Paul L. Caron

Wednesday, May 27, 2020

Why Won’t Universities Spend Their Money During The Pandemic? Endowment Hoarding By Presidents.

Following up on my previous post, University President Explains Why Faculty/Staff Pay Freezes And Layoffs Are Preferable To Dipping Into Endowment During COVID-19:  Brian Galle (Georgetown), If Not Now, When: Why Won’t Universities Spend Their Money?:

CoronavirusThese are tough times for higher education. Even name-brand institutions are announcing hiring freezes and salary cuts, among other austerity policies. ... [W]hat on earth explains why Stanford and Harvard are taking similar measures? These are institutions with tens of billions of dollars in endowment savings. Harvard, as I have pointed out elsewhere, could cease operations tomorrow and still cover its bills for twelve years. Equally insane, these are schools with guaranteed donative revenues that are sure to exceed their annual endowment payouts by several multiples. That is, Harvard brings in more money in donations every year than it spends out of its endowment. Any first-year finance student would tell Harvard to borrow against its future inflows by spending out of the existing endowment.

So put another way, the present moment should end forever the argument that university endowments are rainy day funds. If institutions aren’t drawing on their supposed reserves now, when will they ever? ...

One possible explanation for why universities act so irrationally is because the law forces them to. ... [T]he legal argument is nonsense. ...

[A] team of finance professors has what I think is a more persuasive answer [How University Endowments Respond to Financial Market Shocks: Evidence and Implications, 104 Am. Econ. Rev. 931 (2014)] ... Their answer is agency costs. Basically, university administrators use endowment as a measure of their own success. As fairly compelling evidence, the profs show that universities do sometimes dip into endowment spending, but almost never to the point where the endowment would fall below what it was worth when the current president took office. Presidents protect their endowment “legacy,” at the cost of their real legacy. (Wharton legal studies prof Peter Conti-Brown also argued this point, albeit with less empirical basis, in his student note [Scarcity Amidst Wealth: The Law, Finance, and Culture of Elite University Endowments in Financial Crisis, 63 Stan. L. Rev. 699 (2011)]; see also this nice paper  [The Coming Showdown Over University Endowments: Enlisting the Donors, 77 Fordham L. Rev. 1795 (2009)]). ...

[A]dministrators who are not constrained by ego should be aggressively drawing down endowment spending right now. ... [T]he marginal returns to present spending are very high, and they have lasting benefits. Many cut-backs are hard to reverse and have long-lasting sting (once you sell off your engineering school, it doesn’t come back). Students and support staff are in need. Opportunities to hire or poach faculty away from shorter-sighted schools are highly available.

Inside Higher Ed, Will Colleges Tap Large Endowments During Pandemic?:

Should colleges leverage their endowments to patch temporary revenue holes and prevent pandemic-necessitated cost cutting, or should they hold spending rates steady to ensure endowments' long-term strength?

The answer, like those to most college finance questions, varies greatly by institution and investment philosophy, and experts come down on both sides. ...

For wealthy colleges that lean heavily on endowment returns to make up their operating budgets, shifts in spending rates can more drastically impact future endowment outlook.

For example, Princeton University president Chris Eisgruber said in a May 4 letter to students that, absent growth, the university would deplete its entire $26.1 billion endowment at its current spending rate after 20 years. Princeton is one of a few that have announced they will likely increase their endowment spending rate amid the pandemic -- from 5 percent to 6 percent.

“We believe that an average annual endowment spend rate slightly above 5 percent is in fact sustainable. With this year’s decline in endowment value, however, we expect to be spending more than 6 percent of our endowment. That rate is not sustainable,” Eisgruber wrote. “We therefore need to reduce the University’s operating expenditures, especially because there is a substantial risk that greater economic distress may lie ahead. That is why Provost Deborah Prentice has rightly called for salary freezes, tighter vacancy management, and reductions to non-essential expenditures.”

Another prevailing argument to maintain and not raise endowment spending rates year to year is that a consistent rate preserves intergenerational equity -- the belief that past, present and future students are getting the same quality of education regardless of the economy’s health at the time.

But not all experts buy it.

“It’s sort of a joke to say that the problem is to maintain intergenerational equity,” said Charlie Eaton, an economic sociologist and assistant professor at the University of California, Merced. “Because if you look at, say, Harvard or Princeton, the endowment is 1,000 percent larger than it was in the 1970s.”

For complete TaxProf Blog coverage of the coronavirus, see here.

Coronavirus, Legal Ed Scholarship, Legal Education | Permalink


Calling Mr. Unemployed,

Care to defend stingy old Harvard again?

I recall your argument was they had little or no flexibility in their endowment distributions, even in times of crisis like this.

Posted by: MM | May 27, 2020 5:51:14 PM

Has anyone looked into the argument that many large endowments are populated to a great extent with restricted gifts, thereby (further) limiting the flexibility of trustees to spend?

Posted by: Michael L. Wyland | May 28, 2020 9:33:04 AM

M. Wyland: "Has anyone looked into the argument..."

Yes, and though true, it doesn't mean they have no flexibility.

From Harvard's own 2019 financial statements:

"Endowment and GOA returns liquidated from investments and made available for operations over the course of the fiscal year are distributed to University department and program budgets to spend, subject to donor restrictions where applicable

While the University has no intention of doing so, there are additional investments held by the University and the endowment that could be liquidated in the event of an unexpected disruption. While a portion of the endowment is subject to donor restrictions, there is $7.1 billion in endowment funds without donor restrictions and $3.7 billion of General Operating Account investments (GOA) that could be accessed with the approval of the Corporation and subject to the redemption provisions."

Posted by: MM | May 29, 2020 5:52:36 PM