Wednesday, March 04, 2009

Academic endowments: the curse of hoarded treasure

A Businessweek article argues that U.S. universities are cutting budgets and shortchanging today's students to risk what's left of their endowments in financial markets. Harvard relies on its endowment for 30% of annual operating funds, and Yale gets 45% of its annual operating budget from the endowment.

Is there a better way? There could be. Here's an idea: Maybe rich universities should act more like companies, which somehow manage to operate without endowments. Universities could raise just as much money from wealthy alumni and other donors as they do now, but they wouldn't hoard it in a great big piggy bank. They'd spend it as it came in, the way companies spend their revenue on current needs.
Why must universities Hoard money?

Most universities that aren't super-wealthy already do behave like companies because they have little choice: They don't pile up endowments because they have urgent current needs for the money. Take California State University at Long Beach, where about a third of undergraduates are first-generation college students. The school does raise money from alumni and other sources, but it puts most of the proceeds to use right away for such purposes as scholarships. In a Feb. 27 interview, President F. King Alexander said: "Our students need that money. We're not wealthy enough to sock it away when we have so many needs on our campus right now."

Any ordinary company that followed the money-hoarding strategy embraced by such institutions as Harvard, Princeton, Yale, and Stanford would soon receive an inquisitive letter from the likes of raider Carl Icahn, who would want the CEO to explain why he or she couldn't find anything more useful to do with the money than stash it away. It's a fair question, both for companies and for universities.

The most frequent argument for having a big endowment is that it's supposed to tide schools over tough times. It sure isn't working out that way. True endowment funds can't be spent even in an emergency; only the cash income and capital gains from them can be spent. (Does anyone remember what capital gains are these days?) So-called quasi-endowment funds can be drawn down if necessary, but universities seem loath to do so even in the current circumstances, as if preserving capital is a higher priority than preserving academic programs.


Some of the larger and richer universities made things worse for themselves by investing in private equity and other illiquid investments that are harder to get out of. During the boom times, that seemed like a good strategy. Yale and Harvard's investment managers were highly regarded and became a bit like superstars.

The article also argues that assuming living standards continue to rise, saving donations for the endowment, as opposed to spending them in the general fund, can be tantamount to robbing present day students to give to future ones.

This is potentially an issue for many nonprofits, such as churches. The Episcopal Church has an endowment. Given that we are not a rapidly growing church in general, I'd argue that it's justifiable to continue to fund our endowments. However, one could make a counterargument to that.

Anyway, in closing:

Human foibles may be a better explanation for the accumulation of huge endowments, Hansmann seems to conclude. On the supply side of funding, he writes, "many donors restrict their gifts for use as endowment, not to advance education and knowledge, but to purchase a bit of personal immortality."

On the demand side, boards of trustees may solicit funds for endowment rather than current spending simply because they like the idea of presiding over a big pile of money: "It may be that, consciously or unconsciously," he writes, "university trustees tend to focus on the size of the university's retained earnings (that is, its endowment) as a measure of the success of the management of the institution." That amounts to collecting money for money's sake. Adds Hansmann: "One sometimes has the sense that universities compete among themselves to have the largest endowment."

Memo to the board of trustees: You're supposed to be running a service business here, not piling up treasure.

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