Why Not Use the Endowment to Pay for Everything?

 Why do some colleges attract more donations than others and why don’t they use the endowment to reduce tuition for everyone?  We will answer these questions on today’s episode.  I am Larry Bernstein and welcome to Charging U.

“I noted that just in proportion as the usefulness of the school grew, his donations increased.”  That was from the LibriVox recording of Up From Slavery by Booker T. Washington read by Mark Nelson.

In 1964, Michael Bloomberg graduated from Johns Hopkins University with a BS degree in electrical engineering.  The following year, he reportedly made his first donation to the university.  It was for $5.  He went on to earn an MBA from Harvard Business School.  He later founded a financial information empire and accumulated an estimated $59 billion in wealth.  His charitable foundation, Bloomberg Philanthropies, has donated billions of dollars to organizations which seek to advance the goals of education, public health, the arts, the environment, and government innovation.  Higher education institutions have been the recipients of a large amount of the funds.  These entities include Harvard University (where he got his MBA), Princeton University (which his daughter attended), New York University (which his mother and other daughter attended), Cornell University (which has a new campus in New York City where Bloomberg lives and was mayor), and Johns Hopkins University, to which he has been the most generous. 

At Johns Hopkins, the foundation funds fellows, research, and conferences to address addiction, obesity, and gun violence.  A grant of $350 million in 2013 has supported the teaching and research of 50 faculty members.  Bloomberg Philanthropies has donated millions to research the use of immunotherapy to fight cancer as well as to build a Children’s Medical Center.  But by far, the biggest donation to Johns Hopkins was for $1.8 billion for undergraduate financial aid.

As we have seen, historically, colleges and universities have looked to improve or add to their existing programs, expand infrastructure, and generally improve their standing. Tuition revenues have not been sufficient to pay for these projects, so additional sources of funding have been sought.  The goal of this fundraising has been to develop a dependable source of money that the university controlled and had at its disposal to advance its goals.

In the second half of the nineteenth century a few fortunate colleges depended on wealthy benefactors to subsidize their expenses.  Institutions such as Johns Hopkins, Stanford, Vassar, and Cornell bear the name of those benefactors.  In the early twentieth century, colleges and universities began annual solicitations from their alumni and from the greater community.  

Fundraising by higher education institutions has evolved over the last 150 years and is now a big business. $53 billion of the total $485 billion donated to charitable institutions in 2021 were directed to American colleges and universities. In the United States, only religious institutions received more money than higher education.  

The money raised by college development offices resides in the endowment.  Endowment is defined by The American Council on Education as "an aggregation of assets invested by a college or university to support its educational or research mission in perpetuity.”  These last two words, in perpetuity, are very important.  Most donations are restricted in that they are earmarked for a purpose which the donor has specified. A donation may go toward a new dormitory, cancer research in a specific area, or athletics.  Overall, 38% of donations are earmarked for financial aid. While the individual contributions are part of the endowment collection of funds, each may reside in a specific account within the endowment. At the University of Michigan, there are more than 12,000 such accounts.  So an endowment is not a pool of money with which the college does as it pleases. Only 7% of the funds are given without restrictions as to the purpose for which they can be spent. 

Having said that, the college development officer can try to influence donors to contribute to a cause the university is trying to advance which is also of interest to the donor.  She can say to a potential donor that the university needs a new chemistry building to do research on climate change and your name could be on it.

Alumni with pre-existing ties to the college are the second largest group of donors, accounting for 23% of contributions. On average, over a two year period, only 8% of graduates donate to their Alma Mater. But like most things we have discussed with respect to American colleges and universities, there is a very wide variation. The rate at which alumni from private institutions  donate to their college is three to four times the rate of alumni giving to public institutions. 

It is in the interest of the college to provide a positive student experience and develop loyalty so that more students will donate after graduation. Therefore, it may be wise to invest in amenities and activities if it leads to more donations from alumni. Emphasizing the exclusivity of the college which admitted the graduate also helps.  Princeton University and Williams College are among the most successful at fundraising. The share of their alumni who donate is at or above 50%. I'm not sure if that's considered giving back or paying it forward, but it is impressive and provides significant amounts of money for the college or university. This model of high expenses, high tuition, high financial aid to a small number of students, and high amounts of alumni giving is a business model that has been successful for a number of private colleges.  

It is not surprising that those institutions have been at the top of U. S. News and World Report rankings in their respective categories since alumni giving, in and of itself, was a component of the rankings.  The money can be used to boost other measures of the ranking system such as research, faculty pay, and student-faculty ratio.  It can also be used to increase retention, that is, the number of students who remain at the college or university.  Since a very large number of students who leave college do so for personal or financial reasons and not because of academic struggles, the money can help support those students experiencing hard times. The way the system was set up, an institution with successful fundraising can buy its way to better rankings. That's not the fault of the college; it is just responding to the incentives presented to it.

The $53 billion total raised in 2021 by higher education institutions is similar to the $49 billion the federal government spent that year on sponsored academic research and, like the research money, it is concentrated in a relatively small number of institutions. In large part, the institutions that receive the lion’s share of research dollars also get a disproportionate amount of the donated dollars. The exception being a handful of small, long-standing, prestigious, private liberal arts colleges that are adept at fundraising.

In 2018, the top ten recipients of philanthropy to higher education alone received 18% of all money donated to higher education. Seven U. S. institutions received individual gifts of $100 million or more. Michael Bloomberg’s gift of $1.8 billion to Johns Hopkins alone accounted for almost 4% of all money donated to higher education that year. Johns Hopkins University also receives more federal funding for research, by a wide margin, than any other university

Just as the federal government looks to academia to do research in specific areas vital to the nation’s interest, independent foundations and unaffiliated individuals look to the universities to pursue their visions and to do research to advance their missions. Those groups provide half of all higher education donations. The colleges and universities with proven track records in the fields that are of interest to those foundations and individuals are the recipients of more of their dollars. This fact is as true today as it was 150 years ago when Booker T. Washington was soliciting funds for Tuskegee Institute and wrote,  “I noted that just in proportion as the usefulness of the school grew his donations increased.” This is one reason why philanthropy is not evenly distributed across the multitude of colleges and why the institutions which receive the bulk of research funding also receive the bulk of donations from those without previous ties to the college. The rich get richer.

Prior to the 1960s, endowments were invested conservatively, avoiding risk.  Returns on those investments were modest but predictable.  In the 1960s, some of those managing the portfolios of schools with larger endowments became more daring and began investing in stocks.  This coincided with a bull period in the stock market and resulted in better returns.  As the funds available to a university to invest grew, so did its ability to take on risk.  Larger endowments had more cushion to absorb the short term losses inherent in riskier investments, as long as those investments also provided more upside gains over the long term.  Larger pools of funds also afforded larger endowments access to instruments such as private equity funds which could potentially yield even higher earnings and which were not available to smaller endowments.   University of Michigan's average return over the first 20 years of this century was 9.9% compared to the median college endowment return of 7.4% over that same period. Putting that in real terms, if the average college invested $1,000 in 2000, it would have had $4,170 in 2021.  On the other hand, if the University of Michigan invested the same $1,000 in 2000, it would have $6606 in 2021 or 58% more than the median college endowment.  Of course, the principal of University of Michigan endowment is many times greater than that the median college further magnifying its gain.  So it may be more realistic to say that the University of Michigan invests $100,000 and it grows to $660,000 compared to $4,170 for the average endowment.  The rich get even richer.  

Over the last 150 years, the institutions that benefited from the donations of industrialists also became skilled at raising funds from alumni and the general public.  They then took risks investing their endowments which paid off handsomely.  The result is that they had more money to spend on research and programs which enhanced their reputations.  That is why the colleges and universities which had the largest endowments 100 years ago, Harvard, Columbia, Stanford, University of Chicago, and Yale, still have among the largest endowments and highest rankings of prestige today.  This is remarkable when one considers that the largest corporations in 1917 were U. S. Steel, American Telephone and Telegraph, Standard Oil of New Jersey, Bethlehem Steel, Armour and Company, and Swift and Company, none of which is a dominant player today.

How are endowments spent? First, it's important to understand that only a portion of the endowment is disbursed each year because the definition of endowment says that the funds have to last forever.  The percentage distributed hovers around 4.5% for most institutions.  The endowment is not a rainy day fund of which more is spent in hard times and it is not used to reduce total costs. This is because most funds can only be spent on the purpose for which the donor specified. Having said that, student financial aid is usually the largest beneficiary of endowment funds. Colleges tend to use unrestricted funds to increase financial aid during difficult financial times. They tend not to increase the percent of the endowment that is distributed during good times.  The effect is to keep the net cost to the student at a desired level that maximizes the college’s economic surplus.

Like the inequality seen in so many other areas of higher education, there is a wide range in the size of endowments between colleges.  Of the more than 2000 four-year colleges and universities, only about 100 have endowments valued at greater than $1 billion while about 800 have endowments of less than $25 million. To get a further idea of the skewed distribution of endowment assets, consider that in 2016-17 the richest 10% of private doctoral colleges and universities had $1,200,000 in assets per student. In the 80th to 90th percentile the average was only a third at $412,000 per student and the overall median for all institutions was only $63,000 per student or one-nineteenth that of the top decile, and that was the median, not the lower half. For public doctoral institutions, the top 10% averaged $120,000 of assets per student or one-tenth that of its private peers.  The median amount of assets per student for all public doctoral institutions was $17,000.  Regional public universities which awarded only bachelors or masters degrees, in general, had endowments even lower than the average.

Because of the inequality in endowments, in 2015-16 private research institutions in the top 10% had an average endowment income of almost $67,000 per student compared to the peer median of just under $4000. The wealthiest 10% of public research universities had an average per student endowment income of $6200 or one-tenth that of its private wealthy peers.   But it was still almost seven times greater than the average public college endowment income which was only $900 per student. Of course, about half the schools receive less than $900.  So, that’s $67,000 per student vs. 6,200 vs. 900, or less.  That is a huge difference in what different institutions have at their disposal to spend and remember, rankings are highly correlated with how much money an institution has and spends.  Some claim that endowment spending is a source of income above and beyond tuition, analogous to state appropriations for public colleges, but, clearly, at wealthy private universities it is on a different scale.

On average, almost half of endowment payouts go toward student financial aid. Academic programs and research receive 16% of funds, endowed faculty positions 11%, capital facilities 10%, and 17% go to all other purposes.  But as we continually see, there is no such thing as an average college.  For schools with larger endowments per student and wealthier students, a lower percentage of the endowment needs to be spent on financial aid, so more can go to research, professor salaries, athletics, and buildings.  

Private colleges with medium-sized endowments can use the endowment to pay for approximately 5 to 6% of the general budget. The wealthier schools, especially those with smaller enrollments, can use the endowment income to support up to 30% of their general budget.  Colleges with small endowments, such as regional public universities must rely almost entirely on tuition to meet their financial obligations.  They must keep their tuition charges high in order to pay their operating expenses.  They are not able to offer as much financial aid or tuition discount.  This is why it is sometimes less expensive for a non affluent student to go to a private college than a regional public university.

In many ways, the generosity of Michael Bloomberg and his charitable foundation is illustrative of philanthropy to higher education.  It is often given to institutions to which the donor already has a connection.  It is disproportionately directed to colleges which have a reputation for doing the best research, receive the most federal dollars for research, are highly ranked, and are already wealthy.  The funds are restricted to specific causes determined by the donor.  The most common causes are financial aid, research, and faculty positions.  Most significant, is the fact that the overwhelming majority of the money does not go toward the general operating expenses or lowering the overall sticker price.  It is used to add to the scope of the university and pays for the initial expansion it creates.

Thank you for listening to Charging U.  In this episode we looked at endowments and how they cannot be used to lower tuition for all students.  In the next episode, we will explore how the interests of colleges and students do not always align.  

If you enjoyed this episode of Charging U, Please leave a rating and review.  Please let all those who are concerned about the high cost of higher education know about the podcast.  Until next time, be well and be safe.