Why do universities have endowments?

Alan Gunn asks:

Why do universities (in the US and Britain only) have endowments, and should they? And why does no one but Henry Hansmann [pdf, eBook version here] write about this question?

Because they can.  Tax law doesn’t stop them, and why should a University President spend down the fund?  An ongoing high balance in the fund means prestige, a good ranking, and an ability to make credible commitments to quality faculty and quality programs.

Current donors know that their support will feed into something long-run and grand.  Rationally or not, it is less persuasive for an alumni donor to hear a pitch like “We will spend down the corpus.  Penn State will rise seventeen spots in the ratings, for twenty years, and then fade into obscurity.”  Many givers care predominantly about the “here and now,” but they donate to political campaigns, or benevolent charities, not universities.

Ultimately we need a theory of segmented giving, and how board structures of universities support such giving.  University board members benefit most from a prestigious school with a high endowment and other prestigious board members.  In general those boards will support accumulating the endowment, at least if the school has any chance for prestige in the first place.  Spending money within the university instead distributes those benefits to current faculty and students, rather than to the decision-makers over the endowment.

Note that while the most visible colleges and universities usually have large endowments, the median and modal schools have endowments very close to zero.  They have no chance of accumulating their way to substantial prestige benefits.

Alternatively, you could drop the fancy institutional economics and apply crude price theory.  Universities can borrow or otherwise raise money tax-free, and at g > r you should expect ongoing and rising accumulation.

It is striking how much the list of top U.S. universities does not change over the last century, albeit with some new entries from the west coast.  Among other things, that suggests there has been no fancy, expensive and effective new product that a school might invest in and run down its endowment for.  This might change in the next twenty years.  One can imagine a middling school running down its endowment to spend its way to leadership in on-line education.

I have never seen a good paper on which non-profits accumulate endowments and which do not, and how that difference functions as both cause and effect.  I would think, for instance, that the Heritage Foundation has a substantial endowment, but many think tanks do not.

Here is a new paper on university endowments (pdf), by Gilbert and Hrdlicka, asking whether endowments are invested in too risky a fashion.  It also raises the question of how well endowment practices will survive in a time with low rates of return.  Here is a 2008 dialogue on endowment reform.  Here is a 2009 law review piece on university endowments, it is a little slow to load.  Here is a TIAA-CREF perspective (pdf) on the investment committees for university endowments; they tend to be run by donors.  Here is a look at mandatory payout proposals.  Here is a good 2010 paper (pdf) on what happens when endowment values decline, it is called “Why I Lost My Secretary.”


Everyone likes to be well endowed, don't they?

"One can imagine a middling school running down its endowment to spend its way to leadership in on-line education". One can more easily imagine a top school like MIT, with a fair number of people who understand how technology is a huge driver of long term structure and a fair amount of money.

Hmmm... mindreader, prescient, or in the know? Pick one.

MIT launches online learning initiative

Wait... it seems they announced it on December 19th... but I only heard about it on Metafilter today.


When I was at Edinburgh people were still complaining about the scandalous fact that when the finances of the University and the City were disentangled in the 19th century, the city made off with the bulk of the endowments. I deduced from that that endowments were viewed as desirable.

"Ultimately we need a theory of segmented giving"

Good news: I've been working on that paper, and will eventually finish it. :)

What's "segmented" giving?

Reminds me of this extract from Gandhi's autobiography which might have some truth to it (can't say if he meant this to apply to universities):


And now after considerable experience with the many public institutions which I
have managed, it has become my firm conviction that it is not good to run public institutions on
permanent funds. A permanent fund carries in itself the seed of the moral fall of the institution. A
public institution means an institution conducted with the approval, and from the funds, of the
public. When such an institution ceases to have public support, it forfeits its right to exist.
Institutions maintained on permanent funds are often found to ignore public opinion, and are
frequently responsible for acts contrary to it. In our country we experience this at every step.
Some of the so-called religious trusts have ceased to render any accounts. The trustees have
become the owners and are responsible to none. I have no doubt that the ideal is for public
institutions to live, like nature, from day to day. The institution that fails to win public support has
no right to exist as such. The subscriptions that an institution annually receives are a test of its
popularity and the honesty of its management; and I am of opinion that every institution should
submit to that test.

European universities used to have endowments -- it was called The Church. Then the French Revolution (and Napoleon, and Josephism, etc) happened and they lost it all over and over again. In England, there were other institutions with endowments, but only the Colleges kept them (in fact, I'm not sure the universities of Oxford and Cambridge have particularly large endowments, especially compared to some of the ancient colleges).

Thanks, Tyler. I asked about universities, because that's where the big bucks are, but it's not just them, of course, it's charities generally. I once had a client which was a charity that had been established over 150 years ago to support a particular medical activity. Over the years it had accumulated over a million bucks, yet all it did with the money was dole out a few hundred (or occasionally a few thousand) each year to the organization it was supposed to support. Mostly the trustees just let the money pile up (all from earnings; there were no new contributions). They weren't bad people, and they got no prestige or anything similar for doing that as nobody much even knew they existed. It seemed to me that it had never occurred to them that their main responsibility was anything other than preserving and increasing the pile of money they were sitting on.

Somebody once asked some Notre Dame administrators why they had accumulated so much. One of them said "the donors insisted on it," while another flatly denied that.

I know of one law school, NYU, which decided some years ago to spend a chunk of its considerable endowment on increasing the quality of the school so as to boost its prestige. The effort was, I think, very successful.

Regarding the 150 year old rigid charitable donation: Isn't there a legal Rule against perpetuities to address exactly this sort of inefficiency? Dead man's hand and all that?

The Rules against perpetuities has a charitable exemption. And some states in the US have abolished the rule.

The endowment effect.

"at g > r you should expect ongoing and rising accumulation"

What does g stand for?

g is the growth rate of assets, r is the interest rate paid to borrow money. With g > r, it makes sense for the university to finance spending with debt because it earns more interest from its endowment than it pays to borrow the money.

g = total return of endowment
r = spending rate of endowment

Which is it? This or the explanation above?

Rahul and Alan Gunn wrote interesting comments. I think this is sufficiently off topic that Tyler didn't need to address it, his post is pretty substantive. But I've gotten the impression that there is a growing problem of large non-profits starting to behave like for-profits, but keeping the tax advantages of non-profit status. It may have become a big enough problem that the iRS should start a crackdown.

Or...a crack up. Maybe economists could resend the memo that people are self-interested.

I remember a client that had a for-profit and a non-profit. The non-profit was devoted to education, training and certification. Problem: the non-profit made tons of money. Solution: transfer the non-profit's trademarks to the for-profit, have the non-profit license those trademarks from the for-profit, transfer all profits from non-profit to for-profit.

"It is striking how much the list of top U.S. universities does not change over the last century, albeit with some new entries from the west coast. Among other things, that suggests there has been no fancy, expensive and effective new product that a school might invest in and run down its endowment for."

This comment strikes me as pretty parochial. I don't know if the list of top US universities in the US has changed much over the last century, but I'm pretty sure that the list of top World universities has a lot more US universities now than it did in 1911. Of course without looking at comparative levels of endowment it's hard to know if they had much effect.

In 1911, a list of top world universities would have been a bunch of German institutions plus Cambridge.
In 1851, delete Cambridge, add Edinburgh and perhaps Glasgow.

The schools that have substantially moved up in the rankings over the last 50 years were heavily tied to increases in wealth (both the endowment and/or alumni giving). Think USC, Vanderbilt, Northwestern, Duke, WUSTL, Emory, NYU. And of course Caltech was basically recreated in 1920 and Stanford was mostly a regional school pre 1950s.

USC has been undergoing a campaign to raise $3 billion solely for the endowment, with the purpose being to drive up its US News ranking (I'm not sure this is explicitly acknowledged, but talk to alums and students, and they're very aware of it). As one of those west coast schools that has risen tremendously in the last hundred years, there is a very clear benefit to past alums. They received a degree from a university that was considerably less competitive and prestigious but now enjoy the prestige of the current high ranking in spite of the fact that they probably wouldn't gain admission if they applied today with their credentials from yesterday.

You mentioned the investment committees of the boards, but what about the investment managers themselves? Whoever manages Harvard's $300 billion or whatever it is has to derive a lot of fee income from doing so. The larger the endowment, the larger the management fee. That's arguably a way of getting around the IRS prohibition against non-profits privately distributing their net income, sort of a larger-scale version of Herman Cain using donated campaign funds to buy his own books from his own company.

Likely to be a fairly small amount in comprison to the sums involved.

Weisbrod (and others) wrote a book not long ago, Mission and Money, which dealt with exactly these questions. It has lots of interesting data and useful interpretation. I'd suggest it as a good starting point for anybody that wants to study this subject in depth.

How much money is in public-college endowments? Will states be able to resist tapping it to shore up budgets, or is it inconseqential? Are there barriers to state government appropriating public school endowments?

"How much money is in public-college endowments? " Very substantial amounts. Well over $100 billion in total.

"Are there barriers to state government appropriating public school endowments?"
Since the money would come directly at the expense of the faculty, staff and students at the most prestigious universities in the country, I would say there are very high barriers and the money is pretty much untouchable by state governments.

It is possible that state governments could reduce their contribution to schools that have large endowments. In effect, adapt a progressive system of funding, whereby the schools with lesser endowments receive more money. However, since most of the politicians involved attended those schools and whose kids or grandkids are attending those same schools, it seems very unlikely.

The public "land grant" universities often have large endowments. The University of Washington, for example, owns large chunks of downtown Seattle which it has mostly leased out on long terms. Those endowments are, indirectly, controlled by the state governments and I think most of those state universities have grown so huge that while their endowments can be large per institution they aren't that large per student.

So endowment per head:
University of Washington $1.3b, 42,000 students -- $30k/student
Harvard $30b, 21,000 students -- $1,400k/student
University of the Pacific (a small private college with a good endowment) $0.2b, 6,000 students. -- $33k/student
University of California system: $6b, 230,000 students. -- $26k/student
University of Texas, Austin: $7b (largest public university endowment according to wikipedia, it struck oil), 50,000 students -- $140k/student

One of these things is not like the others...

Anyhow, yea California or Washington would eat their endowments very quickly if they started spending principles. Austin could last a while. Harvard looks like it could live off its investments indefinitely.

I like Ghandi's thoughts.

Walking through the halls of a recently build UCSF research building I was struck by how palatial it was. Marble floors, three rows of stained wood bumpers down the hallway to keep carts from marking the walls, tasteful sconces lighting it up in multiple colors, wide stone porches for lunching. It's the building the regents meet in. Seems to me that higher education has crossed the line between building to last and inspire over to building palaces. The wealthy elite who manage the universities at the highest level tour the glittering hallways they have had built and try to ignore the little people outside who seem somehow distressed. Tsk tsk, if only there was more money... but we simply must get more marble into the next building.

Yes, there are barriers: Technically, the public institutions (and hence the state) don't own the endowments. The endowments are raised and managed by separate 501(c)3 organizations.

Chance can play a role. The University of Rochester in the 1960's was feeling flush, as its endowment had been boosted first by Kodak dollars, and then the Xerox gold rush, so it made a play to boost its national standing. I believe the University of Texas was also boosted by oil dollars perhaps in the 1980's, leading them to invest in the papers of literary figures.

NYU actually spent a big amount of its endowment on buildings and professors as part of a strategy to capitalize on its brand name as the university of the world's most important city, while assuming that it could get more from its donors. This strategy appears to have worked fairly well.

I've often wondered about this. My conclusion: when people are making donations to higher education institutions they are more often pursuing status (or the recognition that being linked with the institution will bring) than trying to achieve a social benefit. If status is the goal, then the fact that their contribution to a university with a huge (often growing!) endowment will achieve nothing at the margin does not diminish their motivation.
And with funding sources like this - what motivation do university boards have to change their ways?
I think Tyler's first sentence nailed it: the universities that have big endowments have them because they can get away with it. The interesting questions are all about which factors allow such nonsensical institutional arrangements to persist.

The first sentence is meaningless, your typical academic empty, nonsense. We "need" a theory as much as we need an asshole on the elbow. The second sentence could apply to any public, private, small and large board or, for that matter, to anything at all. Giving the choices on almost anything, prestige is preferable to non-prestige. The last sentence is the only once addressing the issue and providing clarity to the debate. Joe Doe has $100 in the bank and Joe B has $100,000,000 in the bank. Which Joe is better?

"Ultimately we need a theory of segmented giving, and how board structures of universities support such giving. University board members benefit most from a prestigious school with a high endowment and other prestigious board members. In general those boards will support accumulating the endowment, at least if the school has any chance for prestige in the first place. Spending money within the university instead distributes those benefits to current faculty and students, rather than to the decision-makers over the endowment."

There is research on the topic of why the big stay big. "Accumulative advantage" or the "Matthew Effect" was first described by Merton; there's a new book out by Rigney that, I believe, discusses it. The most succinct discussion was in a 2003 ASHE paper by Caboni, but you may have trouble locating that.

Hansmann is most certainly not the only person writing on the topic. Even in the pages of the Chronicle of Higher Education there are discussions of endowment; every time the economy is doing well and return rates are high, someone calls for spending down endowments. Then the economy tanks, and (somewhat ironically) the best-endowed schools now have negative returns on their endowment, and paying the bills becomes a challenge. At its most basic, endowments provide a hedge against bad economies, although of course that doesn't explain endowments at the levels of Harvard. Why do rich people have money in the bank instead of spending it all? Same reason.

A university's endowment is a collection of endowed funds established by individual donors for a particular purpose. The purpose may be to support undergraduate, need-based, financial aid; it may be to provide salary support for faculty (i.e. an endowed chair in Economics), or for the English Department at Darmouth to have daily afternoon tea (http://0.mk/4af26). The university, or other non-profit, is beholden to the donor's intent in giving the gift. This intent is memorialized in written agreements between the institution and the donor and can be enforced by a state's Attorney General.

Non-profit endowments are further governed by the Uniform Prudent Management of Institutional Funds Act. This act would prevent an institution from "spending down" their endowment for any purpose whether it was consistent with the donor's intent or not. One of the first assumptions the UPMIA makes is that when a donor establishes an endowment he or she does so with the expectation that the endowment be managed prudently, so as to exist in perpetuity (http://0.mk/50c10).

So why do endowments exist? For one, because they provide an institution with the ability to make long-term commitments to students and faculty. An institution like Harvard or Princeton can say to its applicants and current students, we will admit you regardless of your financial need and we will not saddle you with student loan debt upon graduation.

To the faculty member, the institution can say, we will grant you tenure and essentially guarantee that you have a paid position here for as long as you like. Think about that, in what business setting do you hire an employee and say upfront, we are committing to you for the next 40+ years regardless of whether the demand for your skills still exists?

In the 70s and 80s, Soviet and Russian studies was all the rage. Schools built up their faculty presence in response to student demand. Today, Soviet/Russian studies have been replaced by Arabic and Chinese, but most/many of those faculty hired in the 70s and 80s are still around and just now beginning to retire. Today, far fewer students are studying romance languages and far more are studying Mandarin and Arabic.

I think Tyler's argument is slightly off. Rather than maintaining a high balance because a high balance alone signals prestige, I think prestige accrues to those institutions with high balances because those large endowments allow them to pay for the very best faculty and students and to conduct the type of research that begets the Nobel Prize or prominent coverage in the NY Times Science pages. A very wealthy school would necessarily be very prestigious if it didn't use that wealth to attract "prestigious" human capital.

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