Endowment Spending: Senate Finance Committee Evidence

By Richard Vedder

I read in Inside Higher Ed that schools are generally complying with the Senate Finance Committee's "request" for information on their endowments, although a few schools (including my alma mater Northwestern and former employer Washington University in St. Louis) are refusing to have the information released --that reduces the size of MY next contribution to Northwestern given its apparent aversion to transparency).

Data on 17 of the most well endowed schools is revealing. Looking at the 1998-2007 average payout rate, the median rate was about 4.41 percent, below the 5 percent mandatory payout rate widely discussed, but not dramatically so. No school spent less than 4 percent, while a few (Johns Hopkins, Cornell, University of Southern California and Rice) actually did spend over 5 percent.

The data generally support the idea that using an endowment payout rule to solve the cost explosion issue in higher education is an exercise in futility. A majority of even top endowment schools have less than $500,000 in endowment per student, with the number much lower for high enrollment public schools like Texas, Texas A & M, Michigan, or California, and even for some prestigious private schools ( e.g., Columbia or Northwestern). If 4.41 percent is a representative payout rate, increasing the rate to 5 percent would increase per student spending by less than $3,000 a year at a school with $500,000 endowment per student -- and much less for the less well endowed public institutions. Since the cost of higher education to the typical student at good private universities is probably at least $30,000 a year after discounts, and over $15,000 a year at good public schools, the 5 percent rule is not going to dramatically impact costs --even if every cent of incremental spending went for student financial aid --which it would not. To be sure, at Princeton, with about two million dollars per student in endowment and a 4 percent payout rate, the 5 percent rule would have a potentially huge impact if devoted exclusively to financial aid --cutting the average student payment surely more than 50 percent. But for every student going to Princeton, there are 10 going to schools like the Universities of Texas or Michigan. And remember, restrictions on endowment spending by donors further constrains the legal ability of colleges to use their endowment in the way that payout rule advocates want.

Moreover, the vast majority of American college students do NOT attend a high endowment university; for these students endowment payout rules are almost completely irrelevant. Spending a lot of time hassling over payout rules detracts from doing something more fundamental --slowing or stopping the extraordinary real growth in college costs, not only to students and their parents, but to society as a whole. Endowment payout rules do nothing about this.

Having said that, however, with the benefit of hindsight we can say that universities were too conservative in their payout rates in the last decade, because the rate of return on investments was so high that a large portion of endowment income actually went into increasing real endowment principal rather than funding current operations. A 6 or 7 percent payout rate would have been fiscally sound. Yet universities did not know that these super high returns would exist before the fact, and they remember periods (e.g., the 1970s) when real endowments actually fell for many schools. I would not be surprised if that were to happen for many schools in this fiscal year if equity prices remain stagnant (not to mention the losses is highly speculative investments that have been in favor recently at some high endowment schools).

The Finance Committee exercise should teach the universities a positive lesson. Revealing a little light on university operations leads to more, not less sympathy, for the position of higher education institutions. Transparency, rather than damaging universities, might actually help them in their political travails. I will probably be writing shortly about this more in the Chronicle of Higher Education, so stay tuned.