Center for Business and Public Policy
at the University of Illinois, Urbana-Champaign

Professor Brown poses an interesting thesis that universities like Illinois should consider eating more of their seed corn by spending deeper into their endowments during times of economic stress. What better time than now to invest in our future, might be the argument. 

While I am no expert on the subject let me for the sake of debate share some thoughts.  I actually agree with many of the points Jeff raises, yet let’s consider a counter argument.

Most endowments use spending rules that are in effect a function of trailing three- to five-year market valuations.  With well diversified portfolios, these spending rules if managed wisely can have the effect of providing a smoothed stream of revenues, thus dampening the impact of economic shocks from other revenue streams of the sort we are experiencing today.  Many schools do have modest discretion in “tweaking the dial” on endowment payouts in some years, yet those changes are subtle.

Suppose, though, for the sake of debate that we consider spending into endowment principle in a meaningful way to replace at least some portion of lost state support – not a tweak, but rather a material change in endowment payout policy. 

To implement this, we need to first be relieved of a few constraints.  Perhaps foremost is that the vast majority of the endowment pool has spending agreements which define how earnings should be spent.  Few donors provide unrestricted funds of the sort that could be considered “financial reserves.”  That pool of assets we think of as a potential resource to tap into is instead a blending of thousands of little agreements.  To implement aggressive spending of the endowment, one first needs to be freed of these legal restrictions to redirect money from supporting project X to hiring faculty member Y.  (True, with a “quasi-endowment” as Jeff mentions we have modest ability to accelerate payouts within a given academic area, yet the scale of those investment dollars is often relatively small and unstable.  From a policy perspective I am not sure this would be a wise expenditure for what is otherwise a “long-horizon” investment in human capital).

Next, we might consider the second order effects of such an action. Does the near term gain from the redirection of endowment funds outweigh the chilling effect this action might have toward future donors who might be concerned as to how their designated gift is honored?  This argument has two sides of course, yet this policy does set a tone that a donor’s fund agreement may not be the last word. 

For the sake of argument though let’s avoid dwelling on these legalities.  Jeff makes brief reference to a key insight that unlike most corporations whose operations are exposed to the capital markets, universities generally do not share the same depth of exposure to these important economic disciplinary forces. Universities for example do not have clear, easily identifiable equity holders. While universities like Illinois can and do issue debt and manage a capital structure, it is hardly fair to say that these external entities have a meaningful impact on academic decision making at the margin.   

And this creates the rub.  Universities face only a limited number of natural forces which constrain inefficient academic investment. Tough economic times present one of the few disciplinary forces that require universities to define their academic priorities in a manner consistent with their organization’s economic viability and sustainability. 

I do not wish to advocate the Rahm Emmanuel doctrine here: never waste a good crises. One never hopes for difficult times to beset an organization. Yet by eating into our endowment, do we not avoid the difficult questions of asking who are we and what are our academic goals and priorities?  Stated differently, how can we distinguish a temporary shock to our income from the more serious concern that today’s economic stress is the result of long-term structural problems?

While endowments create a funding stream that insolates to some degree a given academic activity or program from transient levels of support from other sources, to dig into those endowments in a material way opens up the possibility of perpetuating or accelerating inefficient academic investment.  How can we commit to our donors that their gifts which were offered to provide perpetual support toward a particular mission will not be inadvertently redirected and squandered (those are my words) on inefficient academic activities that might potentially drag down the overall institution?

Does that mean each academic program must float on its own fiscal bottom or each faculty member “earn their keep?”  Of course not. Universities, for better or worse, cross subsidize various academic activities in pursuit of their missions all the time (another point Professor Brown laments above!). Yet it also seems clear that reduced exposure to external economic pressures allow universities to evolve into administratively inefficient structures, perhaps for long periods of time.  

Jerry Carson responds above with a call to arms saying now is a time to redefine the university’s business model. I cannot disagree with his refined stakeholder definition of the board.  Digging into our endowment base, as repulsive as that might be to our donors, allows one the pleasure of delaying the day of reckoning for poorly structured academic organizations.

Of course, Jeff raises a good point that surely now must be a terrific time to hire great academic talent in the marketplace.  Good point.  If we assume a benevolent and well informed administration willing to identify which units to support and which to avoid, these would indeed be good if not great outcomes.  Yet one problem with a decentralized decision making environment (one without a clearly defined ownership structure) is that inefficient or ineffective academic units can often make similar claims on the central campus, thus potentially perpetuating their status. 

If Adam Smith’s invisible hand is limited to but a few invisible fingers in the context of universities, should we restrain those disciplining forces even further at this crucial time when clear headed decisions today are perhaps our best shot at a brighter future?