We can go down the rabbit hole and explore all the possible avenues of the debate on higher education; we can exhaust both sides of the debate on the future of learning, on teaching paradigms, on student debt...but I want to hone us in on one very specific facet of this industry: the endowment.
We will explore the place of power that an endowment has, and why a greater endowment indicates a greater place of prestige. Alumni play a very important role in not only donating to the university and contributing to its endowment, but also in generating a sense of community pride, supporting departments and initiatives, and generating stories of success that can be used as examples promoting the caliber of the university.
But now, middle tier universities are getting hit pretty hard in terms of alumni donations, causing their capital intensive initiatives and their endowment to suffer.
How has the relationship between an alumnus and their school changed intergenerationally? Why was relying on alumni donations such a common, acceptable, and reliable practice in the past, and why is it much less so in the millenial society?
What is an endowment?
The leading private universities in the United States commonly maintain a large pool of financial reserves known as an endowment. An endowment is a fund organized into the university, a portion of which can contribute regularly to the operating costs or capital requirements of the university. Endowments can also be restricted to specific efforts within the university such as professorships, chairs, or the development of specific land.
Each year, about 4-6% of a university's endowment is utilized towards its expenditure. The endowment is typically invested across a diverse set of interests and securities so that it can keep pace with the value of the economy. This money is derived largely from donations from the alumni of the university and other supporters of the institution, and these donations are neccessary and appropriate for financing higher education.
Endowments are extremely useful for an institution because they provide some sort of insurance against financial shocks to which a university is extremely sensitive. In times of a fiscal crisis a university is particularly susceptible to issues because:
- It cannot sell or negotiate equity,
- It has faculty that are tenured and so much of its staff cannot be downsized and is owed a particular amount of money
- It has students and users on a four year cycle and so their term must be completed
- When the economy suffers, research grants awarded to universities by the government reduce and become much more competitive
- Less students can afford to pay tuition and financial aid allowances through government aid and student loans become restricted, reduced, and regulated.
- In order to grow, a university takes on debt and borrows capital, and an increase in accumulation of this debt with worse prospects of repayment (that happens during a crisis) can slide the university's debt rating, leading to fewer grants and financial aid from the government and higher interest rates.
So an endowment was implemented as a fail-safe, as a way for the university to ease the burden of meeting its operating costs and expenses by dipping into a pre-existing pool of resources.
The larger the endowment, the greater your resources. And since greater resources mean more money to spend on the quality, community, and excellence of your institution, the strength and might of your university can be correlated (at least through public sentiment) to its yearly contribution to its endowment. And this friendly competition has existed ever since the university became largely dependent on community donations to operate.
Which is always.
In 1899, a mere eight years after it was founded, Stanford University had an endowment of $18 million, the largest of any institution at the time. This would be close to $500 million or half a billion dollars in today's currency. Stanford recently also came out on top by raising over $1 billion in one year in 2013 becoming the first university to ever hit the billion mark in funds raised in a single year. The other top schools didn't do too badly either: Harvard raised $650 million; Yale, $544 million; the University of Southern California, $492 million; and Columbia, $490 million.
So what's the problem?
There are a few issues with being endowment-dependent but we will focus on just a couple:
Endowments are great; but only if:
- They are large enough to contribute significantly to the operating budget of the university, and yield a positive return
- Alumni keep contributing to it
Unfortunately, that is not necessarily what is happening today.
Budgets are inflating consistently while endowment value is massively volatile
University budgets have been becoming substantially large and while endowments are also increasing at par with their growth, the university's dependence on drawing from its endowment in order to pay for its operating expenses has also increased.
Between 2007 and 2009, Harvard depended on its endowment for one third of all its operating expenses. When the financial crisis of 2008 hit, its endowment lost 27% of its value. When the economy suffers, so does the endowment and it loses value just as other costs skyrocket. Harvard was depending on the endowment to pay professors' salaries, to hire staff, to maintain its campus, and pay off its debts. In 2009, due to the reduced value of the endowment, Harvard took a loss of $11 million, and the university's net assets declined by $14 billion. Harvard had to compensate by freezing professor tenureships, cutting benefits and salaries, and asking sixteen hundred eligible employees to retire voluntarily.
In order to gain more liquid assets and meet operating expenses, Harvard had to take on an additional $1.5 billion in debt. Their ratio of resources to debt fell from a comfortable 9.2 to a cautionable 3.9.
This endowment dependency didn't just impact Harvard then, it is still causing major problems for the prestigious institution today. The endowment's decline caused the university to reduce their endowment payout by a whopping $96 million in 2010, and $129 million in 2011.
While all this is happening, their interest expense almost doubled from $146 million in 2008 to almost $300 million in 2011.
Harvard is acutely aware of how dire their state of endowment dependency is. Here are excerpts from their 2012 Annual Report:
The financial crisis has acted like a tidal wave that, as it receded, exposed certain vulnerabilities with a new clarity: endowment dependence and volatility, federal government dependence, non-endowment revenue stagnation, and a highly fixed cost structure.
The primary financial risks facing Harvard also are present at other large private research universities.
The need for change in higher education is clear given the emerging disconnect between ever-increasing aspirations and universities’ ability to generate the new resources to finance them
The year 2012 didn't do much better for Harvard, as it yielded flat return on investments. While one can expect the value of endowments to rise and fall as markets allow, if we are dependent on endowment revenue to pay off expenses, we are making ourselves extremely vulnerable and extremely desperate for other liquid resources when the market crashes or even dips, which occurs more than we want it to. These liquid resources often end up being loans (since donations also go down during a recession) leading to the murky world of large and debilitating debt, that can affect a university and drain its resources for years to come, including years of financial prosperity.
So. Endowment dependency = scary, and Harvard is actively looking for ways to be less endowment dependent.
The alumni with the most incentive to donate to the endowment are also the alumni with the least incentive to donate
Alumni contribute to endowments for many reasons, but one big reason is that alumni have a big incentive to ensure the longevity of their university. Attending a school with a large endowment lends some confidence that the institution will be long-lived.
When we graduate college or university, we typically do it because we want to utilize our degree in some way. We want to either get a job or use the skills we learned in some other capacity, or we want it as proof of our knowledge and competency so that we can qualify for more advanced learning. So upon graduation we really care about that piece of paper that grants us as qualified because that is what will get us our careers, our opportunities, and will (if we want it to) describe/affect the next few years of our lives.
However, once you've landed your job, once you're already in graduate school or doing a post-doctoral thesis, once you're already a lawyer who's passed the Bar exam, your interest in that piece of paper largely declines.
The older you get, the more money/disposable income/savings you have to donate to your alma mater, but the less you need your alma mater to sustain itself fiscally because you have the capacity to be successful without it. You have accumulated work experience, you have seen the world, you have other things and accomplishments that lend prestige and social/identity capital to your ideas/initiatives. People will still care about whether you went to college, and whether you are educated, but they won't care as much about the where/what/why.
So now, if we are a middle-tier university, research-oriented, private, small, somewhat known in some specific circles but largely invisible next to the Harvards and MITs of the world, we have found ourselves in an interesting dilemma.
Those with the most capacity to make large donations to us, our older alumni, don't have as much of a stake in making sure we are expanding/prestigious/long-lived. Those that do have a stake in our health, young alumni, have significantly smaller incomes and can make small donations. Therefore in order to have a sizeable endowment, we need more donations from a lot more young alumni in order to meet our needs.
And here is when we start knocking on doors, making phone calls, and wining and dining the alumni with the most to lose if the university ends up being unsustainable. And we assume that since the "asking people to donate money" model has worked for centuries past, it still will today. Alumni will donate because that is what alumni do. Everyone knows that, and all universities rely on the truth behind that single fact.
However, there's a major difference between our older and younger alumni, and it has to do with what their transaction with the university looked like.
Let's say our older alumnus graduated from a good, reputable middle-tier university in the 60s. It was a golden age for higher education. Research money was pouring in, the United States was recovering swiftly from the war, colleges became selective enough to exist in a state of prestige, and coming from the industrial era of the early 1900s, college is now responsible for creating a whole new tier of specialized jobs and employment opportunities.
And it cost $1,800 a year to get this education.
When the generation before ours were in college, college was a privilege to attend, and the cost of that privilege was a steal. A college education gave you avenues to research, brought the bright, young stars of the community together, gave you access to people you'd never have access to otherwise, and a degree firmly placed you in a different tier of opportunities where you graduated into a whole new set of possibilities. You had access to white collar employment, you had access to class mobility, and you had an education.
All of these things are still largely true of the university. The degree to which it provides these things may have changed, but it does provide you these things in some capacity. Is it worth it? Research says "Yes", college is still worth it. You have access to better opportunities, higher income, and the vocabulary and insight you need to see the world and utilize your connections in a way that maximize your potential.
But what has changed significantly and importantly is how much it cost for you to get access to it.
For previous generations college was a bargain comparitive to its benefits. For a mere $2,000 you got access to all this and much more, and so you walked away with gains that were much greater in magnitude compared to what you invested. Older alumni walked away from college indebted to the university for adding such value to them. They got a much higher return on their small investment. You felt like you walked away from university with an obligation and more importantly, a desire to give back to your institution, because you got so much value from the little you put in.
This isn't the case anymore for the small, middle-tier research university. Students are still very much getting the gains they were promised. Except now they aren't getting it for a bargain, they are over-paying, or at best, paying market value. The going rate for an education is $100,000 and that's what a student is resigned to pay.
The cost of getting an education is less of a surprise, and more of a purchase. Millenials have bought their education at a rate that was their only option. They accepted this, and whatever gains they receive from it, are gains that they expect, and feel entitled to receive.
Many students even continue paying for these gains throughout the formative years of their careers. Since the "going rate" is incredibly high, most millenials have to borrow money to get access to the perks of a college education, and spend much of their disposable income attempting to pay off this debt.
So when "Alumni Relations" comes calling for donations...
The current student generation, unlike all their predecessors, do not feel obliged to give even more money to their institution, because they've already fulfiled all economic obligations towards it.
It's like buying a Macbook for $3000 because you need it/want it, and Apple calling you every year after you bought it to donate more money to the company because you enjoyed using it. If you got free or extremely cheap software because it was open source and you loved using it, you'd be more inclined to donate to the developers because you got much more value out of the product than you transacted for. However, the higher education game does not play by these rules anymore.
One of the arguments of the institution is that you should still donate because it costs a lot more than your tuition to keep the university running. But this only weakens their case for a millenial student who has payed much, much more than they could afford to give for their tuition.
Why this very important for the future
If universities continue to impersonate the Harvard model, and fuel their addiction to growth, expansion, and prestige by increasing endowments and operating budgets leading to endowment dependency, they will have to rely on the donor model in order to populate this endowment.
The donor model worked well in the past because the cost of an education kept pace with society's ability to afford it, and in fact older alumni largely underpaid for a very extensive and valuable list of gains. However, due to the rising costs of tuition, where even low-tier, online colleges and universities are unaffordable for students without taking on a huge burden of debt, there is no motivation, nor incentive to add even more money into an endowment pool.
The university will have to vastly re-think its funding practices and explore avenues to be more sustainable without the donor-dependency, unless they severely reduce their costs to re-create the lost incentive structure, and re-capture the dream.
- Hansmann, Henry. "Why do universities have endowments." J. Legal Stud. 19 (1990): 3.
- "Bureau of Labor Statistics, U.S. Dept. of Labor". Consumer Price Index.
- "National Center for Education Statistics, U.S. Dept. of Education". Average institutional charges for tuition and required fees.
- The Shaping of American Higher Education Emergence and Growth of the Contemporary System, Mobipocket Edition. N.p.: Jossey-Bass Inc Pub, 2009. Print.
- Harvard Annual Report 2012