Combat Pay or Economic Rent?

By Richard Vedder

The New York Times yesterday had an interesting story about how college presidents are facing increasing pressure from faculty and other members of the university community to perform, or be given the boot. The Larry Summers incident at Harvard has triggered more questioning of university presidents, overt votes of no confidence, and even faculty threats to strike unless changes are made at the top. Focusing on Pace University, the story notes rising resentment by faculty over the rapidly widening differential between their salaries and that of the senior administrators (the president at Pace makes over $700,000 a year, yet the school is reeling from falling enrollments and budgetary woes).

With the help of Whiz Kid Matt Denhart, I have been documenting the soaring salaries of college presidents. One interpretation is that as colleges have more research money come their way, and as they raise tuition fees mightily because they can get away with it owing to generous federal student financial aid policies and the rising high school-college earnings differential, universities use some of the incremental funds to reward themselves. This is the "rent-seeking" explanation -- pleas by university presidents for more funding from alums, legislators, and the federal government are partly a scheme to enrich themselves, or at least that has been the unintended consequence of this quest for funds.

The second explanation is the market explanation. The supply of good university president material is shrinking because of the rising possibility of job loss and public humiliation. This forces up salaries and the rise can be considered the equivalent of combat pay in the military. A related market explanation is that university presidents, like others, are paid roughly their marginal revenue product, that is the incremental funds they bring into an institution. A good university president can bring in millions of more annually than a mediocre one, so the age of the million dollar college president is the result. As universities think and behave more like for-profit institutions, trying to maximize something akin to profit, they start to pay according to the economic theory governing wage determination in profit maximizing firms in competitive markets. This is the age of the multi-million dollar corporate executives and entertainers, each exploiting their unique talents. Why should not the same thing happen in universities?

One thing to keep in mind, however, is the funding differences. Entertainers make their money from people willing to pay directly or indirectly for their service --if the demand falls off, so does their income. Corporate executives earn tens of millions if they add to profits and stock price, but usually (but not always) suffer if performance suffers. Private individuals buying goods and services fund their salaries. With universities, the funds are largely indirectly coming from taxpayers, and people are increasingly questioning whether government subsidies should be used to finance salaries many, many times those earned by the politicians who devise the funding policies, or, for that matter, the taxpayers who pay the bills.