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
By DANA G. MEAD and JEREMY M. JACOBS
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.