatives that actually improve society. The entrepreneur looks forward, not backward. We believe we’re in the business of creating the new, not fixing the old.

One question we ask ourselves is: How many people are approaching us versus a partner when thinking about new initiatives? Then, secondly, as grantees, are they in the business of actually creating risky new institutions that will advance economic growth?

That’s how Mr. Kauffman conceived of us. He was very clear that becoming an entrepreneur was central to his own passage from poverty to wealth. He was very much of the view that entrepreneurship was one of the most effective ways to advance human dignity, to climb out of poverty, and to advance individual welfare—and taken as a whole, social welfare.

PHILANTHROPY: Where do you see real entrepreneurial achievement among foundations in the last century?

MR. SCHRAMM: Foundations contribute to the advancement of democratic capitalism through institutional entrepreneurship: they create completely new organizations or fields. The Rockefeller Foundation, in many ways the archetype of the first generation of foundations, practically created the field of public health. That’s an enormous achievement. Rockefeller set out to eradicate certain diseases, like hookworm and yellow fever, and then it set out to synthesize visions of the future for medical science. It pushed medicine into new terrain, by helping create the discipline of molecular biology, for example.

I think no one would ever dispute that the democratization of knowledge pioneered by Andrew Carnegie’s support for public libraries was a fundamentally important step in the process of expanding democratic capitalism in the United States. Carnegie also created the Teachers Insurance Annuity Association (TIAA) to provide university professors with pensions—and, in so doing, vastly increased the quality of university faculties by making the market for professors more competitive. The Kellogg Foundation created the community college system, which represented a breakthrough vision of how to further democratize education. Robert Wood Johnson’s invention of the Emergency Medical System was simply brilliant. Nobody else was working on it. They created it. Again, it was a great, innovative, entrepreneurial contribution to the economy, and the market, by itself, was unlikely to have given it to us.

Let me say a word or two about what we at the Kauffman Foundation consider to be our grants of real consequence. I think our work in, of all things, the improvement of government statistics, has been extremely important. We saw a need, and we stepped in. It may be as boring as could be, but without good statistics, you can’t measure the economy appropriately—which can lead to harmful policies. Our basic research in economics has been of great consequence because we’ve helped build up the theory and practice of entrepreneurial capitalism.

I think our work with minority entrepreneurs has been particularly creative. I think the work we’re doing in helping to move intellectual property out of the universities and into commercial applications that help people is very, very important. I think the work we’re doing on campuses, teaching entrepreneurship to university-wide populations, is also very important.

Now, what do all these things—the grants of consequence we’ve made, the great grants by other foundations in the past—have in common? They represent a creative opening of brand-new terrain. Nobody else was working there, even though these were important problems. And our society, lacking the freedom of these foundations, might not have gotten around to resolving these problems. These examples represent the highest and best use of the foundation for the advancement of democratic capitalism.

PHILANTHROPY: And yet, despite the successes you just enumerated, foundations have long been subjected to fairly rigorous legislative oversight. Why is it that legislators seem so leery of the activities of philanthropic foundations?

MR. SCHRAMM: I think there are probably three answers. While I mentioned outstanding grant activity by a handful of foundations, the record is equally filled with sideways or irrelevant—and in some cases, silly—grantmaking initiatives, which the Congress, no doubt, finds as offensive as do many other people.

Second, the Congress is uneasy with the view that there are institutions with considerable resources that somehow seem beyond their regulatory reach. In our democracy, particularly in the early twenty-first century, the Congress seems to be on the prowl to demand that institutions justify their activities, and an institution with a lot of wealth that isn’t well understood will be an obvious target. These days foundations are not safe from Congressional meddling.

Third, foundations are getting bigger, and when the Congress is worrying about the dispersal of public monies, it’s somewhat jealous about the size of private assets that exist for social programs that the Congress increasingly believes only it should do. The debate about national health insurance is an example of the Congress acting as if only government can solve major social problems.

PHILANTHROPY: Is that part of the reason you decided that this was the appropriate time to construct a theoretical framework to justify the activities of foundations?

MR. SCHRAMM: I think my theory is evergreen. But it is especially necessary right now because foundations simply aren’t making a clear case—either to the Congress or the public—as to why they exist, and why they should exist. It’s a serious missed opportunity, not least because the case can be made very clearly. Among the institutions of democratic capitalism, the foundation, when it’s acting responsibly, benefits the welfare of all by advancing innovations across society.

Because of its financial structure, and because it is above and apart from politics, it can go to places that aren’t necessarily popular. The record is very clear about what has been achieved historically. Foundations can explore new frontiers and take risks that government can’t and private industry won’t. Which is why I think it’s particularly important that we appreciate what foundations can be when they’re running at their very best, and strive to make them operate that way.

PHILANTHROPY: In your article, you tend to ground your justification in utility rather than in principle. That is to say, you defend foundations on the basis of what they do rather than what they are. How would you respond to those who say that the foundation is best justified by what it represents: an expression of purposeful free association that intends to improve civil society in a manner consistent with the wishes of its founder? To put it another way: suppose you believe a foundation is working at what you take to be cross-purposes with democratic capitalism. Would the foundation still be legitimate?

MR. SCHRAMM: My work attempts to connect principle to utility. If we look solely to principle, we risk divorcing it from concrete historic reality. If we speak exclusively in terms of utility, on the other hand, we risk a haphazard style that has no strategy and no context. The trick is to pursue utility, a test of usefulness, in the context of principle.

So you might put the question differently. Should foundations pursue a utopian vision of society, or should they pursue a better society, one that is actually achievable by direct, pragmatic, utilitarian steps? The latter is in a sense “grubby” work for foundations to be involved in. It’s messy, and it does not produce the high-minded rhetorical pronouncements of what a perfect world would look like.

Our view is that there is no perfect world, but there is a better world. We can make it a better world, but only by applying our limited resources in very tactical, cat-like, utilitarian ways, such that if we’ve been lucky, there can be no doubt we’ve improved social welfare. And let it be for others to understand that improving social welfare inevitably results—I hope inevitably results—in a stronger civil society. What we are trying to achieve honors the best of the past while looking to a yet better future.

PHILANTHROPY: In your article, you argue that the two primary functions of foundations are wealth reconstitution and institutional entrepreneurship. Is that an accurate account of what most—or even many—foundations actually do? Many foundations support the arts, or animal welfare, or any number of projects that are not particularly involved with either wealth reconstitution or institutional entrepreneurship.

MR. SCHRAMM: Again, we need to be precise with language. It’s deceptively easy to think of “wealth reconstitution” and “institutional entrepreneurship” as strictly economic concepts. But democratic capitalism is a social, political, cultural, and economic system—we can’t speak of “civil society” as something apart from this system. I argue for a shift in perspective that will create a shift in substance. Every foundation represents a “reconstitution of wealth” for the purpose of improving human welfare, and “institutional entrepreneurship” is really a way of underscoring the dynamic nature of democratic capitalism.

No institution or organization can simply stand still: not foundations, firms, animal shelters, nor museums. There is a constant institutional contest; institutions and organizations are always pushing each other towards improvement. In my article, I quote the president of the Kennedy Center, who acknowledged that the Center can’t simply stand still. Institutions and organizations must be innovative, or else they will stagnate. Foundations play a vital role because they are free to really push other institutions. My argument is that by neglecting their larger role within democratic capitalism, many foundations—not all—have turned away from such institutional entrepreneurship.

In our own work, the Kauffman Foundation makes grants to places like the Nelson Atkins Museum of Kansas City. At the same time, we’re pushing our schools to improve math and science education for middle and high school students. The distance from “more kids competent in math and science” to “expanded economic activity” is pretty short. And likewise, we set out to create a population that has more entrepreneurs who are more successful, who create scale companies, and, in due course, move people out of poverty and into good jobs that improve their sense of human dignity. Ewing Kauffman, our founder, said it best: “Every individual that we can inspire, that we can guide, that we can help to start a new company, is vital to the future of our economic welfare.”

PHILANTHROPY: You propose that foundations should be granted wide latitude of freedom for action, unless they engage in any of four behaviors. The first three behaviors seem like fairly uncontroversial abuses of foundation resources: diversion for private gain, obvious frivolous action, and the advancement of partisan political ends. But you also characterize “programs that set out to erode or destroy aspects of our system of democratic capitalism” as abuses of foundation assets. Presumably it is an abuse you would want to see regulated.

But is it not dangerous to allow regulatory bodies to define and circumscribe the work of foundations? And would it not infringe upon the prerogative of the donor to define the purposes of his or her foundation? At the very least, it seems problematic to the extent that there will inevitably be disagreement as to what programs erode or destroy aspects of democratic capitalism.

MR. SCHRAMM: This is an issue for trustees to worry about. They need to recognize that foundations are a creation of democratic capitalism. The Soviet Union did not have private foundations. Foundations should not be in the business of biting the hand that feeds them. That’s a crude way to put it, but it gets to the essential point.

I certainly agree with writers such as Joseph Schumpeter, who argue that the forward march of democratic capitalism requires the constant examination of our institutions. It’s perfectly fine to be critical of our institutions. But it’s highly ironic to set out to erode or destroy these institutions—and we do find, from time to time, foundation programs doing exactly that. The money that they live with and that they dispense came from democratic capitalism. Virtually all philanthropists have been people who grew their wealth, and they appreciated the system in which they grew their wealth.

Not only that, but in case after case, we have their written record, in which they claim that the creation of their company—the jobs they created, the contribution their company made to advancing the whole economy—had much more long-term impact on improving social welfare than their foundation would ever have.

PHILANTHROPY: What are the biggest challenges facing American foundations as they head into the future?

MR. SCHRAMM: As I mentioned, the biggest single challenge is to be self-renewing, and to operate with the innovation that generally characterizes foundations in their first ten or twenty years. If you look at foundations over their lifespans, you often find them making their greatest contributions in their earliest years. I like to think that has something to do with the presence of the donor, including a slowly fading but nonetheless continuing presence, in the decade or two after his or her death.

Continuous self-renewal and innovation require discipline and systematic analysis. But these two challenges will not be met through government oversight, sector-wide self-regulation, or more professional administration. They will only be met through the diligence of trustees and management, informed by an awareness of, and appreciation for, the foundation’s proper place within democratic capitalism.

This interview was originally published in the November / December 2007 issue of Philanthropy magazine.