Monday, December 03, 2007

Endowment Policies

Here is a thoughtful article on the issue of endowments written in response to suggestions by some in Congress that universities and other large non-profits should be required to spend 5% of their endowment each year. As noted by the authors, this would be bad policy. (Note: I serve on the MIT Corporation, along with Mr. Mead.)

Don't Require Colleges to Spend More of Their Endowments
Chronicle of Higher Education
November 9, 2007

The demand for higher education and academic research ­and the costs of providing them has risen in recent years, and the search is on for easy answers to limit the financial burdens on families and the government. The most recent suggestion has been to require colleges and universities, especially large and prestigious ones, to spend more of their endowments. Congress, for example, is considering a proposal to require institutions with big endowments to spend at least 5 percent of that money each year, the same percentage that nonprofit foundations are required to spend.

So why don't universities spend as much as they can of their endowments to stop tuitions from rising, or to allow more low-income students to attend college, or to reduce the need for federal investment in scientific research?

The short answer is, they already do.

We serve as chairmen of the boards at two of our nation's most-important research universities. As taxpayers, business people, parents, and citizens, we strongly support the goals of making college affordable, aiding low-income students, and conducting research. And as board chairs, we know that endowments are used for precisely those purposes and more. Last year alone, America's colleges and universities spent more than $15-billion from their endowments to subsidize tuition, make college inexpensive or free to millions of students, raise the quality of education, conduct research, and otherwise improve the services that they provide to students and society. On average higher-education institutions spent 4.6 percent of their endowments last year.

Why don't we spend more? In part, it is because we can't. We have a legal and moral responsibility to honor our donors' wishes and ensure that our institutions' endowments are at least as strong 10, 20, and 50 years from now as they are today, so that they can serve the needs of students and society then as they do now. We take few of our responsibilities more seriously than the stewardship and strengthening of our institutions' endowments.

Indeed, for more than three centuries, endowments have helped colleges and universities assist students, conduct research, construct new facilities, hire faculty members, and carry out a host of other activities that would not have been possible had they relied solely on tuition and government support.

An endowment is typically made up of numerous different funds contributed by separate donors. Individuals, businesses, foundations, and others are exceedingly generous to colleges and universities; in the 2006 fiscal year alone, they provided $28-billion in contributions. People contribute for a variety of reasons: out of loyalty, because institutions are an important part of their community or state, or simply because they believe in the missions that the colleges are supporting.

Most of those donors are, in fact, fairly specific about their objectives. They might direct the money to research on a specific disease, to the establishment of a faculty position in a particular area of studies, or to financial aid for students. Institutions appreciate their generosity, and they are legally and ethically bound to honor a donor's intent.

Moreover, donors also usually specify that they want their generosity to produce benefits for many years to come. They want their contribution managed so that some of the earnings are spent, while the rest are reinvested to ensure that the endowment rises enough to let the annual payout keep pace with rising costs ­ in good economic times and in bad.

For example, a donor contributes $1-million to create a permanent fund for cancer-related research. She wants the fund to produce research support that keeps up with inflation, regardless of the markets' performance. To do that, the fund must grow larger, even as it is paying out a steady stream of research dollars. Recall Joseph's advice to the Egyptian pharaoh to store grain during the coming seven years of abundance to feed his people during the drought that would follow. Endowment managers reinvest revenues earned during years of abundance to ensure that spending can keep up with inflation during the lean years, when markets are not so friendly.

The issue is not only one of donor intent, however. Between us, we have served on dozens of corporate, university, foundation, and other boards. In each of those positions, we have shared with our colleagues management and fiduciary responsibilities for multimillion-dollar or even multibillion-dollar corporations and other institutions. An essential part of our stewardship of those institutions has been to ensure that they are at least as strong in the future as they are today. Robust endowments are crucial to sustaining colleges' high-quality education and research.

Endowments are, in fact, providing increasing support for current activities. Among the colleges with large endowments, about one-third of annual operating revenue comes from endowment spending ­ and at Harvard, for example, that figure has grown from 21 percent just 10 years ago, while at Yale it has almost doubled.

For many higher-education institutions, endowment spending is the single largest source of revenue ­ more than tuition, research grants, and clinical income from medical schools. Some institutions with large endowments have undertaken bold initiatives on student aid; Princeton University, the University of Pennsylvania, and the University of Virginia, for example, have made a college education virtually free for students from low-income families, as well as those from many middle-income ones. Endowment revenue is also indispensable for investments in academic programs that make American universities the envy of the world.

Endowments have grown significantly in recent years, despite what they spend, and that is a good thing. It helps ensure that colleges and universities have the resources to continue to improve and contribute to the well-being of our society. Much of the growth has been a result not only of increased donations but also of sound financial management. But to update Joseph, and paraphrase the warning investors have heard many times, recent growth of investments is no guarantee of future performance. Indeed, average endowments declined nearly 10 percent between 2000 and 2002. Institutions would be irresponsible if they assumed that investment returns will always grow rapidly. And endowment managers are under no illusion that they will.

Strengthening higher education and research in both the short term and the long term is important to our nation's well-being. Forcing endowments to spend more quickly might help in the short run, but it's a recipe for long-term weakening of a major national asset. Too often we see the government ignore long-term needs to address short-term goals. It shouldn't force us to do the same.

Dana G. Mead is chairman of the Corporation of the Massachusetts Institute of Technology, of which he has been a member since 1996. He was chairman and chief executive officer of Tenneco Inc. from 1994 to 1999. Jeremy M. Jacobs is chairman of the Council of the University at Buffalo, State University of New York, and chairman and chief executive officer of Delaware North Companies.


Anonymous said...

If you don't want to spend the 5%, don't take the tax break. It's a boondoggle. Every foundation can make exactly the same argument you make here. What makes you so different?

Barry Carol said...

I have no argument with the points made with respect to university endowments. I do have a problem, however, with what I see as an inability to control costs throughout much of higher education and especially at the most elite schools. A lot of the faculty bidding wars and expansion of the physical plant is aimed at enhancing the reputation and prestige of the university's graduate schools but contributes comparatively little to the education of undergraduates. At the same time, facilities like dorms and dining halls are probably self-sustaining from the revenue they generate while law schools and business schools are profit centers. Meanwhile, undergraduate tuition increases faster than general inflation year in and year out making the cost of a college education increasingly expensive for the upper middle class that often fails to qualify for financial aid. It's absolutely incredible to me to see the huge expansion throughout the Ivy League, for example, over the last 20-25 years, yet their capacity to educate undergraduates hasn't budged until very recently. Plump endowments notwithstanding, there is plenty wrong with this picture, in my opinion.

bev M.D. said...

I am with Barry 100% and as usual, he says it better than I can. As a parent of an only child high school senior, I have been disgusted and dismayed at the corporatization of our higher educational system. I told her the other night that higher education has gone the way of all big business in this country - maximize advertising, marketing and profits and dodge accountability for your product as much as possible.
As the author of a book about college admissions (formerly at Duke) noted, it's all about advertising so you get as many applicants as possible, collect their fees, and then reject most of them so your selectivity looks high. Or you give "merit" scholarships to the smart kids to, in the words of another insider, buy high SAT scores.
Sorry Paul, I don't buy this argument about endowments. Many of the Ivy league endowments are massive and growing - a downturn of a few years will hardly endanger them a bit.

Paul Levy said...

It seems to me that, if donors felt that the universities' endowment policies were inappropriate, they wouldn't give their money to those schools. Or, to put it another way, the fact that the donors concur with this approach is part of the reason they give. The point is, why should Congress intervene in this matter if both the giver and the receiver concur?

Anonymous said...

Sir, I think that you should have a look at this, if you are not already aware of it. It is the third in a (so far) three part series where progressive blogger goddess extraordinaire Jane Hamsher has set you in her slanderous sights. In particular though, please read the comments at the bottom of the thread.....there is someone there in your community who seems to seriously need some help.

Anonymous said...

oops, forgot to add the link. here it is:

Anonymous said...

Mr. Levy, I visitied the link that has been posted by anon 11:01pm. My sympathies to one of the posters who feels slighted by BIDMC and cannot find employment. However, I am very hard pressed to believe that his current state of affairs is because of you. To me, s/he sounded like a disgruntled former employee. I also do not think that any of the posters there want to have a respectful discussion. The language itself cannot even compel me to want to consider their view, howver valid their concerns. In my opinion, and apparently the opinion of the BIDMC Board, faculty, physicians, patinets and even several employees (as evidenced by some of the posts we read here) you are doing a good job there, otehrwise they would replace you. Nobody is perfect and you will also make your fair share of mistakes; but so far, you are doing well and by extension the hospital. You will always have people who complain and offer no solution.

David said...

Hi Mr. Levy,

First of all, thank you for the blog; it's great that you're so committed to it. Second, it's invaluable to hear your perspective on such things as endowments at major institutions. I think most people would agree that an endowment should be unencumbered enough to promote growth that (at a minimum) beats inflation, and I see what you're saying about non-interference if both donor and recipient are happy. My one concern stems from my ignorance on the subject of the laws governing endowment money, and I'd love to hear your take on it. Specifically, I worry that the endowment money of many organizations is subject to laws, especially tax laws, that are more lenient than they would normally be because the endowment is for a non-profit/charity/whatever. If this is the case, then the endowment and its contributors may have less of a claim on the government to stay uninvolved, as they are benefiting from special governmental treatment already. Again, this is just speculation, so feel free to knock this all down.

Furthermore, is it possible that you are reading too far into the intentions of endowment donors? Maybe 99% of money given to endowments is carefully considered and comes with tons of donor-imposed regulation, or maybe a good chunk of the money is given without consideration of how much of it will be spent out every year. Also, small donors don't generally set terms with an endowment; they can either pay into it on its current terms or just forget it. Anyway, just some thoughts.


Paul Levy said...


Nicely put. Yes, income on endowment is exempt from taxes because it supports a non-profit. And yes, therefore, you could argue that the government has the right to set whatever rules it might want to. But, I would still suggest that there is no reason for government involvement here in that no one is hurt by the current policy.

Of course you are right that small donors may not choose to investigate the specific endowment policies of a college or university. But all of those who donate -- large or small -- are a self-selected group. No one forces them to give money. They give it because they believe in the goals and mission of the institution and in the good intentions and good management of that school.

bev M.D. said...


Here is my repeat comment regarding your 12/3 9:13 comment, which got lost in the maw of the robot-beating letters. Only now David beat me to it and said it better than I. I disagree, however, with your latest comment that "no one is hurt by the current policy." Of course someone is hurt - all the people who could have benefited by the university (or hospital, as the case may be) spending more of their endowment on things that benefit their students, or patients, or customers; whatever term applies. Making endowments bigger and bigger(and I mean truly HUGE in some cases), when they are tax-exempt and within a nonprofit organization is not only greedy but marginally legal, given that nonprofits are supposedly so because they use all their money on their "customers". I believe this is one of the reasons that the IRS has vowed to scrutinize nonprofit organizations more closely.
OK, here goes with the robot letters; already I am not sure of some of them!

bev M.D. said...

This is a late comment, but I was gratified to read in the paper that Harvard has just decided to spend some of its endowment on helping middle-income students afford to attend Harvard (I presume we are talking mostly about undergraduates.) No one will ever know if this decision was taken because they felt the pressure from Congress, or just felt it was the right thing to do, but it's nice to see in any case.