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

By Stanford Graduate School of Business

FinanceEducationBusiness
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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.

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