Wednesday, December 08, 2010

Rent Seeking Presidents

by Jonathan Robe

Awhile back, Andrea Fuller reported in a Chronicle piece that for calendar year 2008, there were 30 chief executives at private colleges and universities who received total compensation packages in excess of $1 million, up from 23 for fiscal year 2008 (the IRS recently changed the reporting requirements from the fiscal to the calendar year). While I'm not, as a matter of principle, necessarily opposed to high college executive pay, I do think that it's reasonable to say that high pay should not be awarded unless it is first found to be justifiable. That any actual economic justification is mostly absent from this story provides us, I think, with an excellent reminder of the odd economic structure pervasive within American higher education today.

What are the most important factors for setting college executive pay? Within the broader labor market, it's generally understood that wages reflect productivity, that is, a worker is paid commensurate with the output she provides. In most industries, output is readily observable and measurable, though in the service industries this is a rather difficult task. Within higher education this difficulty is even more pronounced because there isn't any agreed upon measure of performance within the industry (this is one reason, by the way, why college rankings have played a critical role in some university planning decisions). It’s difficult, therefore, to know with reasonable certainty whether a particular university president in a particular year performed well or not. We can't say that the president of such and such a school did a great job running the school because X number of students this year were able to learn Y% more than they did last year. We simply don’t have that kind of information. Sure, the president might appear to be successful in bringing $3 million of donations or in raising the school’s rank by 10% but that doesn't necessarily translate into success regarding the institution's educational mission. In fact, the very opposite could be the case.

Unfortunately, some within higher education try to side-step the difficulty of providing a robust economic justification for these examples of high executive pay. For example, Raymond D. Cotton, a lawyer specializing in executive pay and who was quoted in the Chronicle story, said that large increases in executive pay, especially in cases involving large retirement payouts, can be troublesome because of the role favoritism plays between boards of trustees and presidents. Yet he defends the general high compensation of college executives because it is, as he puts it, the price set by rapidly rising demand and limited supply.

There are, however, several problems with Cotton’s analysis. While I agree that favoritism occurs in some circumstances and is a problem when it does happen, it’s merely the symptom of a much larger problem. In other words, it’s the distorted economics of higher ed which allows favoritism to occur. Thus, even though it might appear that supply and demand set college presidents’ salaries, it’s really distorted supply and distorted demand which are at work to set those high salaries. Colleges don’t necessarily hire executives who will do a good job in improving the educational output of the students; they tend to hire those individuals who would further the institution’s reputation, whether or not that means the students wind up receiving a better education as a result.

But even given these market distortions, there are some instances in which high executive pay is just bizarre. Take the example given in the Chronicle story of the late Bernard Lander, the founder and president of Touro College (it’s not my intention to pick on the late Mr. Lander; I’m just using this as an example for how the distorted market works in practice). The College trustees decided in 2008 that they had underpaid Mr. Lander over the years, so they awarded him a compensation package in excess of $4 million. And how did they know he had been underpaid? The trustees decided “that Mr. Lander had been undercompensated compared with presidents at similar institutions.”

Is that the real standard by which college executive pay is to be judged? No wonder why college cost continue to rise faster than family incomes, inflation, etc. And no wonder administrative costs at colleges are skyrocketing. Calling this the “academic arms race” seems to be very much appropriate. Colleges spend money, look around at their neighbors and see them spending more, so they turn around and increase spending just to keep up with Joneses. And the vicious cycle repeats. Of course, it doesn’t matter that the Joneses might have spent some or all of their money irresponsibly; all that matters in the “arms race” is that they were spending more, so everybody needs to spend more to avoid being left behind. I know the higher ed market is peculiar but this is normally called “economic rent-seeking.” When is it all going to end, or is it just going to spin out of control?

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