A potential crisis for the private, nonprofit university is looming. Congress has just regulated for-profit colleges as never before; most observers believe that even more regulation—this time of private nonprofit higher education—is coming. Will it be our own 1933? That was the year Congress passed landmark securities legislation to correct a corporate culture that had inflamed the crash of 1929 and then the Great Depression. Are we—should we be—on the verge of a legal revolution in accountability?
The answer: Most likely, and soon.
Public higher education's regulatory structure is usually more accountable than private higher education's. But failures in the private-college system will cause more students to flood public institutions, which do not have the capacity to handle the influx. Mismanagement in the private sector will thus lead to challenges to the entire delivery system of higher education. The longer we wait, the more painful change is likely to be. If Congress doesn't act quickly, our nation's goal of increasing the number of people with college degrees will be in jeopardy.
Most nonprofit colleges have existed in a tiny crack in corporate law that insulates them from significant corporate legal accountability. The dangers of that fault line were barely visible during higher education's nearly uninterrupted post-WWII boom. Now that we are experiencing a college "market correction" of unprecedented proportions—with the money to support our half-century of expansion drying up—the gap in corporate law has seismic potential. Nonprofit higher education faces the very real threat of closures, serious downsizing, even the risk of confidence-shaking scandals.
Private, charitable nonprofit corporations can exist in a number of forms. What principally distinguishes them from their for-profit counterparts is the absence of owners or shareholders. In the nonprofit world, the corporation takes the "profits." It may, but need not, have dues-paying or other members, who often have voting rights, hence governance rights. Members may also have so-called derivative rights to hold boards of directors accountable. Those rights can include the right to raise fiduciary and other governance issues in court—a tremendous power for fostering accountability when coupled with voting rights. If there are no members, governance is vested in the hands of a self-perpetuating board of directors or trustees. The lack of members, or shareholders, is the corporate legal fissure.
Private nonprofit colleges are some of the last "corporations" that survive that way. Essentially, corporate law permits most private, nonprofit institutions of higher education to operate without any significant external legal accountability. We are not like our cousins in the rest of the nonprofit sector—think Dupont Circle—that have elected boards accountable to an organization's membership.
Lack of membership has its privileges and its consequences, particularly as colleges operate more and more like corporations. Witness the big increase in the cost of college, the supply-and-demand problems (institutions pumping out graduates with little regard for the hiring market; failing to create sufficient numbers of graduates for key social needs), the creation of an indentured economic underclass of the newly educated who are paying debt service, and the lack of industrywide assessments of student competencies.
The law does vest oversight power over nonprofits in state attorneys general, who are responsible for ensuring that a nonprofit acts in accordance with its mission and that its directors are fulfilling their fiduciary duties. But the general public—or the student body—has no standing to challenge perceived wrongs. As a number of authors have pointed out, regulation of nonprofits by attorneys general has been largely ineffective. Lack of resources and mandates from state legislatures, political pressure, unfamiliarity with these corporate creatures, years of the veneer of successful higher-education management (like growing endowments), historical laissez-faire attitudes toward regulating higher education—all combine to undermine oversight effectiveness. Most important, higher education in the late 20th century evolved from modest roots into a big, interstate—indeed, global—enterprise. Expecting state regulation is simply too much to ask.
There are other potential sources of legal accountability. Some colleges have engaged in voluntary compliance with the Sarbanes-Oxley Act of 2002, which sets standards to protect shareholders and the public from business fraud, although the law does not, in most cases, apply to nonprofits. The IRS has increasingly sought more disclosures from nonprofits, particularly regarding conflicts of interest, but it lacks the direct power to regulate nonprofits' fiduciary duties. One might hope that faculty members would provide some oversight. However, they, like students, lack the legal standing to bring the derivative actions to seek accountability that are a ubiquitous check on corporate governance in the for-profit sector. A court in Alabama in the 1970s (recall the recession in the 70s—it was the other moment when higher education's business boom was interrupted) held that students could bring derivative actions against colleges. The Alabama Legislature later changed that.
The old corporate order of higher education under law worked well in a world of modest endowments and tiny intercollegiate athletic systems, when college was a local experience. Today the illusory promise of self-policing governing boards must be tempered with reality.
Some boards or board members come to give; but as The Chronicle recently reported, some may come to take as well. Although board members cannot receive financial gain from a nonprofit, their companies may do business with a college (although doing so may jeopardize the institution's tax status). Even more troubling, a board or board member may arrange sweetheart deals with other businesses. A college needs services just like a city—garbage, security, etc. Promote a lucrative contract with a service provider and perhaps your company will get a valuable concession in a collateral contract with that provider. There are a variety of ways a board member could benefit substantially from board membership without direct profit-taking.
I do not mean to suggest that every collateral benefit to a board member is a breach of fiduciary duty, or that breaches of fiduciary duty are rampant. Most boards and board members provide exemplary service to their colleges. But not all board members are saints, as we have seen in recent, highly visible nonprofit scandals.
Moreover, there are at least three other concerns under our current legal structure. First, board members are usually a mix of politicians, business people, wealthy people, successful alumni, and the like. What is noticeably lacking among most board members is extensive frontline experience as college administrators or professors. That can lead to a disconnect between a board's priorities and a college's educational mission, a disconnect that can be seen in the facts that faculty pay and security have moved forward very little in the past decade and that student-teacher ratios have often climbed, even though almost every campus has grown immensely in physical plant (and athletic facilities). Endowments rose astronomically until the recent recession, but students are paying more than ever before, and student debt is rising.
Second, higher-education boards often manage in questionable ways from a business point of view. Board members often blur the line between setting policy and executing it. It is not uncommon, for example, for administrators to be in direct contact with board members about operational decision-making. Management by committee is usually bad for business.
Third, there will be substantial temptation in this major economic correction for boards to use their power to wallpaper over previous mistakes. If boards find their financial decisions coming back to haunt them, they may turn—as is typical in the for-profit corporate world in such a cycle—to an unprecedented round of higher-education mergers and acquisitions, and even some liquidations. We are already seeing deferred maintenance, hiring and pay freezes for faculty and staff members, fringe-benefit changes, and increases in rates of admission. There is no particular legal incentive to design innovative strategies to reclaim the industry.
We can either remedy this crack in corporate-governance law or wait for an earthquake. Accountability may be the best way to preserve our colleges and help them grow. Accountability is not the end of self-governance. It is the necessary response to corporate behavior that can cause lack of innovation from within.
In any event, new federal rules on accountability are almost inevitable. At present those look as if they will focus on issues like graduation rates, cost versus value, and student competencies and outcomes rather than on legal accountability. But federal regulation of any kind would be less necessary if corporate-governance rules for private nonprofit higher education—which might well achieve many of the government's goals—were revised.
Boards would be wise to adopt strict accountability principles for themselves. Some, like DePaul University, already have. However, voluntary compliance will very likely not be enough. Congress and the U.S. Department of Education should understand that reforming federal student lending will not, on its own, ensure the future of the core mission of American higher education. The precise fixes needed in corporate law may not be clear. There are several potential choices—like permitting derivative actions or requiring a membership class that has voting rights. None are perfect. Derivative actions, for example, could flood the courts and colleges with expensive and time-consuming lawsuits; it's not clear who would be members: students, faculty members, the public?
But it is time to start the debate, before we have our very own Bernard Madoff or Enron. Higher education has become an enormous corporate business, and the law should evolve to reflect that fact.
Comments
1. eudaimon - December 06, 2010 at 08:20 pm
American law has not turned its gaze toward private colleges. As it does so, a hornet's nest of trouble will be found. In the area of employment law, the murky distinction between faculty who are managers and faculty who are not, and the relations between them, will surely be a fecund source of litigation. Conflict of interest among faculty and administrative staff is another issue lying in wait, as is confidentiality, and proper record and information management. Finally, it will be interesting to see if courts stop treating private universities in the same way as for profit corporations, namely, as individuals with property interests. Private universities are public trusts and should be examined under a different lens from that of private businesses. Hopefully the courts will recognize this soon.
2. pedrolorenzomartinez - December 07, 2010 at 09:23 am
Professor Lake,
I enjoyed this column immensely because I have witnessed how chancellors and presidents cut sweet deals with board members. Some come in the form of "perks" such as football tickets, lavish dinners and free advertisement for the companies or corporations they represent. Some are stealth; others are just blatantly flaunted because they lack supervision from a system office. One that disturbs me greatly is when a board member is given preference for employment within the university immediately after resigning or completing his/her tenure. Whether this was planned or not, it prostitutes the objectivity they must have while overseeing the university business or while making an objective assessment of its chancellor's/president's performance. When universities create a position(s) within its structure and board members and/or ex-board members are considered prime candidates and reap the benefits from hiring agents, those whom they have previously served and evaluated, it jeopardizes the integrity of the system, it erodes the trust of the public because these situations may impair a board member's impartiality and judgment based on future employment. University systems should create rules for board members that preclude them from being hired for a period of time similar to those for lobbyists. If they consider this unfair, let them seek employment as a common citizen just like the rest of the other applicants and not serve as board members with some degree of future expectation or entitlement.
3. 11211658 - December 08, 2010 at 05:04 pm
I am hard pressed to decide what this piece is. Is it a stalking-horse, smearing nonprofit colleges as part of the "they're just like us" campaign of the for-profit sector? Is it broadside to promote future publications? Or is it an honest suggestion to have a large-scale debate about uniform replicable standards of accountability? If the latter, I can only say that this piece has done nothing to advance a serious discussion on the topic.
Mr. Lake would like to craft a sector-wide solution for an idiosyncratic problem. Speaking from a state with extensive private college regulation, I differ with his claims of a problem, his undefined solutions, and his tabloid rhetoric.
Where are these private-college failures that are going to "flood the public system"? In Ohio, three independent institutions have gone under since 2006. The first two institutions had fewer than 1,000 students between them, and the students at the other are now under a new college banner. The other 140,000 students at 50+ colleges whose histories stretch back to the Monroe Administration. Our sector grown steadily for decades while the public four-years are static.
Where are these major scandals? His only evidence is gratuitous smears. The purported "lack of transparency" also exists in most of the for-profit world, a.k.a., private corporations. Directors and staff interacting? Inability of stakeholders to take derivative actions in court? Local business people on boards? That's the entire American economy.
I could rebut the piece point-by-point (comparisons to "Madoff or Enron"? Really, Mr. Lake? Really?) but most preposterously, the author avoids the existing vast accountability systems.
First, if students stop coming nonprofit colleges close, like Ohio's recent three. If fewer students than planned arrive, adjustments are made. That fundamental accountability occurs every day at independent colleges, and presidents are held accountable for their success.
Second, regulations are omnipresent. Aside from the laws that apply to every other private corporation, nonprofit colleges must report vast amounts of minutiae to state and federal regulators. They also engage in a voluntary form of self-improvement through regional accreditation that has few equals in any sector.
Most importantly, nonprofit college boards take accountability seriously. The "perks" of board membership include hard work, unreimbursed time, and the satisfaction from giving back. Private colleges are well equipped to hold themselves accountable; they are doing it every day.
C. Todd Jones
President
AICUO
4. lothlorien - December 08, 2010 at 07:09 pm
I fully agree with C. Todd Jones above. This is a very corporate-sounding piece; one that makes dubious, straw-man arguments without evidence. Perhaps Professor Lake could do us the courtesy of providing some actual facts to support his wild claims. Consider just the following:
"As a number of authors have pointed out, regulation of nonprofits by attorneys general has been largely ineffective."
This sounds like the old Fox News tactic, "some have said...," in reality, meaning the two books you read that agreed with you. Your lack of a bibliography is tellling.
"Second, higher-education boards often manage in questionable ways from a business point of view."
Coming from a corporate background, Professor Lake can be forgiven the difficulty in telling widgets from students and knowledge. The increasing corporatization of higher education has produced more problems than it has solved. But I will bite anyway, what management decisions of what boards do you refer to? How often is often? As far as I can tell, most do a good job, but I am sure you have concrete data to share with us to support this claim.
"Nonprofit higher education faces the very real threat of closures, serious downsizing, even the risk of confidence-shaking scandals."
Scandals? Really? You, of course, have concrete evidence of specific scandals in the making, right? You would not engage in hyperbole just to make a point, right?
And finally, this gem: "...(institutions pumping out graduates with little regard for the hiring market; failing to create sufficient numbers of graduates for key social needs), the creation of an indentured economic underclass of the newly educated who are paying debt service, and the lack of industrywide assessments of student competencies."
Agsin, according to Professor Lake, our entire educational system should be dedicated to fulfilling the needs or multinational corporations. Hiring market? Please, even when there was a market, it was manipulated by corporate types and hedgefund managers, promoting not thought but obedience. Unfortunately, universities teach thinking, not mindless drones in blue suits. And since when are we to dictate to students what their degree should be? There is apparently no need for majors in philosophy, history, arts, humanities, and the like. No, lets just all become trade schools that serve at the altar of the almighty marketplace, and not inspire students to great thoughts.
With all due respect, Professor Lake, you might genuinely be better suited to either a for-profit school or ITT Tech, both perfectly fine types of schools, but not universities.
5. heyogrady - December 09, 2010 at 08:21 am
Higher education is a bubble. Universities are happy to tell you that the reason they have increased prices is because demand is up, our service-based economy requires more education, blah blah blah.
In reality, the more the government offers tuition loans and subsidies, the more these institution soak that money up. Prices are increasing at twice the rate of inflation. Building, buying and salaries have never been higher. And that cost is being passed on to the clueless 18 year old who doesn't realize what $80,000 of debt at 22 really means for the rest of their lives.
Like all bubbles, this one will burst. The unsustainable supply of easy money will dry up, enrollments will dip, there will be short term pain, and these private universities will figure out how to educate more cost effectively, without building residence halls that look like a Marriott and cafeterias that look like a PF Changs.
6. quidditas - December 09, 2010 at 08:22 am
"With all due respect, Professor Lake, you might genuinely be better suited to either a for-profit school or ITT Tech, both perfectly fine types of schools, but not universities."
He can't manage ITT Tech. We already outsourced those jobs and now he's coming for you.
7. quidditas - December 09, 2010 at 08:27 am
"Higher education is a bubble. Universities are happy to tell you that the reason they have increased prices is because demand is up"
Oh is increased tuition what you mean when they say higher ed is in a bubble? I've heard the term used to mean the market for educated people is saturated and there's declining need for the higher ed product.
8. categorical - December 09, 2010 at 09:16 am
This new scrutiny of for-profits reminds me of an analysis that the Economist did in the 1980s of some Soviet industries. After pricing inputs and examining outputs, they found that many industries were value-subtracing rather than value-adding. I think that we're going to find something similar here. My guess is that much of the for-profit industry will prove value-subtracting.
9. 11223435 - December 09, 2010 at 09:31 am
Just like the "Voluntary" System of Accountability slammed in place by AASCU and NASULGC (yes, I still prefer the older name, a pronounceable acronym),
"They heard the train a-coming, a-coming 'round the bend, so they jumped on the rails, grabbed their ankles, and hoped it don't hit them."
I feel the need to continue this Cash retrospective, but I'll spare you.
10. fewgardens - December 09, 2010 at 04:06 pm
I think the article is extremely spot on for those who have worked within private colleges and universities. I know of many examples of board abuse at private colleges where board of trustees members are not "servants" to the institution but are being "serviced." One such example involves a small university in North Carolina where the president of the university hired the son of the board of trustees chair of the Presidential evaluation committee. No way this happens in a state institution but this happens all the time at private non profits. I suspect that your article will draw the ire and attention of the defenders of non profit private institutions because they have wielded power and authority without any state and federal oversight for a very long time.