Chapter Two
Do Private Colleges Make Big Profits?
Gordon Winston
Williams College
W
inston presents an economic model of selective higher education grounded in the pursuit of excellence, reputation, and a top quality student body. He associates excellence with wealth, and notes that it is in the competitive interests of any one institu-
tion to increase its wealth; its success depends on its position. He warns, however, that institutions
may be accumulating too much wealth—at least in the eyes of an increasingly skeptical public.
Winston encourages institutions to effectively articulate why they save, and why they have not
passed on their savings to students in the form of tuition reductions. Thoughtful and perhaps persuasive answers to these questions exist, and Winston warns of increased political intervention if
higher education does not provide them.
If you’d just finished taking Econ 101 and, for
change in net worth––define its profits, and those
some odd reason, you looked carefully at a recent
financial reports would show that for wealthy
financial report for one of the leading private
colleges, total income minus total current costs was
colleges or universities, you’d come to a strange
very big, indeed. Net worth increased a whole lot.
conclusion: that these non-profit organizations had
Some numbers: At Swarthmore, net worth
made significant––indeed huge––profits in 1995-96.
increased during 1995-96 by $97 million, at
You’d just been taught that a firm’s total yearly
Stanford by $763 million, at Harvard, $2.0 billion. In
income minus its total current production costs––its
one year. Recognizing differences in size, those
22
numbers
expressed
per
student
become:
have evolved understand them. Profits accrue to a
Swarthmore $73,000, Stanford $54,000, and
firm’s owners, but nonprofit firms don’t have own-
Harvard $91,000. We could as easily have picked
ers––they operate under “a nondistribution con-
different schools with similar results: Duke, $441
straint,” meaning that anything they make that looks
million or $40,000 per student; Williams, $88 million
like profits can’t be distributed to anyone.
or $44,000 per student; Princeton, $686 million or
Even more fundamentally, perhaps, in colleges
$107,000 per student. Big, impressive numbers.
and universities the “firm’s” income doesn’t come pri-
They compare with the average student’s net tuition
marily from selling its “product” to its “customers”—
at those schools of roughly $20,000 to $25,000.
on average, students contribute less than 30 percent
But—the last crucial piece of the picture—you
of a U.S. college or university’s income (less than 45
couldn’t even have seen these numbers before
percent in private institutions). The major sources of
1995-96 because they were hidden under the
the income that supports a college’s costs and sav-
obscurities of college fund accounting and could
ing (and subsidizes all its students) are asset earnings
be discovered only with long, hard digging.
and gifts from its donors, and it’s a real stretch to call
DO PRIVATE COLLEGES MAKE BIG PROFITS?
So a fact of fundamental importance about
the charitable contribution of a wealthy donor to his
colleges and universities has––thanks to the new
or her old alma mater a source of profit to the college.
accounting standards of FASB 117––become highly
It does, on the other hand, support saving––which is,
visible to one and all. Public attention and judgment
like a family’s, the excess of a year’s income over
seem bound to follow. Time led off with a carefully
spending on current activities.
researched but narrowly slanted article early in 1997 on
Penn’s saving, and there’s surely more on the way.
But that just puts a new and more accurate
1
label on the question. It still leaves U.S. with “What
should we make of these huge savings at the lead-
Profits or Savings?
ing private institutions?”
What should we make of these profit fig-
Why Colleges Save
ures––these dramatic one-year changes in net
Why should colleges save at all? Three uncon-
worth at our leading private schools?
troversial accounting answers to that question that
First of all, it’s a mistake to call those changes
provide a good place to start.
in colleges’ net worth profits, even though elementary economics would define them that way. This is
Most basic is the Red Queen problem2––that
one among many examples of how our understand-
we live in a world of inflation and if that fact isn’t
ing of colleges and universities can be served very
recognized, a college can easily go backward by
badly by our business intuition and easy analogies
just standing still. So every year, it needs to save
with for-profit firms or the economic theories that
something simply to offset the effects of the year’s
23
inflation on the value of its financial assets. If it
Figure 2-1, showing Williams’ saving over the 32
doesn’t, the college ends the year with less than it
years from 1956-57 to 1988-89. What stands out is
started. With the 5 percent inflation that was
the very high degree of volatility in total saving,
recently part of our lives, an institution with a $500
including a few grim years in the 1970s and again in
million endowment had to save at least $25 million
1987 when it was negative––when total net worth
to hold its own, to protect the purchasing power of
declined. Smoothing short-term variations, then, is
that $500 million. This––maintaining the real value
essential to understanding college saving, because
of the college’s assets by spending less than is
asset income is volatile, making saving volatile even
taken in in the average year––is often seen as a
with steady spending patterns.
fundamental fiduciary responsibility of a board of
It’s even worse than that (this is my last
trustees. And it’s hard to argue with that.
mechanical/accounting
point
on
saving).
Accounting standards have (sensibly) changed in
does not a trend make. Savings go up and savings
the past decade to value financial assets at what
go down and any single year’s saving at these
they’re worth in the market, rather than, as before,
wealthy private institutions is heavily dependent on
what had been paid for them when they were
the value of their endowments, which is heavily
originally purchased. That means, of course, that a
dependent on financial stock markets. And we don’t
run-up of stock prices like we’ve been seeing for the
need to emphasize that those markets have gone
past few years is translated immediately into
up and down at breathtaking annual rates. The
income, hence saving. But it also means that those
figures above are from 1995-96, when the Dow rose
income and saving figures are going to be just as
by 24 percent, July to July. Of course, t’was not
responsive when the market goes down. The rare
always thus. Williams is the only school for which
and modest periods of negative saving in Williams’
we’ve seen long term total saving figures, but it’s
historical data, therefore, understate the volatility we
probably representative of the others. So look at
can expect of college saving in the future. Until
10,000,000
WILLIAMS COLLEGE SAVING: 1956-1988
Constant (1967) Dollars
1967 Dollars
8,000,000
6,000,000
4,000,000
2,000,000
0
•
(2,000,000)
(4,000,000)
1956-57
1961-62
1966-67
1971-72
Figure 2-1
24
1976-77
1981-82
1986-87
DO PRIVATE COLLEGES MAKE BIG PROFITS?
Just about as basic is the fact that one year
1987-1988, those data reported income more con-
now only because of their past saving. To have
servatively (and inaccurately) and that damped its
accumulated its roughly $1.2 billion in current
changes. To see what difference that makes, a
financial and physical assets over a 200 year
3
shows that if
history, Williams, ignoring inflation, had to save an
the stock market had fallen by 11 percent during
average of $6 million every year in 1997 dollars. The
1995-96 as it did in 1987-88 instead of rising, the
wealthy schools are able, now, to provide a very
year’s savings reported above would have been,
high quality, high cost education at a price to their
instead, a negative $75 million for Swarthmore, -
students that covers only a fraction of cost
$561 million for Stanford, -$297 million for Harvard,
because of past saving.
back-of-the-envelope calculation
$9.5 million for Duke, -$59 million for Williams, and
If we look forward, then, to our future students,
-$527 million for Princeton. So ups and downs in
a very clear obligation would seem to require
the stock market now translate into more
colleges to save now for them, forsaking some
exaggerated ups and downs in saving at colleges
possible current spending or tuition reductions.
simply because of accounting changes.
To do less would make colleges and their students
But there’s a good deal more to the question
now
some
sort
of
intertemporal
free
DO PRIVATE COLLEGES MAKE BIG PROFITS?
of college saving than these essentially mechani-
loaders––accepting all the benefits of past saving
cal/accounting issues. We might want to rephrase
while asking, too, for the present benefits of more
the central question as “How much should colleges
current consumption: “We appreciate the saving
save—smoothed over yearly volatility, after protect-
done for us, but have no intention of doing the same
ing the real value of their financial assets?” It’s pret-
for anyone else.” Intergenerational equity is a noto-
ty
we
riously slippery matter.4 That, in a nutshell, is the
can’t easily get) would still have been very large
posture that undermined Eric Larson’s technically
for the past few years.
very thoughtful Time article, in which he said, in
clear
that
the
numbers
(which
There are good reasons for a college to save
effect, “Penn should reduce its saving now to give
that go well beyond these matters of accounting:
me and my daughters (for whom I’ve not saved
two argue for saving on social-ethical grounds;
enough) lower tuition prices, along with all the
the other on institutional self-interest.
benefits of Penn’s accumulated wealth that comes
from others’ saving in the past.”
A strong social justification for saving follows
from the simple fact that these schools now have a
And if that weren’t enough, the Red Queen
great deal of wealth––endowments and physical
enters again here with the likelihood that the real
plant––that they need to produce and sell their very
cost of producing high quality education rises with
high quality education to their students at highly
time. It might be because of the “string quartet”
subsidized prices. But they have those resources
phenomenon described by Will Baumol and Bill
25
Bowen––that the productivity of the players doesn’t
seen as very objective. So even if it is correct that
rise through though their competitive wages do––or
these resources will serve society best if they accrue
it might be because of the increasing cost of con-
to the elite colleges and universities, we can’t expect
stantly improving scientific measurement or the
our assertions of that fact to be very persuasive.
need to have increasingly expensive equipment in
And because of the temper of the times, col-
order to conform to the world after college. So,
leges and universities may be in a situation
according to the familiar and persuasive argument,
where it’s more important to be persuasive––credi-
simply to maintain the same, unchanged quality of
ble––than right. Which brings us to the third and
education will require increasing real expenditures.
most uncomfortable reason that colleges save.
Future generations will be short-changed if we pass
A few years ago, a review of the saving being
on to them only as much as we got.
done by Williams, Wellesley, Amherst and
Swarthmore revealed that Williams was saving less
ment––for college saving is simply that the benefits
than Swarthmore or Wellesley––though a good deal
to society of dollars put into elite colleges and uni-
more than rival Amherst. The reaction to that fact
versities are every bit as large as the social
was, without hesitation, to urge the Williams admin-
benefits to be got from other uses of those dollars. If
istration and board to take measures to increase its
so, $2 billion more wealth at Harvard may serve
saving to protect (or improve) Williams’ relative posi-
society better, ultimately, than any other appealing
tion with these peers. The message was, quite sim-
use of that money, such as early childhood
ply, that Swarthmore and Wellesley would bury
intervention for poor families or higher quality K-12
Williams, by virtue of their superior saving, and we
education. That’s not intended as a loaded
couldn’t let that happen.
comparison, suggesting the superiority of taking
This reaction is noteworthy because it reflects a
care of small helpless children––the additional $2
widespread characteristic of colleges and universi-
billion at Harvard might lead to a cancer cure or a
ties that makes this matter of defensible college
cheaper substitute for early childhood intervention,
saving much more difficult to resolve. The problem
or a way to improve K-12. Eighty-eight million more
could be posed, with some risk of hyperbola, this
at Williams may allow 50 more bright-but-poor kids
way, “Where––as a college’s savings increase
to get a first-rate education in every class. So soci-
––does prudence end and greed begin?”
ety may be best served by all that collegiate saving.
Any one college has a powerful incentive to
The hitch is that there’s no evidence to support
increase its wealth relative to that of its competition.
that belief––and no prospect of getting any. It can
Higher education functions in a hierarchy of
only be supported by a judgment call. And our
institutional quality–quality of students and faculty
judgement, from within higher education, can’t be
and programs and facilities––that rests on a
26
DO PRIVATE COLLEGES MAKE BIG PROFITS?
A less abstract argument––a social argu-
hierarchy of resources–of wealth5. Every school is
surely would not want to move down the hierar-
positioned within that hierarchy and none competes
chy to be overtaken by the ten or so below. So
with very many others: some say it’s 20––the ten
presidents often feel that they’re more valuable
schools above and the ten below––and that seems
on the road, asking for donations, than back
about right. In August each year, colleges and
home, minding the store.
universities wait with bated breath for the U.S. News
The point is to recognize that there are power-
and World Report rankings that will tell how they’re
ful incentives for an individual college or university
doing, and in May they wait to learn the school choic-
to save, quite apart from any moral obligations to
es of the high-quality students they’ve admitted.
future students or the social benefits provided by its
The aspects of educational excellence quality
wealth. A college might decide that it was doing
that define a school’s position in the pecking order
much saving on behalf of its generations or that
are many, subtle and complex but, ultimately, most
there was too much use of resources in elite higher
are heavily influenced by wealth. Wealth is used to
education. But that college is unlikely to decide that
subsidize students to create an excess demand
it can do too much saving to increase its education-
queue to allow the selection of students on quality
al excellence and relative position among its peers.
that––through
essential
If a little bit of saving will hold off the competition
component of a high quality education . A similar
from below, more will move a school ahead to com-
mechanism works from wealth through payment of
pete with those that have been at a higher level. So
an efficiency wage to faculty to generate an excess
tuition is increased at the same time colleges are
supply, allowing the use of tenure decisions to
hitting the jackpot in the stock market. And “If we
select faculty, too, on quality. And wealth pays for
don’t do it while our peer institutions do, we fall
buildings, equipment, aggressive recruitment
behind.” The Red Queen, yet again, in the
programs, winning teams, and all sorts of other
escalation of an arms race.7 That picture is rather
dimensions of institutional excellence.
bleak, but neither unrealistic nor novel.8
peer
effects––is
an
6
DO PRIVATE COLLEGES MAKE BIG PROFITS?
Since saving is the way––the only way, by
Limits to Saving
definition––to augment wealth and wealth in turn
supports excellence, individual schools have a
If there are only weak and uncertain
powerful incentive to save in order to increase
internal restraints to college saving, does
their wealth relative to their competitors. Saving
anything else promise to limit the saving of
is the route to educational excellence; saving
private colleges?
more than the competition is the route to moving
Three things do. The first is markets. All of
up in the hierarchy. And if institutional modesty
the colleges’ and universities’ major income
were to make an administration less than eager to
sources––tuitions, gifts, grants and asset earn-
overtake the ten or so schools above them, it
ings––have market limits. Tuition income may not
27
look tight in schools where fewer than 20 percent of
and makes the ability to charge tuition and generate
the applicants are admitted, but those schools
gifts dependent on the respect in which individual
remain sensitive––hypersensitive––to the quality of
institutions, and higher education collectively, are
their students, and any loss of competitive edge in
held. So, unlike milk or asphalt or microchip
attracting high quality students brings immediate
producers, the good fortunes of colleges and
concern. Few data are as closely monitored as the
universities depend in many ways on society’s
SATs of recently matriculated students, the number
climate of respect and affection.
So the second source of effective resistance to
quarterbacks who will arrive in the fall, and how the
college saving is just those social attitudes.
competition made out on those same measures.
Markets work through parents and students, facul-
Those at the top of the universities’ pecking order
ty and donors––a college’s own patrons––and the
shook up a long-standing detente on “early deci-
impersonal caprice of the stock market. But if
sion” and “early notification” in admissions when
society as a whole comes to see the newly visible
Stanford lost an unacceptable proportion of super-
saving in colleges and universities as excessive,
star freshmen to Harvard and then retaliated. In
and their efforts to jockey for position in the peck-
1998, the competition for student quality began to
ing order as socially wasteful, such changes in
alter prices and aid policies at Princeton, Yale,
attitudes will be reflected politically, in public
Harvard, Swarthmore and others. The New York
policies. Already, the tax revolt has tightened the
Times reported a shift of high income students from
screws on public higher education.
private to public universities. So those seemingly
And while private colleges and universities are
infinite queues of ultra-high quality students have, in
not very dependent on government appropriations,
fact, clear limits and increasingly price-sensitive lim-
they are extremely vulnerable to changes in tax pol-
its as well.
icy. A few years ago, calculations for Williams––one
Gift income, too, has limits––development
of the most private of private colleges––showed that
offices and presidents meet resistance from all but
fully twenty percent of its total yearly costs were
the most loyal alumni as the wealthy have other
covered by tax breaks––on real estate, endowment
things to do with their money. The decline in feder-
income, and donors’ gifts. Those are tax conces-
al research grants has been a major fact for most of
sions that the public could easily withdraw if col-
the past decade, and whatever happens to the
leges were seen to be more interested in increasing
stock market, asset income is entirely out of the
their wealth than society’s well being. Other coun-
control of colleges and universities. Finally, there’s
tries––notably Canada and Germany––have taken
the inhibiting fact that higher education works in a
steps to rein in universities’ tax-exempt freedoms. In
trust market––one might say a trust-and-affection
the United States, foundations have long been sub-
market––that puts limits on aggressive marketing
jected to saving restrictions by the IRS. Federal
28
DO PRIVATE COLLEGES MAKE BIG PROFITS?
of National Merit Scholars and heavily recruited
action taken in 1998 against TIAA’s tax benefits
tion. The emphasis has been on the new visibility of
looks like a warning shot fired across our collective
saving to the world outside academe, but FASB
bow.
117 reveals those succulent savings to inside
The third potential source of resistance to exces-
stakeholders, too. So justifications for saving have
sive collegiate saving is the most preferable, that col-
to persuade not only those shaping public policy,
leges and universities use self-restraint to keep from
but those within the community as well.
running into either of the other limits—the market or
Conclusion
punitive tax policy. This has some of the flavor of an
DO PRIVATE COLLEGES MAKE BIG PROFITS?
old fashioned sense of what’s seemly or––alternative-
The leading private colleges and universities
ly––of what’s politically savvy. Self-restraint suggests
have been amassing huge savings. They always
that more than lip service be given to reassuring an
have––that’s how they can now offer high-quality
increasingly edgy, hostile public by very visibly pass-
education at a fraction of its costs. Because of an
ing up opportunities to save and to increase wealth.
arcane accounting system, it’s been very hard to
Institutions can demonstrate self-restraint in a number
see just how much they saved (it still is for public
of ways, for instance, through a well-publicized deci-
institutions). But with new accounting requirements,
sion to forgo any increase in tuition in light of extraor-
how much colleges save has become obvious to
dinary stock market performance and the saving it
the world: all anyone has to do is look up “Total
generated. That, it could be made amply clear, would
Changes in Net Assets” in a private college’s
share the good fortune with the customers and with
financial report and they’ve got the information.
society. Though only wealthy private colleges and uni-
Since the fact of large saving is no longer protected
versities with significant endowments might do this,
from view by accounting complexities, we need to
their disproportionate influence on the public’s image
recognize that there are times when colleges do
of higher education would probably make the gesture
save a whole lot12, and to understand, discuss and
disproportionately reassuring. And even a cold
defend the practice––or reduce saving. And
Machiavellian, focusing on colleges’ tax status, might
because of the conflicting incentives in colleges and
conclude that sacrificing some saving in the short run
universities, any protestations that they’re not really
could maximize wealth in the long run. One would
saving too much may lack credibility without some
hope the motivation might be more principled than
concrete demonstration of self-restraint. If colleges
that, but in a pinch, it would do.
don’t have good, thoughtful and persuasive
answers for why they save as much as they do, the
public––through the political process––is likely to
Colleges could, of course, eliminate excessive
generate answers for them.
saving simply by spending more––and some
faculty and administrations might urge that solu-
29
4
Acknowledgments
There simply is no formulaic answer to what
Support of the Williams Project of the
constitutes intergenerational equity. We can argue
Economics of Higher Education by the Andrew W.
that real saving must, at worst, be zero to protect
Mellon Foundation is gratefully acknowledged, as
real wealth over generations, but there is no equiva-
are the help and comments of David Booth, Henry
lent upper bound to intergenerational transfers,
Bruton, Jared Carbone, Cyd Fremmer, Al Goethals,
desirable though it might be to have one.
Kay Hansen, Steve Lewis, Larry Litten, Maureen
5
Devlin, previous discussions with Mike McPherson,
With, importantly, incorporation of the asset value
and the participants at the Forum meeting in Aspen.
of anticipated appropriations that brings public
I took much of their advice.
institutions into the hierarchy on comparable terms.
6
Endnotes
Gordon C. Winston, “Why Can't a College Be More
Like a Firm?” Change, (September/October, 1997).
1
Eric Larson, “Why Colleges Cost Too Much,” Time
(March 17, 1997.)
7
Fred Hirsch, Social Limits to Growth (Cambridge:
Harvard University Press, 1976) and, more recently,
2
Robert H. Frank and Philip J. Cook, The Winner
Lewis Carroll, the Red Queen explained to Alice that
Take All Society (New York: The Free Press, 1995)
in her country, “it takes all the running you can do,
have emphasized the waste inherent in activities of
to keep in the same place. If you want to get some-
a “positional economy.”
where else, you must run at least twice as fast as
that.” Lewis Carroll, Through the Looking Glass, in
8
Martin Gardner, The Annotated Alice (New York:
Elite Higher Education (Princeton: Princeton
Clarkson N. Potter, Inc., 1960): 210.
University Press, 1996).
3
9
See Clotfelter, Buying the Best: Cost Escalation in
These figures are calculated by subtracting from
A rough calculation of the effect of a zero-tuition-
the saving reported earlier 30.5 percent of each
increase policy on the numbers above suggests that
school's beginning of year financial assets: 19.5
it might well have a greater public relations effect
percent as the average NACUBO reported total
than saving effect-it may cost relatively little.
return in 1995-96 for endowments over $400 million
tuition income hadn't been increased at all in 1995-
and another 11 percent to reflect the1987-88
96, Swarthmore's savings would have been lower
decline in the Dow. Chronicle of Higher Education,
by 3 percent, Stanford's by 2 percent, and Duke,
Almanac Issue (1997).
Williams, and Princeton by 4 percent, 2 percent, and
1 percent, respectively.
30
If
DO PRIVATE COLLEGES MAKE BIG PROFITS?
For those too young to have been brought up on
10
One might hope that faculty and staff would rec-
ognize that their personal fortunes have already
been helped by the same run-up of the stock market––creating “TIAA Millionaires”––but that's probably hoping for too much.
11
The information available in a financial report
based on FASB 117 does fairly well against an economically coherent set of college accounts. See
“The Logic and
Structure of Global Accounts,”
Williams Project on the Economics of Higher
Education Discussion Paper-23 (January 1994).
Total saving for the year is reasonably described in
such reports by “Change in Total Net Assets” (or
variations like Swarthmore's “Increase in Equity”).
Predictably, the major elements of financial saving
(change in financial net worth) are captured better
than saving in the form of physical assets (change in
DO PRIVATE COLLEGES MAKE BIG PROFITS?
physical net worth).
12
A flat denial of actual saving based on a preoccu-
pation with Current Account surpluses left over from
Fund Accounting will surely be seen as dissembling
or evasion, even if it is only naivete.
31