Ep58 How Rich Are The Ivy League Universities, Really? University Endowments Explained

Key Concepts

• University endowments
• Tuition discounts/financial aid
• Operating revenue vs. expenses
• Intertemporal budget constraint
• GAAP accounting principles
• Present value of commitments
• Sustainability of university operations
• Endowment payout
• Investment in students
• University mission

How Rich are Ivy League Universities, Really?

Endowment Size vs. Financial Reality

• The podcast addresses the question of how rich Ivy League universities truly are, despite having endowments in the tens of billions of dollars (e.g., Harvard ~$50B, Yale ~$40B, Stanford ~$40B, MIT & Penn ~$20B).
• The discussion is framed around a consistent framework proposed by Harvard authors John Campbell, Jeremy Stein, and Alex Wu.

Private vs. Public University Funding Models

• Ivy League universities are private institutions relying on private donations, unlike many top global universities that are public and funded by taxpayer dollars.
• A key question is how large an endowment a private university needs to compensate for the taxpayer revenue available to public universities.
• Private universities have different expenditures compared to public universities.

Tuition Revenue and Financial Aid

• Universities receive revenue from tuition, but there's a significant discussion about whether everyone should pay full tuition.
• Many students receive financial aid, reducing the actual revenue the university receives.
• Private universities effectively "price discriminate" by charging different tuition rates based on a student's willingness to pay (financial aid).
• The published tuition price is the maximum anyone pays, not what most students actually pay.

Example:

• At Harvard's Faculty of Arts and Sciences in fiscal year 2023, official tuition and fees were $449 million, but the tuition discount was $303.7 million.

Endowment Distribution and Operating Revenue

• A significant portion of a university's operating revenue comes from net endowment distribution.
• At Harvard's Faculty of Arts and Sciences, the net endowment distribution was $834.9 million, dwarfing the $145 million collected from tuition.

Expenses and Long-Term Commitments

• Total salaries and wages are a major expense (e.g., $557 million at Harvard's Faculty of Arts and Sciences).
• A substantial part of these wages are committed for many years due to tenured professors who have job security and salary guarantees.
• These commitments must be factored into long-term financial planning.

The Perpetuity Assumption

• Universities ideally operate in perpetuity, meaning they should function under the assumption that they will exist forever.
• This requires maintaining operations without significant cuts and ideally growing in terms of faculty and students.
• Combining long-term commitments with the mission of perpetuity creates financial challenges.

Harvard's Financial Situation: A Provocative Conclusion

• Campbell, Stein, and Wu's paper argues that Harvard University's Faculty of Arts and Sciences is in a dire financial situation.
• They claim that the present value of all commitments exceeds the value of its assets, resulting in a negative number.

GAAP Accounting vs. Economic Reality

• GAAP (Generally Accepted Accounting Principles) accounting can hide the true financial value of an organization.
• Accounting principles often focus on short-term budgets rather than long-term financial health.
• Example: Buying a $100,000 truck. Finance views it as a $100,000 cash outflow today, while accounting spreads the cost over the truck's lifespan (e.g., $10,000 per year for 10 years).
• The authors argue that accounting principles are outdated and don't accurately reflect economic realities.
• Campbell, Stein, and Wu project future expenses and compare them to the current value of the university's assets to assess its true financial standing.

Assumptions and Sustainability

• The authors' assumptions are consistent with the university continuing on its current track without major adjustments to financial aid, tuition, or faculty hiring.
• If the current endowment value and projected giving are insufficient to cover projected costs, even small disturbances to inflows can lead to budget cuts.
• Recent events (e.g., Trump measures, reduced NIH subsidies, decreased charitable giving) make universities nervous because they are already operating close to break-even in present value terms.
• Many universities are freezing hiring and staff due to these concerns.

Budget Balance and Endowment Spending

• Universities operate with budgets that are essentially in balance.
• Cutting revenue requires cutting expenses.
• Spending more from the endowment today reduces future resources and jeopardizes the university's long-term sustainability.
• Future gift-giving and university needs are tightly connected.
• Universities are likely to survive, but not in the same way they are currently spending money, as their spending is unsustainable even before recent economic changes.

Intertemporal Budget Constraint

• The paper emphasizes the importance of considering the intertemporal budget constraint, which takes into account the entire future of cash flows, rather than focusing on annual budgets.
• One-year budgets can be misleading, especially in the context of accounting principles.
• The endowment may not serve as a sufficient buffer to maintain operations at the same level during bad times.

Endogenous Budgets and Investment in Students

• University budgets are endogenous, meaning that increased endowment payouts lead to increased hiring and spending.
• Universities often view endowment payouts as a form of income.
• Endowment expenses on students should be viewed as an investment.
• Charging tuition less than the cost of education is an investment in future donations from successful alumni.

Admissions Decisions and Investment Returns

• The podcast raises the question of whether admissions officers explicitly consider the expected present value of a student's future giving.
• Admitting students can be viewed as a venture capital investment, where a small percentage of successful alumni finance the education of many others.
• There are differing views on the mission of a university: some prioritize doing good regardless of investment returns, while others believe in ensuring long-term sustainability by prioritizing students more likely to give back.
• Students who came from poor backgrounds but were enabled to become wealthy by the university are often the most generous donors.

Example:

• Phil Knight's statement about how the Stanford Graduate School of Business enabled him to become successful and a major donor.

Conclusion

• University administrators should think more intertemporally about their budget constraints.
• The financial situation of elite universities may be much tighter than people realize.
• The promises universities have made may be closer to or even exceed the value of their assets.
• This explains why universities are already cutting budgets in response to recent economic changes.
• Universities may need to re-evaluate their commitments, especially tuition discounts, to ensure long-term sustainability.