• September 1, 2015

Financial Affairs: Why the Endowment-Spending Debate Matters Now More Than Ever

Charles Grassley-Stairs

Harry Hamburg, AP Images

Sen. Charles E. Grassley, an Iowa Republican, says that while health care and jobs preoccupy Congress, his fervor for the endowment debate remains.

U.S. Sen. Charles E. Grassley hasn't forgotten about college endowments.

And he's not alone.

Despite plunging endowment values, colleges continue to face big questions over whether they spend enough of their endowments for society's benefit to justify the tax exemption they get. The events of the past two years are also raising a crop of provocative new endowment questions that deserve center stage in campus boardrooms and faculty senates.

On the "big question" front, one intriguing idea comes from the chancellor of the California State University system, Charles B. Reed, who has been pushing a proposal to reward institutions that enroll higher numbers of Pell Grant students with more federal money and withhold support from colleges whose Pell enrollments fall below 15 percent. Rich institutions should use their endowments to meet those thresholds, Mr. Reed argues, and the tax exemption on their endowments should be yanked or restricted if they fall short.

Mr. Reed says this kind of endowment rule, more than the 2007 proposal by Senator Grassley, Republican of Iowa, and others to require colleges to spend at least 5 percent of their endowments' value annually, could actually bring more needy students into the most richly endowed colleges.

They'll claim "the sky will fall," says Mr. Reed. "It won't." (Mr. Reed's 433,000-student system, with about 35 percent of undergraduates receiving Pell Grants, would fare quite well under such a plan.)

In a similar vein, a leading figure in global health, Peter Hotez of George Washington University, recently published an editorial faulting the 50-plus universities with endowments worth more than $1-billion—most of them major research universities with international profiles—for spending meagerly on research and education in the developing world. "The pharmaceutical companies are doing more for the poorest people than most of our wealthiest universities," Dr. Hotez told me.

Of course, squeezing more money from wealthy endowments wouldn't heal the world's health problems any more than it would make college truly affordable for millions of struggling students. (It will take a true economic recovery and renewed commitment from the states to begin to tackle that.)

But when thoughtful people continue to question how universities are using their endowments­—even after they fell an average of 23 percent last year—it's clear the endowment debate isn't going to fade quietly away, however much it can sometimes seem to be a political sideshow.

In Washington, the issue is clearly alive and well. Although health care and jobs now preoccupy Congress, Senator Grassley says his fervor for the issue remains. It's shared by the Internal Revenue Service, whose "interim report" on a broad inquiry into colleges and universities is expected to be made public any day now. (That inquiry is separate from the in-depth audits of 40 or so universities that the IRS is also conducting.)

A national poll released last month found that 60 percent of Americans think colleges are more concerned with their own financial well-being than with giving students a "quality education." That and a spate of attempts by cities like Pittsburgh and Providence to exact property taxes and other payments from colleges suggest colleges aren't exactly in the public's favor, even accounting for expected resentments in tough economic times.

Colleges may not be helping themselves. In January, the Education Trust reported that public flagship universities continue to direct most of their financial aid to wealthier students. And an analysis last summer by the Pell Institute for the Study of Opportuntity in Higher Education found that 52 of the 245 U.S News & World Report "best" national universities and liberal-arts colleges actually reduced their proportion of Pell Grant enrollments between 1992-94 and 2006-8—a period when overall enrollment of Pell Grant students nationally grew by 38 percent. More than a third of those 52 were among the most likely to be able to afford to serve such students since they had recently reported having an endowment worth at least $500-million.

Maybe Mr. Reed has a point.

Flawed Strategies

Several other questions about endowments also continue to stir debate.

Heading into the recession, were some funds invested inappropriately? Paul Jansen, a director emeritus with McKinsey & Company and an oft-quoted expert on the topic, says unequivocally yes. Approaches that relied on volatile and illiquid investments to cover fixed costs were "inherently flawed," he says.

Mr. Jansen has long argued that universities aren't creative enough in using their endowments for "strategic repositioning" so that they can compete based on distinctive strengths, rather than fancier student centers. As many institutions now struggle to redefine themselves for an era of financial limits, that's a lesson that might finally strike a chord.

Did a focus on building and preserving endowment wealth—what the Barnard College economics professor Perry G. Mehrling calls "the 'mine is bigger than yours' thing,"—distort the college mission? No surprise where Mr. Mehrling, for one, stands on that one. Colleges that cut programs and people to preserve the endowment are undermining the very reason for an endowment at all, he asserts: "The point of the endowment is to protect the core, not to endanger the core." Otherwise, "it's not a resource, it's a constraint."

Has the financial crisis shown that the thousands of institutions with small or no endowments are actually better off without them because they weren't suddenly forced to make the kinds of cuts that endowment-dependent institutions like Brown and Dartmouth have recently made? A number of colleges have made that argument over the past year, and the virtues of such a self-reliant approach are undeniable. But Geoffrey R. Woglom, a professor of economics at Amherst College, says it's hard to imagine situations where having more money is worse than having less. Having an endowment is only a problem, he says, "if the endowment becomes the be-all and end-all."

Like Mr. Jansen and Mr. Mehr­ling, he's an advocate for higher levels of endowment spending than the 4- to 5-percent range that most colleges now spend. (His own institution leads the way on this front, recently agreeing to spend more than 6 percent until 2018, and then stay at 5 percent after that.)

In 2009, 54 percent of colleges spent more from their endowments than in 2008, even as most endowment values fell. But that statistic, from the latest survey of 842 institutions by the National Association of College and University Business Officers and the Commonfund Institute, may give more credit than is due. Some institutions spent more because they stuck with their spending formula, which was based in part on the higher endowment values of previous years.

Only 152 institutions, about 18 percent, went further by taking a special appropriation from their endowment to pay for things like student aid and campus improvements. (Interestingly, quite a few also used it to spend more on fund raising.) And only 22 of the 152 were institutions with endowments valued at $500-million or greater—the ones Senator Grassley and others have focused on for questions about endowment hoarding.

Colleges rightly argue that endowments are not simply rainy-day funds. But this apparent reluctance to use them during an undeniably rainy period, either to stave off cuts or to make strategic investments, can only add weight to the questions that so many already have.

Financial Affairs is a column about the business of the academic enterprise. Send comments to goldie@chronicle.com. Follow her on Twitter: @GoldieStandard.


1. ceasterling - March 10, 2010 at 09:06 am

Grassley is a real nutcase on this and other issues. How he stays in office is a huge mystery. Endowments aren't actually intended to be spent, but invested; then the earnings on the investments are to be used for operations, salaries, etc. Even in early 2010, blue chips like McDonald's, WalMart, Microsoft, etc., are still paying 9 to 12% dividends. Annuitizing the endowment will produce at least 4% without loss. To spend it down is frittering away the future.

2. 11191774 - March 10, 2010 at 12:00 pm

Using CHE data, I published a visualization of the Ivy League Budgets and expenditures for FY 07 and FY 08 to show how the market conditions had affected their budgets. I think the display is compelling, although the more interesting stuff will come in FY 09 and beyond.


3. _perplexed_ - March 10, 2010 at 12:41 pm

The University does not exist to raise funds for the endowment?

4. davi2665 - March 10, 2010 at 01:11 pm

Endowments should be used for support of the research and educational missions of the institution, not for providing bragging rights to board members that "my endowment is bigger than your endowment." Endowments should also serve to help universities through rainy days- if we are not facing rainy days now, what are they waiting for; although future hyperinflation might put universities in a flood rather than a rainy day. If endowments are not intended to be spent, as #1 claims, then why should anyone contribute to them? Major research universities will never spend their vast wealth in endowments as long as they can feed at the public trough. An excellent step in the right direction would be to eliminate all faculty salary reimbursement from federal grants other than training or career awards, and let the universities make strategic investments in areas they deem to be consistent with their academic mission. Thank goodness for someone like Senator Grassley who has the audacity to actually expect universities to act in an ethical, transparent, and accountable manner.

5. jvwellman - March 10, 2010 at 01:20 pm

Good piece, on an important topic. Another question is why it is that during the 1990's and early part of the 2000's, when endowment-generated unrestricted revenues were growing at astronomical rates, the high-flying institutions still needed to increase tuitions every year, by an average of 4-6% per year. The answer would seem to be because they could. Grassley's solution - to require higher spend-out rates - might actually have made this situation worse. And spending begats spending, with no evidence that it went to improve access, quality, graduation rates, or R&D. When are our pals the economists going to start talking about market failure?

6. salrosario - March 10, 2010 at 01:21 pm

I find it scary when those who are bankrupting the U.S. government start advising universities on how to manage their endowments. There have to be more pressing problems in U.S. higher education right now, particularly in the public sector.

7. elm9779 - March 10, 2010 at 02:19 pm

I am surprised that this article does not explain that endowments at large institutions are not just pots of money that can be used for any purpose the institution deems necessary. A majority of donors who give to endowment do so for a very particular purpose, restricting the usage of the income generated by their gift. Legally, the institution cannot just take dollars that are given for, say, genetics research and use them for student aid. I think the public perception is skewed in that regard. It would be interesting to see a breakout of a $500M+ endowment -- how much is unrestricted? How much for scholarships? Research? Faculty salaries? Facilities? I'm all for responsible spending and getting more people through college without mountains of debt, but I don't think endowments are the answer.

8. hmallon - March 10, 2010 at 08:04 pm

The endowment was initially referred to as a "perpetual investment account" designed to institutionalize the financial sustainability of the institution. It inital growth occurred when boards realized that net tuitions, annual fund and ancillary income was insufficient to support the institution unending appetite for spending. As a result, the endowment and the related distribution strategy allowed the institutions another source of funds to offset the divide between revenue and expenditures.

Over the years however the endowment has been continually re-engineered by the board. Today's growth in the endowment is primarily the result of the expansion of the campus and other mission based requirements.

The capital campaigns, which continued year after years to expand the instution changed. That is, the campaign, which we in the past used to pay off the cost of the building projects are now deposited in the endowment. The expansion of the campus is now funded by tax-exempt bond financing. The capital campaign funds are invested in the endowment and design to cover the annual debt service and principal payment, which is often less than 5% distribution restriction imposed by the investment committee, and the excess earnings is accumulated. At maturity of the bond, the institution has sufficient funds to pay off the loan and has the initial principal of the capital campaign. Hence, the wonders of arbitrage and if the economy hadn't taken the downturn, such an approach might have continued to work. Unfortunately, as the typical endowment declined (upwards of 40%+) , this srategy has begun to unwind and will continue.

While Grassley wants to reconsider the spending policy of these endowments, I suggest he look more closely at the underlining assumptions and carrying cost that are hidden in the weeds.

It design though often leads to misconceptions as to what it can do and what is doing. First, for decades the board has

9. rpaincor - March 11, 2010 at 04:23 pm

The future is now!

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