The financial security of a strong university endowment would seem to matter most when hard times come along—when revenues slow and core functions are in danger of being compromised. At such times, an endowment can help guard against shortsighted cost cutting that harms both near-term quality and long-run vitality. But it turns out that many universities do nothing of the sort.
During the recent recession, most endowments took a beating, with the average endowment losing a quarter of its value. That decline followed years of heady growth that led endowments to grow at a far faster clip than university spending did. As a result, the losses suffered in the market meltdown represented a much larger loss relative to universities’ annual operating budgets than did any previous market correction.
The losses came at exactly the same time that other revenue sources, such as tuition and corporate giving, were also under strain due to the recession. To make matters worse, the economic downturn increased demand for financial aid because families were not faring as well as they might have been during normal economic times.
In response, some universities ignored their own spending guidelines, which are designed to help smooth over market fluctuations, and instead chose to actively cut endowment payouts by even more than indicated. In short, they acted to preserve the value of the endowment instead of using the endowment to preserve the value of the university. Those practices raise fundamental questions about whether the university leaders and the boards to which they reported had truly acted in the best interest of their institutions.
These findings are reported in a paper published in the March issue of the American Economic Review, in which I, along with my University of Illinois College of Business colleague Scott J. Weisbenner and two Nanyang Technological University professors, Stephen G. Dimmock and Jun-Koo Kang, examine the behavior of more than 200 Ph.D.-granting universities in the United States from 1985 to 2009. We consider whether institutions follow their own guidelines to smooth over financial shocks by spending a specified fraction of a multiyear moving average of past endowment values.
Our analysis shows that although universities follow their endowment-spending guidelines during good times, many of them cut spending during bad times by more than their own guidelines would suggest. In other words, they cut payouts precisely when it was most damaging to do so.
Endowment hoarding cannot be explained by regulatory or donor constraints against spending the principal. Nor can it be explained as a rational response to economic uncertainty. After all, if one believed that a full economic meltdown was just around the corner, then it would have been wiser to invest in human capital than to leave money invested in falling markets. Conversely, if one believed that the market drop was a temporary blip and that future returns would be higher, then there would have been no need to panic by cutting payouts at such a critical moment.
The most damning evidence is that hoarding was concentrated among universities whose endowment sizes hovered within plus or minus 10 percent of their value at the time the sitting university president took office. Although it is usually endowment-management boards that formally make payout decisions, university presidents have substantial influence at most institutions. The finding that payouts are reduced when the president’s reputation for increasing an endowment is most at risk cannot be reconciled with any standard justification for the existence of endowments. Indeed, this evidence is consistent with the theory that the presidents considered the negative reputational effects of having the endowment shrink on their watch, and acted to avoid it. And their boards did not stop them.
To be clear, it is sometimes in universities’ best interest to help strengthen and maintain the reputation of their leaders. And because some external organizations include endowment size as a factor in their annual rankings of universities, boards and presidents may have honestly believed that preventing the endowment from falling below the value at the start of the president’s term was a reasonable objective in its own right. But when temporarily preserving a leader’s reputation or an institution’s annual ranking comes at a substantial cost to the university’s ability to deliver on its core missions, boards should be deeply concerned.
The data leave little doubt that those decisions had real costs. The larger the negative endowment shock relative to the university’s budget, the more the universities downsized their support staffs. In the year after the economic decline, those universities that intentionally cut their payouts by more than their own guidelines suggested were much less likely than their peers to increase their tenure-track faculty. And as with the cuts in payouts, those employment changes were most severe at universities where the president’s reputation for being able to raise the endowment was most at risk. Interestingly, the hiring patterns of administrators were completely unaffected by the fall in endowment value.
But this isn’t just about staffing. The evidence calls into question how university leaders view the role of their endowment. Most would agree that endowments play a vital role in ensuring the long-term viability of an institution. Donors give money to endowments, knowing that their gifts will benefit the institution in perpetuity. There is no doubt that the tremendous generosity of donors has enabled universities to better serve their mission of creating and disseminating knowledge.
But if the purpose of an endowment is to provide for the long-term health of the university, then the last thing any leader should do is manage the endowment in a manner that exacerbates rather than mitigates the effects of severe financial shocks. Payout policies that are designed to smooth over fluctuations in endowment values should not be deserted at critical times out of fear that such policies will hurt the reputation of those in charge. Board members should exercise vigorous oversight, particularly in times of crisis, to ensure that the long-term interests of the university are being well served. Those who contribute to and those who benefit from higher education deserve no less.