IMPROVING FOR-PROFIT COLLEGES:
REALIGNING MARKET INCENTIVES TO MAXIMIZE SOCIAL WELFARE
by
Thomas P. Gibbons Jr.
April 3, 2013
A Senior Thesis presented to the Faculty of the Woodrow Wilson School of Public and
International Affairs in partial fulfillment of the requirements for the degree of Bachelor
of Arts.
Abstract
This paper addresses the ability of for-profit postsecondary programs to meet the current
and future needs of our country’s educational system and labor market. Because a
school’s financial success is detached from student outcomes, for-profits are often poor
investments for students and do not maximize total welfare. The higher education market
is not capable of forcing the poor performing schools to exit the market and can even
incentivize low-performance. To correct market failures, regulatory bodies try to punish
unproductive firm behavior and help students make informed decisions about college
choice. However, this paper argues that an effective for-profit school system requires an
accountability framework that compensates a school based on its ability to provide value
to students.
2
Dedications
The underlying premise of this thesis is that the people who will help you succeed in life
are the people who care about you the most. For that reason, I would like to thank my
mother, father, and the rest of my family for all of the help they have given me. After
many years of tuition payments, my parents are undoubtedly the principles of my
education, but they are also my agents. If every for-profit college cared about their
students like my parents care for me, the schools would be unparalleled (although
admittedly involving more class trips spent hiking and inside museums).
3
Acknowledgements
I would like to acknowledge the people at Princeton responsible for my interest in
education policy. Thomas Espenshade and the members of his freshman seminar, Claire
Cole and Devany Schulz who led my Pace Center trip to Houston to study the business of
education, and Nathan Scovronick and Cecilia Rouse who taught two of my Wilson
School classes on education and informed how I approach these issues. I am thankful to
the Whitman thesis boot camp and the Carl Fields Center for providing me a location to
complete this senior thesis.
I would also like to acknowledge Bob, Chris, Forest, Jeff, Luke, and Tucker for their
support and friendship over these four years as well as Ben, Bonnie, Phil, Tommy, and
Will over the past two years. To my carrel mates Aaron and David and my eleven
friends, I thank you.
I would also like to acknowledge Wendy Kopp who demonstrated how much one WWS
senior thesis can revolutionize education policy.
Finally, I would like to thank my thesis advisor Professor Alexandre Mas for his
guidance in helping me complete this project.
4
Table of Contents
Chapter 1………………………………………………………………………6
Introduction…………………………………………………………………….6
Research Question……………………………………………………………...7
Methodology and Data………………………………………………………….9
Chapter 2……………………………………………………………………...12
Background…………………………………………………………………….12
Growth of the For-profit Sector………………………………………………..14
The Investor Influence in For-profits…………………………………………..17
The Importance of Federal Aid at For-profits………………………………….19
Chapter 3………………………………………………………………….……22
The For-Profit Investment………………………………………………............22
Inputs………………………………………………………………………….....24
Outputs…………………………………...………………………………..........31
Establishing the Effect of For-profits on Outcomes…………............................37
Chapter 4……………………………………………………………………..…45
A Theoretical Market for Education…………………………………………....45
The Real Market for Education………………………………………………...54
Chapter 5………………………………………………………………………60
How For-profits Compete Productively………………………………………...60
How For-profits Compete Through Circumvention…………………................65
How For-profits Compete Unproductively……………………………………..67
Chapter 6……………....……………………....…………………………….....77
Why Does Government Intervene?.....................................................................77
The Current Regulatory Environment………………………………………….79
A Critical Evaluation of Current and Past Regulation............……...….............84
An Effective Regulatory Framework…………………………………………...91
Chapter 7……………………………………………….…………………….....97
Conclusion………………………………………………..……………………...97
5
Chapter 1
INTRODUCTION
In Warren, Michigan on July 14, 2009, President Obama unveiled his American
Graduation Initiative that will invest in America’s community colleges so that they can
accommodate an increase of 5 million graduates over the next ten years. The President
wishes to reinstate America as the country with the highest proportion of college
graduates in the world by the year 2020 (Obama, 2009). While some politicians seek to
increase enrollment, employers express concern that the current education system does
not adequately prepare graduates for the workforce. Citing the “Skills Gap” as
responsible for the roughly 3 million vacant jobs amidst persistent unemployment,
employers and politicians want to improve the quality of the U.S. postsecondary school
system (Donahue, 2012). Meanwhile, postsecondary institutions face budget cuts in the
face of unprecedented state and federal deficits. For example, the House of
Representatives Fiscal Year 2013 budget explores a reevaluation of student aid that
would minimize taxpayer risk on federal-loan programs and freeze federal grants to avoid
the impending budget shortfalls from keeping aid in pace with rising tuition costs (Ryan,
2012 and CBO, 2013). Greater access, more effective institutions, and less cost to
students and taxpayers are three critical goals to postsecondary education. However,
these three desires appear to be directly at odds with one another. Increasing enrollment
to those currently excluded risks damaging school quality and would certainly cost
additional federal funding.
6
RESEARCH QUESTION
A remedy to these problems in postsecondary education lies with the for-profit
sector. Between 2010 and 2018, the economy will create 46.8 million jobs of which 63%
will require some college education. During this time, the postsecondary system will
produce a shortage of 3 million college graduates in the labor market (Carnevale, 2012).
Between 2008-2013, 38 states cut their higher education budgets totaling an $8.7 billion
or 11% decrease in spending (ASPCU, 2013). Meanwhile between 2000 and 2010
associate’s and bachelor’s degrees at for-profits increased by 132% and 387%
respectively compared to public increases of 43% and 29% (IPEDS). One study
estimates the cost of educating an additional 5 million graduates through the public
education system at over $825 billion (de Alva, 2010). Increasing educational outputs to
match labor market needs are outside the current systems cost and capacity.
An education sector governed by market forces should theoretically push costs
down and raise school efficiency producing an educational product that competes with
the quality and pricing at traditional schools. Supporting this sector by offering students
tuition assistance should increase access as well. Despite the potential of for-profit
schools, many analysts are not as optimistic on the industry’s presence as a
transformative force. The sector’s performance garners suspicion and prompted public
investigation into the practices of for-profits. Proponents of regulation in the for-profit
sector believe that for-profits do not perform at the level that maximizes total social
benefit relative to total social cost. As a result, the Department of Education leads the
movement for more intense regulation of the industry. Its most recent and impactful
regulations, the 2010 Program Integrity Negotiated Rulemaking Regulations, face
7
opposition from those who believe this will interfere with the growth of the for-profit
sector and its associated benefits (Lawlor, 2013).
This thesis demonstrates why the for-profit sector is unable to produce an efficient
outcome under current market and regulatory conditions and outlines a regulatory
framework that maximizes the benefit from private sector colleges. First, this thesis will
argue that there is a market failure in this sector, adversely affecting students and
taxpayers. As a result, social welfare can be increase with correctly targeted government
intervention. There is a public interest in promoting education, yet market forces alone
do not produce an optimal quantity or quality of the good. The inefficiencies within the
education market allow for-profits to operate at high levels of profitability. This paper
will explain why for-profits are not widely beneficial and how this does not obstruct them
from maintaining profitability in both theory and practice. This section of the thesis will
engage the productive and unproductive ways in which the firms compete and attain
profitability such as increasing their scale of production and misleading students to
increase enrollment. I will examine how efforts to rectify the underprovision of
education through federal support of the industry have failed to solve the for-profit
market failures and created new inefficiencies that distort firm behavior by incentivizing
federal compliance to attain funding. Finally, in understanding how for-profits operate
and compete, this paper will take a critical view of current and near future regulation. I
will outline an effective regulatory and accountability system that is capable of increasing
social welfare by compensating for and removing some of the market failures. Although
this framework is admittedly untested, it provides the general conditions that will allow
the sector to operate at the socially efficient level.
8
METHODOLOGY AND DATA
Much of the arguments in this paper depend on previous literature on economic
theory and for-profit schools. Rather than collect my own data or run my own
regressions that attempt to estimate the benefits of a for-profit education, I will cite the
previous literature that sufficiently analyzes the existing data to forge estimates. I will
engage the existing literature later in the paper when relevant to the discussion instead of
summarizing the literature’s findings here.
Quantifying the exact societal costs and benefits of a for-profit education is
complicated by imperfect data. The National Center for Education Statistics (NCES)
provides the majority of the data this thesis cites including the Integrated Postsecondary
Education Data System (IPEDS), the National Postsecondary Student Aid Survey
(NPSAS), and the Beginning Postsecondary Students Longitudinal Study (BPS). IPEDS
contains survey data for all the schools that receive Title IV funding and their students.
NPSAS compiles data specifically related to student financial aid. The BPS 04/09 is the
only study that followed a cohort of students who entered postsecondary school for the
first time in 2004 and then resurveyed the same students five years later to add data on
individual outcomes.
This thesis also uses data and findings collected during government
investigations. The most important of which was the two year investigation into the
operation of thirty for-profit schools between 2006-2010 conducted by the United States
Senate Committee on Health, Education, Labor, and Pensions (HELP). “For Profit
Higher Education: The Failure to Safeguard the Federal Investment and Ensure Student
Success” (HELP, 2012) uses interviews with industry executives, employees, and
9
students as well as documents on the corporations that are not made public in SEC
filings. Because of the report’s unprecedented access to schools that are not publicly
traded, I will use some of the report’s data even though several years have passed since
its collection.
An ideal experiment to estimate the returns to a for-profit education would
randomly assign students to a treatment group attending for-profits and measure their
performance against a random control group that did not receive any postsecondary
education. To simplify matters and not influence the amount of education a student
consumes, there would be no government grants or loans for either group. This
experiment could discern the effect on wages, earnings, employment status, health,
satisfaction, and any other impact we expect is attributable to schools. If the experiment
measured an aggregate social benefit, then the net social benefit is the aggregate benefit
less the social cost to attending a for-profit. I expect these costs to be dominated by the
tuition costs to the student as well as the opportunity cost of foregone earnings and taxes
on those earnings during the time of enrollment. Using the marginal social benefit from
enrolling an additional student, the federal government could make decisions on how to
appropriate aid to increase the consumption of education to the point where the market
clears and the marginal social cost does not exceed the marginal social benefit. Since this
type of an experiment faces practical and moral objections, I will instead use previous
studies to try to estimate the benefits of attendance compared with the costs of a for-profit
college.
Enumerating economic costs and benefits like loan payments and wage gains is
complicated. Furthermore, estimating all social costs, like the cost of having someone
10
forgo socialization by taking courses online or the benefit of adding an informed voter are
almost impossible. For these reasons, I will leave out ambiguous positive and negative
externalities to an education when making my estimations of social benefits and costs
although I acknowledge their important presence in our public support of postsecondary
education. It is worth noting that although this paper makes frequent comparisons
between the for-profit, the public, and the non-profit schools and students; these
comparisons exist to provide context to the for-profit data. Assuming that the schools
outside the for-profit sector have a total net social benefit greater than zero, for-profits do
not need to outperform those schools to provide a net positive social benefit. In fact,
publics and non-profits experience some benefit already in the diversion of students to
for-profits which lessens the burden on the existing educational structures.
From this cost-benefit analysis, I will ascertain whether society’s investment in
for-profit schools is positive. Then I will review the theoretical literature that provides
insight into why educational firms do not behave in ways that produce efficient
outcomes. Finally I will suggest how to best make education a consistent positive
investment by rewarding schools for the gains students receive relative to school cost.
This policy recommendation can accomplish the educational goals of school
effectiveness and cost. The effect on access is indeterminate. It may increase access if
there are students who will benefit from an education relative to its cost, but it could also
decrease access to students who attaining a degree represents a net negative investment.
11
Chapter 2
BACKGROUND
Proprietary schools have existed in some form dating back to the 19th century, but
their market share and influence on the educational sector has never been larger. The
new for-profit colleges have achieved a size and employ teaching methods that are very
different from the commercial colleges from which they descend. The modern for-profit
school also differs from the public and non-profit schools it competes against. Although
there is much overlap between for-profits and other schools, there are key differences that
exist across the sectors. This section will help a reader unfamiliar with the for-profit
higher education sector understand the important features of the industry that affect how
these schools operate. For the purposes of this paper, the first important difference is the
sector’s rapid growth. Second, these schools are profit maximizing corporations: investor
returns are the most important goals to the ownership. Lastly, the federal government
heavily supports the industry through federal tuition assistance programs. The discussion
of other important differences pertaining to quality of instruction and student outcomes at
for-profits will follow in the chapters that look more closely at student benefits versus
costs. In this chapter, I will only discuss some of the industry’s summary statistics that
distinguish the sector. The purpose is to establish how the for-profit sector’s wide
breadth and dependence upon federal support raises the “stakes” in an industry that
affects investors, an increasing number of students, and all taxpayers.
12
GROWTH OF THE FOR-PROFIT SECTOR
For-profits have captured a growing portion of United States student enrollment.
The magnitude of the for-profit sector reaffirms that these schools are becoming an
increasingly important part of our education system. Although there has been rapid
growth, for-profit schools still approximately represent only 2 million students spread
across 1,400 for-profit institutions compared to over 15 million students at public
institutions and almost 4 million at private non-profits (IPEDS). Since 2000, public and
non-profit institution enrollment grew by 29% and 65% respectively, but for-profit
enrollment increased by 335% over the same period (IPEDS). Postsecondary enrollment
has increased across institution type, but for-profits are growing at a faster rate and
increasing market share as a result (Figure 2.1).
Historical Number of Students Enrolled in For-profits and Forprofit Percentage of Total Higher Education Enrollment (Figure
2.1) IPEDS
10
7
1,500,000
number of students
6
percentage of students
5
1,000,000
4
3
500,000
2
1
0
0
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
Number of Students
8
Percentage of Total Enrollment (%)
9
2,000,000
13
For-profit growth spread into areas and programs that are new to the industry.
Traditionally, for-profits confined themselves to 2-year and less-than-2-year programs.
Recently though, for-profits have started to compete with the non-profit and public 4-year
degree-granting institutions. While the number of 4-year public and non-profit
institutions has remained relatively stagnant, the number of 4-year for profit institutions
is surging and even surpassed the number of 2-year institutions (Figure 2.2).
Number of Instituions by Institution Type
(Figure 2.2) IPEDS
1,600
Public 4year
1,400
Public 2year
1,200
1,000
Non-profit
4-year
800
Non-profit
2-year
600
400
For-profit
4-year
200
For-profit
2-year
0
1976
1981
1986
1991
1996
2001
2006
2011
Part of the reason that for-profits have been able to grow so quickly is due to their
admissions policies and high enrollment capacity. For-profits are almost always
nonselective aside from proof of secondary school completion in the form of a high
school diploma or a GED. For-profits receive relatively few applications but accept
14
applicants at a much higher rate—66% of schools had no application criteria while 9% of
schools generally accept 90% or more of applicants (IPEDS). The potential for over
enrollment does not affect for-profits like it does other schools. For-profits choose to
enroll a student because the marginal cost of an additional student is less than the
incoming revenue. The cost of enrolling a student at most schools ranges from $600$6000 which is still less than tuition when adding the fixed facility and instructional costs
(Silber, 2012). The second reason for-profits are capable of rapid growth is because they
rely more heavily on online programs and leasing classroom space rather than investing
in capacity restricted fixed costs like dormitories, athletic facilities, and laboratories
(Breneman, 2006). Much of the growth in for-profits comes from the for-profits that
already have brand recognition and a presence in markets across the country. They can
teach courses online or at satellite campuses without much effort or warning because of
the scalability of their standardized programs (Figure 2.3).
Percentage of Total Enrollment by School Type
(Figure 2.3) Deming, Goldin, Katz
15
THE INVESTOR INFLUENCE IN FOR-PROFITS
The defining feature of for-profits is that these schools possess the ability to
distribute earnings to owners. As opposed to publics and non-profits that raise capital
predominantly from government and alumni support, debt financing, and tuition and fees,
for-profits have the ability to raise capital through the sale of ownership. Although many
of the schools exist as “ma and pa” proprietary colleges that more closely resemble small
businesses than national firms, the growth in the industry is attributable to the schools
owned by return-oriented investors. In 1991, Devry Inc, was the first higher education
institution in the United States to allow owners to publicly trade the company’s shares on
a stock exchange. Since Devry, 14 institutions followed.
For-Profit Enrollment by School Ownership (Figure 2.4)
HELP
16
While not publicly listed, there are additional corporations owned by private equity firms
or venture capitalist funds. With no publicly listed higher education companies in 1990,
the investor operated schools now teach the overwhelming majority of for-profit students
(Figure 2.4).
The publicly listed for-profit schools are able to grow in part because of their
financial success. Most for-profit shares witnessed remarkable demand between 2000
and 2013. The for-profit sector outperformed the rest of the market during the first
decade of the millennium (Figure 2.5).
Growth in For-Profit Stock Prices Since
2000 (Figure 2.4) Yahoo Finance, 2013
1700
1500
% of Staring Price
1300
1100
900
700
S&P 500
500
300
100
-100
In 2009, the average profit margin for the 15 publicly traded companies was 19.7%
(HELP, 2012) compared to S&P 500 profit margins over the past 20 years that averaged
17
roughly 13% and peaked at 18% (Thomson, 2012). Although financial information on
unlisted for-profits is not publicly disclosed, their institutional and enrollment growth
suggests they experienced similar returns. These remarkable profits sparked interest from
politicians and the media. The compensation of top executives at these profitable
companies attracted attention from a public unfamiliar with the notion of high salaries for
people in the field of education. In 2009, the average salary for a publicly-traded forprofit corporation’s CEO was $7.3 million compared to an average of $1 million and $3
million for the five highest paid leaders at public schools and non-profits respectively
(HELP, 2012). A 2012 investigation by Congressman Elijah Cummings presented
evidence to the Committee on Oversight and Government Reform that companies failed
to demonstrate a link between executive compensation and student outcomes
(Cummings, 2012). A spokeswoman for DeVry Inc. responded to press releases in an email saying, “our first obligation is to our students, and our shareholders understand this.
They know that only by focusing on serving our students and delivering value over the
long-term, will we ensure our economic viability” (Kirkham, 2012). The financial
success at these for-profits and the compensation packages that followed underscore a
transformation in how the country provides education. The operation of a for-profit
school is for the satisfaction of teaching or a desire to do service, it is to make a profit
from the services these schools offer. Whether profits actually depend on “serving our
students and delivering value over the long-term” is crucial to the industry, students, and
taxpayers.
18
THE IMPORTANCE OF FEDERAL AID AT FOR-PROFITS
Part of the reason private sector financials and compensation packages incite
skepticism is because of the massive federal presence on these school’s balance sheets.
While traditional higher education institutions depend on state and alumni support, forprofit revenues come almost exclusively from tuition payments that are heavily supported
with federal loan programs. In 1972, Congress reauthorized the Higher Education Act of
1965 with language that broadened the eligible recipients for Title IV funding. Under
this amendment, for-profit postsecondary institutions could become eligible for Title IV
funding. The two largest tuition assistance programs are the Pell Grants which provide a
need-based grant to students of up to $5,550 for the 2012-2013 school year and the
Stafford Loans which are need-based subsidized government loans that usually collect no
interest during enrollment and have an interest rate of 3.4%. The federal government also
provides unsubsidized loans to students regardless of demonstrated need (U.S.
Department of Education, 2013). The students at for-profits participate in these loan
programs at a very high rate but are less likely to receive financial support from
nonfederal sources (Figure 2.6). Because interest rates are higher than savings rates,
students who borrow pay a higher price for education. Students cannot discharge these
loans and face wage garnishments if they do not repay them. The purpose of federal aid
is to increase the quantity of education and its associated benefits while narrowing the
cost differential between affluent and low-income students.
19
Percentage of Full Year, Full-Time
Undergraduates Receiving Financial Aid
2007-2008 (Figure 2.5) NPSAS, 2008
100.0
Student Receiving Aid (%)
90.0
80.0
% Receiving Any
Financial Aid
70.0
% Receiving Federal
Grant Aid
60.0
% Receiving Nonfederal
Grant Aid
50.0
% Receiving Federal
Loans
40.0
30.0
% Receiving Nonfederal
Loans
20.0
10.0
0.0
Public
Non-profit
For-profit
Because of the level of student participation and the lack of outside sources of
revenue, for-profits depend greatly on these federal programs for funding and consume
these funds at a rate disproportionate to the industry’s size. During the 2010-2011 school
year, the federal government disbursed over $32 billion in tuition assistance (HELP,
2012). These Title IV tuition assistance programs averaged 70% of the revenue per forprofit school with 19% of all institutions reporting that upwards of 85% of revenues came
from Title IV sources (U.S. Department of Education, 2012). As a response to what
congress deemed was an exploitation of government assistance, subsequent
reauthorizations of the Higher Education Act of 1965 mandate that a school receive at
least 10% of revenue from non-Title IV sources or risks losing its Title IV eligibility.
20
The presence of aid complicates the relationship between government and forprofits. The government certainly has power over these institutions to effectively
bankrupt the schools by withdrawing federal support. Owners of for-profits know that a
return on their investment is contingent upon the government’s provision of aid.
Likewise, because for-profits entrenched themselves in the education sector by claiming a
substantial share of enrollment, they too hold a level of “bargaining power”. If for-profits
closed their doors, there would be no schooling for an increasingly large portion of the
population that depends on the for-profit supply. The public postsecondary school
system may not have the structural capacity or knowhow to accommodate these students
while the non-profit sector may be unwilling. The mutual dependence between forprofits and federal government has allowed for the sector to move forward, but at what
cost? There is a need for a critical evaluation of what the taxpayer has purchased.
21
Chapter 3
THE FOR-PROFIT INVESTMENT
In order to claim that reform is necessary in the for-profit industry, there must be
proof of a market failure that could be corrected through government intervention
resulting in a higher net social benefit. This section will weigh the benefits and the costs
of a for-profit education. An appraisal of the costs and benefits starts with a brief
summary of the inputs at for-profits followed by a measurement of the most important
output metrics. This section predominantly relies on raw averages and generalizations of
the sector, but the end of this chapter will cite papers that attempt to control for the
observable differences between schools. Although this paper makes judgments on the
sector as a whole, there is a wide variation between schools. There are undoubtedly forprofit schools that have a strongly positive total impact as well as schools in addition to
the schools with a negative total impact.
The benefits and costs fall into four categories: public economic, private
economic, public social, and private social. The difficulty of assigning a dollar amount to
the less concrete social benefits persists with outputs such as social cohesion and
familiarity with new technologies. Regardless, all of these benefits share the defining
goals of education in the United States: democratic equality, social efficiency, and social
mobility (Labaree, 1997). Theoretically, the for-profits are indifferent to the social
benefits they provide and will only value the inputs that work towards increasing
profitability. However, the public has a long history supporting higher education because
of the societal benefits it creates, and there is much evidence that confirms the
supposition that higher education is a net windfall to society because the positive
22
externalities apply across sectors (Bowen, 1978). Even though for-profits need only offer
a slim total benefit to justify existence, it is also important to consider which individuals
experience the benefits and which individuals bear the costs. For example, if there is a net
zero total benefit but the costs are concentrated among the wealthy and the benefits go to
those less well-off, this is a desirable outcome in a society that values economic
redistribution. This paper will not enlist these types of value judgments that a society
should make when designing an education system.
23
INPUTS
Outcomes like productivity and job placement constitute the treatment effect of
for-profits. The most immediate way for-profits can affect these outcomes is through
instruction. The quality and selection of programs are how for-profits determine the
academic value they offer to students. These same inputs also account for a large portion
of a school’s costs. The major determinants of program quality include school
infrastructure and instructors while the largest influence on the selection of programs is
student demand. Another way schools can improve the positive effect of attendance is
through non-instructional services that will help students complete their academic work
and prepare them for the labor market.
All of these inputs into an education consume revenue and reduce profit. To
afford these things for-profits must generate a significant amount of revenue. Revenue
per student is $15,372 at for-profits with tuition accounting for over 90% of incoming
funds at $14,026 dollars (IPEDS). Because for-profits retain a portion of revenue as
profit, students do not see all of their tuition dollars returned to them in the form of
educational services. The largest added-value at for-profits is the increase in labor
market preparedness that comes from acquiring skills during enrollment. To teach these
skills, for-profits expend an average of $2,640 or 21% of total expenditures on instruction
(IPEDS). Not only do publics and non-profits outspend for-profits in absolute terms,
they also spend on instruction at a higher rate of 25% and 33% (IPEDS). For-profits
usually spend 6% of revenue on capital expenditures although technical intensive
programs like automobile technology schools require much larger capital outlays than
predominantly online schools (Silber, 2012). (Figure 3.1)
24
Another way for-profits increase student satisfaction is by spending on services
that promote student well-being, the academic quality of the school, and assist the daily
operation of the institution. These categories comprise almost 70% of for-profit
expenditures. The information on the further breakdown of expenses is limited
Per Student Expenditures by Purpose and
Institution Sector 2009-2010 (Figure 3.1) IPEDS
4-year non-profit
$50,000
4-year Public
$45,000
4-year for-profit
$40,000
$35,000
2-year public
$30,000
2-year for-profit
$25,000
$20,000
$15,000
$10,000
$5,000
$0
Total
Instruction
Student services,
academic and
institutional support
so it is difficult to know if these expenditures are for student job fairs that help career
placement or administrative services which can mean higher salaries for academic deans
and recruiters. Nevertheless, there is data on the percentage of institutions that offer a
student service which suggests that most for-profits offer services that help students
complete their programs and reach employment. The frequency of services is
commensurate with other schools and almost all institutions offer at least one of the listed
services (Figure 3.2).
25
Percent of 4-year Institutions Offering
Selected Services (Figure 3.2) IPEDS
100%
90%
80%
Non-profit
70%
Public
60%
For-profit
50%
40%
30%
20%
10%
0%
Remedial services
Placement services On-campus day None of the above
Academic/career
Employment
care for children of
for program
counseling services services for current
students
completers
students
Student services and support methods are an important input for preparing students to
achieve after graduation; however, the field of instruction is as important as its quality.
For-profits offer programs that tend to have a strong focus on occupational training.
Some schools have degrees that mimic the course structure and curriculum of non-profit
schools, but many offer the overwhelming majority of their degrees in fields like business
and health. There are very few degrees conferred in the liberal arts which accounts for
42% of public associate’s degrees (IPEDS). Instead, for-profit students graduate with
degrees in fields like computer and information sciences, security, and performing arts
which are more closely tied to occupations rather than general academic subjects like
English or history (Table 3.1). For-profits do not offer these types of programs because
26
they are associated with high job placement rates and high salaries. These course
offering are a response to student demand.
Program of Study by Institution and Degree Type (Table 3.1) IPEDS
Program of Study
Public
For-profit
Non-profit
Associates
Bachelors
Associates
Bachelors
Associates
Bachelors
Agriculture and natural resources
0.9%
2.2%
0.5%
0.8%
0.0%
0.2%
Architecture and related services
0.1%
0.7%
0.1%
0.5%
0.0%
0.1%
Area, ethnic, cultural, gender, and group studies
0.0%
0.5%
0.0%
0.6%
0.0%
0.0%
Biological and biomedical sciences
0.4%
5.7%
0.3%
5.5%
0.0%
0.1%
11.4%
18.5%
22.5%
22.2%
25.4%
43.3%
Communication, journalism, and related programs
0.4%
5.4%
0.2%
4.6%
0.1%
0.8%
Communications technologies
0.4%
0.1%
0.4%
0.3%
0.6%
1.8%
Computer and information sciences
2.6%
1.9%
3.4%
2.0%
9.3%
10.4%
Construction trades
0.6%
0.0%
0.4%
0.0%
0.5%
0.0%
Education
2.3%
6.7%
1.3%
5.7%
2.0%
1.7%
Engineering
Engineering technologies and engineering related
fields
English language and literature/letters
0.4%
5.4%
0.1%
3.4%
0.0%
0.3%
Business
3.4%
1.2%
2.6%
0.3%
5.5%
1.5%
0.2%
3.4%
0.0%
3.1%
0.3%
0.1%
Family and consumer sciences/human sciences
1.1%
1.7%
0.8%
0.7%
0.1%
0.1%
Foreign languages, literatures, and linguistics
0.2%
1.4%
0.7%
1.3%
0.0%
0.0%
Health professions and related programs
17.7%
7.7%
33.8%
9.0%
31.5%
11.9%
Homeland security, law enforcement, and
firefighting
3.7%
2.6%
3.0%
2.0%
8.9%
8.4%
Legal professions and studies
0.8%
0.2%
1.1%
0.2%
2.8%
0.9%
Liberal arts and sciences and humanities
42.2%
2.9%
18.5%
2.8%
1.5%
0.1%
Library science
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
Mathematics and statistics
0.2%
1.1%
0.0%
1.1%
0.0%
0.0%
Mechanic and repair technologies/technicians
1.7%
0.0%
3.5%
0.0%
3.4%
0.0%
Military technologies and applied sciences
0.1%
0.0%
0.1%
0.0%
0.0%
0.0%
Multi/interdisciplinary studies
2.7%
2.7%
0.3%
1.9%
2.4%
2.9%
Parks, recreation, leisure, and fitness studies
0.2%
2.4%
0.3%
1.8%
0.3%
0.2%
Philosophy and religious studies
0.0%
0.5%
0.3%
1.4%
0.0%
0.1%
Physical sciences and science technologies
0.7%
1.6%
0.1%
1.4%
0.0%
0.0%
Precision production
0.4%
0.0%
0.2%
0.0%
0.2%
0.0%
Psychology
0.5%
6.3%
0.4%
5.9%
0.0%
2.5%
Public administration and social services
0.7%
1.5%
0.7%
1.5%
1.2%
2.2%
Social sciences and history
1.8%
11.0%
0.2%
10.7%
0.0%
2.3%
Social sciences
1.7%
8.8%
0.2%
8.5%
0.0%
2.1%
History
0.1%
2.2%
0.0%
2.1%
0.0%
0.2%
Theology and religious vocations
0.0%
0.0%
1.4%
1.7%
0.0%
0.1%
Transportation and materials moving
0.2%
0.2%
0.9%
0.5%
0.0%
0.1%
Visual and performing arts
1.8%
4.6%
2.0%
6.9%
4.0%
7.7%
27
The student populations at for-profits are markedly different from other schools.
Students are inputs in the sense that for-profits select them and one student’s human
capital can heavily impact the surrounding students, but in practice for-profits use open
admissions programs or select on an applicant’s ability to afford the cost rather than the
student’s potential contribution to the school’s academic community. In all sectors, a
student’s background is closely related to achievement. For-profit students are more
disadvantaged than traditional students. According to the data on student characteristics
from NPSAS 2008, for-profit students are more likely to be non-Asian minorities, they
tend to be older, and their parents are less educated than their non-profit and public
postsecondary counterparts (table 3.2). They tend to have independent incomes that are
lower which necessitate a greater need to borrow relative to tuition cost. The vast
majority paid tuition with the help of aid borrowing an average of $16,380 (Snyder,
2012). The students are also less academically prepared: they have lower SAT and ACT
scores (Snyder, 2012), high school grade point averages, and are more likely to have
taken the GED (Deming, 2012) (Table 3.3). Finally, their purpose for attending school
differs from other students. They are more likely to view themselves as employees taking
classes than students who work to meet financial needs and they most frequently state
their purpose for enrolling as gaining job skills or to prepare for a license certification
(NCES, 2011). As previously mentioned, student ability is a resource because students
affect the education of other students (Rothschild, 1995). Human capital is an output but
it is strongly influenced by the surrounding level of human capital.
28
Student Characteristics by School Type (Table 3.2) Education
Digest, 2011
29
Student Academic Background by School Type (Table 3.3) Education
Digest, 2011
30
OUTPUTS
In addition to the data on earnings and job placement, there are other useful
metrics pertaining to achievement that measure student outcomes and school
effectiveness that are also common in datasets. Measurements like dropout rate reflect
student ability to continue to finance his or her education and attend school, but it also
demonstrates the student’s perceived benefit from continuing with his or her schooling.
If a student feels their gains from education do not outweigh its economic cost, then they
would be more likely to withdraw. The time taken until degree completion reflects the
program’s ability to efficiently move students toward a degree and reposition them within
the job market. Pass rates on licensing exams measure how well a school trains its
students to enter their respective job fields. Finally, the student loan default rate
measures how well a student can pay off their loans from their postgraduate level of
income. If a student did not receive the anticipated economic benefit from the school,
then they are more likely to be unable to pay off their loans. Default rate is a rough
estimation for how well the private economic benefit matched a student’s expectations,
but other factors like job market climate and a student’s savings will affect a student’s
ability to repay loans. Because for-profits treat less-advantaged students who are less
academically prepared for college and borrow greater amounts due to lower financial
resources, for-profits will likely struggle with some of these metrics compared to nonprofit and public students. Even if the private economic impact is equal across schools,
the output at for-profits will lag behind other schools because of student’s different
starting points. The size of the private economic benefit becomes clearer when
measuring how the students perform controlling for the observable differences in the
31
population and comparing the outcomes of for-profit graduates to the outcomes of
comparable students who did not receive any postsecondary education.
For-profit students do not complete their degrees with high levels of frequency,
especially at longer programs. At 37.5%, the year-to-year retention rates are low for
bachelor’s programs compared to publics and non-profits (NCES, 2011). Less than half
of the students enrolled in a bachelor’s degree or an associate’s degree program
completed their respective program within six years. Of the students in these programs
who did not attain any certificates or degrees, the majority was no longer enrolled
(NCES, 2011). The 4-year public and non-profit institutions had a much higher
completion rate for bachelor’s or other degree-granting programs and their public 2-year
programs sent a much larger portion of graduates on to bachelor’s programs (Table 3.4).
Average Student Educational Attainment by School Type (Table 3.4)
Education Digest, 2011
Among two-year programs, for-profits witnessed the highest rate of retention at
53% of first time undergraduate students (NCES, 2011). Of students enrolled in
certificate programs, these students received their certificates in around 16 months at 2year for-profits and around 14 months at less-than 2-year for-profits. Compared to the
students attaining certificates at public 2-years who averaged around 25 months, for32
profit students moved through the program at a faster rate (Radwin, 2013). Overall, forprofit 4-year programs do not graduate the majority of their students. However, 2-year
schools that offer certificates and associate’s degrees have higher retention and
graduation rates. Students also complete the programs in less time than at the other types
of schools. Of the 30 schools investigated by the Senate HELP Committee, after one
year the withdraw rate for students was 54.3%, 62.9%, and 38.5% for bachelor’s,
associate’s, and certificate degrees respectively (Scott, 2011).
Pass rates on national licensing exams are another way to measure how well a
school prepares students for their post-graduation occupation. The Government
Accountability Office conducted an analysis of the pass rates on some of the most
popular licensing programs. The study compared first-time test takers at schools from all
sectors on national and state exams for registered nurses, licensed practical nurses,
radiographers, emergency medical technicians, paramedics, surgical technologists,
massage therapists, lawyers, cosmetologists, and funeral directors. Average student pass
rates ranged from 29% and 43% on surgical technician and paramedic exams to over 80%
on funeral director exams (Scott, 2011). The study concluded that for-profit programs
had significantly lower pass rates that reached as much as forty percentage points lower
on nine of the ten exams. These results do not account for differences between the
student populations, but demonstrate that in many instances more than half of students
fail exams they attended school specifically to pass.
Default rates are an approximate measure of an education’s ability to pay for
itself. If students are randomly assigned to schools, the schools with the highest default
rates cost the most relative to future earnings. In practice, future earnings are not the only
33
means to pay off student loans. Using parental income or refinancing the loans is a
possibility but generally an option only for students from a wealthy background or who
have access to credit markets. The default rate at for-profits suggests that a large portion
of students do not earn enough or do not have the financial background to pay off their
tuition investments. After 3 years, over 20% of for-profit students defaulted on their loan
payments regardless of the program duration (Figure 3.3). The average 3-year default
rate for the 30 investigated institutions was slightly higher at 22.6% (HELP, 2012).
Two factors are responsible for the high default rates on federal loans at for-profit
institutions: a student’s debt level and a student’s disposable income. Almost all forprofit students pay tuition with the help of loans from the federal government, the
institution, or a private source. Most for-profit students borrow more than the students at
non-profits and publics. As a result, most graduates leave with a considerable amount of
debt (Figure 3.4).
34
2012 Default Rates by Institution Type
(Figure 3.3) Department of Education
25
2-year cohort
20
Default Rate (%)
3-year cohort
15
10
5
0
Public < Public 2- Public 42-year
year
year
Non-profit Non-profit Non-profit
< 2-year 2-year
4-year
For-profit For-profit For-profit
< 2-year 2-year
4-year
Debt load and Percentage of StudentsReceiving
Federal Loans (Figure 3.4) Department of
Education
$35,000
98%
Average Total
Loan Debt
$30,000
96%
94%
Average Federal
Loan Debt
$25,000
92%
90%
$20,000
Degree
Recipients with
Federal Loans
$15,000
88%
86%
84%
$10,000
82%
$5,000
80%
$0
78%
Private For-Profit
Bachelors
Private For-Profit
Associates
Private For-Profit
Certificate
35
Accumulating debt is not a bad practice if future earnings can repay the debt. If income
upon graduation is insufficient to pay down the debt over time, then the outstanding
balance forces the student into default. Incomes rise with the level of schooling and
students with bachelor’s and associate’s degrees are more likely to have had a job in 2009
than the students who earned certificates (Figure 3.5). However, earnings did not outstrip
debt by a large margin yielding a federal debt to income ratio of 92%, 69%, and 49% for
bachelor’s degrees, associate’s degrees, and certificate degrees respectively (Baum,
2011). Whether this amount of debt is unhealthy or unsustainable requires knowing how
much the student will earn over a lifetime and how would the student fare without a
postsecondary education. If the student would be unemployed, then borrowing high
levels of debt relative to income could still provide a benefit.
2009 Earnings and Employment for FirstTime Students (Figure 3.5) BPS 04/09
$40,000
76%
$35,000
74%
$30,000
72%
$25,000
Earnings Conditioned on
Employment
Earnings
70%
$20,000
68%
Any Job in 2009
$15,000
66%
$10,000
64%
$5,000
$-
62%
Private ForPrivate ForPrivate ForProfit Bachelors Profit Associates Profit Certificate
36
ESTABLISHING THE EFFECT OF FOR-PROFITS ON OUTCOMES
The data imply that a large share of students does not progress through school and
the students who are able to graduate are not in financially strong positions. For-profits
as a whole perform poorly relative to non-profit and public postsecondary schools in
terms of dropout rates, default rates, and employment outcomes, but this data is
misleading. For-profits instruct a disproportionately disadvantaged student body that is
more likely to perform poorly on those metrics regardless of the institution they attend.
Also, for-profits can still provide a positive benefit for students even if the benefit is less
than the benefit in other sectors. The most important metric is how enrolling in for-profits
affects students compared to not attending them at all. To establish whether a benefit
exists, several studies have gone beyond the population means to estimate the effect when
controlling for student background and ability.
To try to measure the for-profit effect on intangibles like democratic participation,
Caroline Hodges Persell and Harold Wenglinsky used the BPS data from the 1989-90
cohort to measure how attending a for-profit affected civic engagement compared to
traditional postsecondary schools. Their results found that for profits had a smaller
impact on seven of the ten metrics of civic engagement even after controlling for prior
levels of civic-mindedness, differences in student backgrounds, and mediating
educational education experiences. For-profit students were less likely to participate in
democratic activities like the 1992 presidential election, discussion about politics, and
community service. This data does not give us the net effect of attending a proprietary
school on civic mindedness, but it does suggest that a cost-benefit analysis should give
37
less weight to the noneconomic benefits at for-profit schools compared to public and nonprofit schools (Persell, 2004).
David Deming, Claudia Goldin, and Lawerence F. Katz authored a recent study of
for-profits titled “The For-Profit Postsecondary School Sector: Nimble Critters or Agile
Predators?” This paper uses BPS data to estimate an ordinary least squares (OLS)
regression of student outcomes on basic student characteristics and a for-profit indicator.
The authors also use a matching method that compares the outcomes of for-profit
students to observably similar students who attended nonselective public and non-profit
institutions. They find that for-profit students are more likely to stay with their program
after the first year and have a higher probability of obtaining a degree or certificate in
short-term program. Students enrolled in bachelor’s degree programs paid higher tuitions
than comparable students at other institutions, took on more debt, and even had higher
default rates when comparing similar debt burdens. They were less likely to be
employed, earned $1,800 -$2000 less than their predicted earnings at another institution,
and claimed to be less satisfied with their college experiences. These results do not offer
insight into whether schools are a good investment, but they suggest that the economic
benefits are significantly smaller at for-profits (Deming, 2012).
In Stephanie Cellini and Latika Chaudhary’s paper “The Labor Market Returns to
a For-profit College Education”, the authors find evidence of wage gains associated with
attending a for-profit. Cellini uses the National Longitudinal Survey of Youth which is a
longitudinal survey that follows 9,000 youths ages 12-17 starting in the year 1997. The
study only uses associate’s degrees because these students often work before and after
enrollment so it is easier to observe the effect of attendance. Enrolling in an associate’s
38
degree program yields an earnings gain of 6-8% although Cellini and Chaudhary do not
rule out slightly negative earnings or extremely small returns in all specifications. The
authors also find evidence that degree completion may be more important for students at
for-profits because completing an associate’s degree generates a weekly earnings gain of
about 22% or 11% per year. Comparing incomes before and after attending an
associate’s degree program gives a better indication of a school’s effect on earnings. The
authors estimate the benefits of attendance, but they do not comment on the cost
necessary to achieve these returns (Cellini and Chaudhary, 2012).
Kevin Lang and Russel Weinstein also used the BPS 04/09 data to see how forprofits affect employment and wages in their paper “Evaluating Student Outcomes at ForProfit Colleges”. To test the treatment effect of for-profits, the authors compared the
outcomes of students who enrolled but did not obtain degrees to students who
successfully completed their program. This method attempts to limit the ability bias with
a difference-in-differences approach that measures the difference between students who
complete programs and students who start but do not finish the programs. Their results
suggested there was no positive impact on obtaining a certificate from any institution or
enrolling in associate program and getting an associate’s or bachelor’s degree from a forprofit. They even supplemented their regression and propensity score methods to try to
control for labor market conditions and selective biases for students who dropped out;
nonetheless, there were no findings of significant benefits to obtaining a certificate or an
associate’s degree although standard errors were high. The notion that there is no
difference between dropouts and graduates does not negate the possibility of a benefit
from enrollment. For instance, the most significant portion of the benefit could occur
39
during the early stages of enrollment. The study also suggests that dropouts make
economically smart decisions by not investing further in their education. Nonetheless, if
every year of a for-profit college was beneficial, these would not be the results
(Weinstein, 2012).
In her study “The Effects of For-Profit College Training on Earnings”, Anna
Chung uses a Mincer model to estimate the effect of for-profit training on wages and
earnings using the rich dataset on student backgrounds and outcomes from the National
Education Longitudinal Study (NELS) 1988-2000. Chung concludes that there is a
positive effect on earnings for women who attained associate’s degrees, but no change in
wage which means the increase in earnings is because of an increase in hours worked.
Although men had higher earnings than women, this premium is not attributable to forprofit training. When analyzing the data for men and together, there is no significant
positive wage gain from attending a for-profit. The effect of certificates was not
significant for all groups. The data without controls showed no statistical difference
between the wages and earnings of for-profit trained workers and non-college workers.
Even when controlling for possible negative biases like being a non-Asian minority, there
are still no significant wage gains from attending for-profits. The negligible impact on
earnings that this study finds suggest that after controlling for observable differences,
earnings for for-profit students are no different than their high school counterparts. The
students in this study should not have taken on any cost to receive these types of results
(Chung, 2008).
These studies are imperfect. The data does not yet report longer term earnings
implications and some of the job placement data comes during a recession. Most
40
importantly, there are observable and unobservable differences between students at forprofits and traditional schools that provide noise around the data. Because of these
differences, it is difficult to make conclusive statements on the for-profit effect on labor
productivity. The data also takes the industry as a whole and cannot show schools that
may perform exceedingly well whose positive impact is neutralized by poor performing
schools. However, the data implies that the for-profits are not offering the same gains in
wages as non-profits and publics. Perhaps employers are prejudiced against for-profits or
there is another reason behind the underperformance. Nevertheless, comparing forprofits to publics and non-profits who receive tax breaks and government funding in
subsidies and research grants is not necessarily an equal comparison, nor does it address
the most important issue. It is not necessary to judge the for-profit sector using the
performance of traditional postsecondary as context. The most important metric of forprofit viability is the return they offer to students. Results like Chung’s are the largest
cause for concern because they suggest that there is no level of cost that justifies
attending a for-profit.
Interestingly enough, 66% of all for-profit BPS respondents claimed the loans
were a worthwhile investment (Wine, 2009). Although less than the other sectors, a twothirds majority believed it was a positive investment even though they faced a tuition
price net grants averaging $5,573 per year and the statistical evidence finding a positive
effect is unconvincing (Wine, 2009). The data suggests these students would have been
better off at public or non-profit schools, but would they have been better without
additional schooling? Even if we accept Cellini and Chaudhary’s 22% wage gain for
completing an associate’s degree, it would take almost twelve years to break even
41
assuming normal degree costs and full employment in either scenario. Over a lifetime,
this would ultimately be a very lucrative investment for the student. It would still cost the
taxpayer a good deal, but in all likelihood the student’s 22% increase in taxable income
would cover the cost of grants. However, this is one of the less than 30% of students
lucky enough to complete the program and experience the largest benefit reported. For
the majority of others who withdraw, the time and money spent was not worthwhile and
the increases in taxable income will not adequately repay the government investment.
Former industry affiliates founded the Nexus Research and Policy Center that
submitted a report on the total costs and benefits to students and taxpayers of attending 4year schools at institutions in each sector. The study divides the schools into categories
based on sector and selectivity and uses salary data reported by payscale.com to
determine the average starting salary and mid-career salary. The school finds very large
benefits accrued over a lifetime to both taxpayers and students. The net benefit to
taxpayers is $6107 per degree and is $788 per enrolled student. The lifetime earnings
benefit to students is $283,707 against a total cost of $82, 274 (de Alva, 2011). The
reason the study finds such large benefits is because it assumes the government will
recoup all its loans and the starting salary in the absence of attending a college is equal to
the average salary of a high school graduate who did not pursue postsecondary education.
Both of these assumptions unfairly bias the estimated benefit upwards.
In Stephanie Cellini’s paper “An Assessment of Costs and Benefits”, she uses
NCES data to estimate a 2-year for-profit total societal cost of $59,200 per year split
between $51,600 in student costs and $7,600 in taxpayer costs (Cellini, 2012). In
comparison, she estimates community colleges cost society roughly $43,600 with student
42
costs of $32,200 and taxpayer costs of $11,400. To break even, students need to
experience earnings gains of 8.5% per year of education. To also make the taxpayer
whole, the return must be 9.8%. Although some studies suggest benefits may be this
high, Cellini’s own work does not and she acknowledges studies that suggest the absolute
returns to for-profits are negative (Turner, 2011). There are those who claim the forprofit industry does benefit students but the methodology supporting these claims and
their sources give reason to doubt their statements. For instance, a consultant to the forprofit industry, The Parthenon group, finds annual income gains in 2-year or shorter
programs of $7,900 against an average cost to taxpayers and students of about $27,000,
but there is little explanation as to how the author arrived at these figures (Lytle, 2010).
There is low precision in estimating labor market returns to for-profit education, but the
weight of the literature suggests that it is unlikely there is a positive impact that can
justify these costs.
For-profits do not represent a significant cost to taxpayers. Corporate taxes offset
a portion of the aid yielding a taxpayer cost between $2500-7000 per student (Shapiro,
2011). These costs can vary greatly depending on how well the government recovers its
outstanding loans. The government reports that between 70-80% of loans are repaid over
their lifetime although because the larger debts are more likely to go unpaid, the lifetime
percentage of dollars recovered is probably much less (Silber, 2012). By repaying the
loans, the student assumes the majority of the cost of attending a for-profit institution.
Depending on a student’s earnings potential without attending college, the total
borrowing cost added to foregone earnings can be extremely high. In these instances,
students would require a substantial increase in wages to justify leaving the job market to
43
attend school. An unfavorable job market or working while in school can greatly reduce
the economic costs of enrolling school. These complicating factors aside, the research
suggests that the necessary break even wage gains do not exist. Perhaps there are
positive impacts of attendance like overall satisfaction, better health outcomes, and
reduced crime, but it is unlikely these benefits are large enough to make college a net
positive investment for students and taxpayers. There may be students who benefit
greatly from enrolling in for-profits and institutions that consistently return value to
taxpayers, but the entire sector does not increase social welfare.
44
Chapter 4
A THEORETICAL MARKET FOR EDUCATION
The evidence suggests that students who enroll in a public or non-profit school,
enter the workforce out of high school, or simply stay home can fare better than students
at for-profit programs. Students enrolling at for-profits spend much of their own savings
as well as the government’s money on tuition and living expenses. Some lose their credit
worthiness from defaulting on student loans. Students cannot discharge federal loans so
they risk entering bankruptcy and facing wage garnishments if they cannot repay them.
Finally, those unable to continue working while in school sacrifice time spent in the labor
market earning wages and gaining work experience. These sacrifices are for the sake of
attaining an education from an industry whose track record for increasing employment
outcomes is unconfirmed. Amidst the high personal costs and the mixed outcomes of
students, it seems improbable that the industry is able to exist. If we accept that forprofits are not only a net drain on society but do not provide a private economic benefit to
students, then how are they able to continue to grow and return profits to ownership?
Despite the growth of for-profits, non-profits dominate the higher education
market. These schools benefit from direct government aid and tax-breaks due to their
designation as 501(c) organizations. Despite this “head-start” for non-profit and public
institutions, for-profits are still able to overcome the barriers to entering the higher
education market. Subsidized school choice helps for-profits enter the postsecondary
market. Rather than dominate the market with public options or expensive unsubsidized
private options, the government subsidizes individuals who are to apply government
funds to a wide range of institutions. This freedom of choice empowers consumers and
45
creates a market for the provision of education that should bring down costs and increase
efficiency like markets for other goods (Friedman, 1962).
In theory, rational consumers with perfect information comprise the market for
education. These consumers have an accurate understanding of what their projected
wages will be after attending school and can calculate the net present value of a decision
to forego working and enroll. They are also fully aware of their menu of postsecondary
options, can attend any of these institutions, and are not constrained by geographic
location beyond the additional costs that it entails. If a rational individual does not expect
earnings increases greater than a school’s cost, the individual will not enroll. Therefore
institutions compete with one another to offer the greatest earnings increases relative to
student costs. Because students theoretically base enrollment decisions on the program’s
relative benefit, schools have a strong incentive to make students better suited for the
labor market and focus the majority of their expenditures on the inputs that will achieve
this goal.
Under the premise of perfect information and rational students, for-profits can
compete even if the public and non-profit sector provides an adequate supply of
education. For-profits can gain market share by offering a similar program at a lower
cost or by increasing the productivity of the program while keeping the price students pay
constant. Another way for-profits can increase market share is through convenience to
the student that. Even without a product that has superior quality, for-profits can enter
the market wherever excess demand exists like in parts of the country that have few
institutions relative to students. Under these market conditions, there are many ways for-
46
profits can enter the for-profit market. However, schools that do not increase student
wages or cost too much to do so cannot compete in the market.
In practice, student outcomes demonstrate that the higher education sector does
not behave efficiently. Students attend more expensive private institutions that are often
negative investments. There are several reasons why the higher education market does
not conform to standard market conditions and is incapable of producing an efficient
outcome. Education has a longstanding tradition as a public good with a significant
public role in its provision. Thus, market forces should not govern education. These
established beliefs about higher education cloud perceptions of how the market should
behave. For instance, a common complaint is that tuition prices are too high at the most
selective colleges and universities to allow for widespread access. However, with the
amount of applications exceeding class space at these schools, it is more likely that
tuition prices are too low. Henry Hansmann outlines three irregularities of the
postsecondary market that insulate non-profit schools from traditional market pressures
(Hansmann, 1987) and Gordon Winston presents a second three reasons for market
failures (Winston, 1997). I will add some of my own extensions and reasons for why the
higher education market does not function like a completely competitive market. The
reasons behind the success of non-profits apply to selective public institutions as well.
The most important characteristic about the education market is that all potential
students face asymmetric information prior to enrollment. When choosing whether to
attend college and which institution to enroll in, students have imperfect information
about what they are paying for. They may know the rough cost (even though tuition
prices change year to year) but they do not know what the absolute returns on this
47
investment will be and they are often unaware of the necessary preparation needed for
college (Scott-Clayton, 2012). After observing many classes of graduates, the school has
a better understanding of how the student will perform. The lack of information forces
students to make a “leap of faith” that the institution they choose will not exploit them.
To attract students wary of exploitation, Hansmann argues that the market for education
is a “trust market” where non-profits succeed because students know these schools have
less incentive to exploit students.
I would add that the problem of asymmetry extends in two directions once the
student graduates. First, employers are also subject to asymmetric information pertaining
to college quality. When assessing a potential hire’s ability, they are unaware of the
student’s actual knowledge base but can use educational background as an estimate of the
student’s ability. They do not know the exact inputs at these schools but hold opinions
on their relative quality. Therefore, oftentimes the best school to attend becomes the
school that employers believe is the best because it offers the best employment
opportunities regardless of the school’s academic quality. Employers’ perceptions of
school prestige will influence students who enroll for the purpose of making themselves
more attractive in the labor market. Second, informational asymmetry should disappear
once enough students graduate and there is a meaningful sample size of students in the
world relaying their experiences. For each class of students that do poorly, a prospective
student increases the chances of interacting with a graduate who will relay the negative
experience. Eventually the graduates would form a significant number that could
dissuade students from entering a bad college. Economic theory paints a much different
picture of how graduates will behave. Faced with the options of praising or disparaging
48
their former school, graduates benefit themselves by praising the institution. Disparaging
the school to potential students or employers will lower the degree’s perceived value,
allow the school to enroll fewer students, create a smaller network, and increase the risk
that the institution exits the market which will further decrease a degree’s brand
recognition. Praising the school has the opposite effect. Even if the feeling is not
genuine, being a proud alumnus is the best strategy when discussing an alma mater.
Unfortunately, this strategy contributes to misperceptions about institutional quality.
Hansmann’s second argument is that because of the nondistributive property of
public and non-profit schools, managers of these schools are not motivated by profits.
Therefore, managers can pursue more altruistic ends like academic excellence, diversity,
and research even if these things are not profitable. Although this may mean the
managers are more likely to be inefficient, the managers of these schools are less likely to
try to deceive the students without perfect information. Hansmann’s third reason why
non-profits transform the market is through their methods of generating revenue.
Hansmann calls non-profit schools “donative-commercial non-profits” which are hybrids
between charitable donations that serve ideological purposes like churches and
commercial non-profits that provide a good or service like a nursing home. The incomes
at these types of colleges and universities do not depend as heavily on revenue from
sales. Instead, revenue depends on donations. Therefore, existence is dependent on
maximizing donations rather than satisfying the customer. These incentives help explain
why schools do not behave like traditional firms.
Gordon Winston extends Hansmann’s argument with his own reasons why
traditional market rules do not apply to schools. The fourth reason for market
49
irregularities furthers the asymmetric information by arguing that students cannot
determine school satisfaction until time passes. Once students become aware of a schools
quality either during enrollment or after graduation, the students do not have the
opportunity to correct their original selection. Because students lack information about
which schools are the “good” ones, the good schools must charge the same price as the
bad schools. Students enter into a one-time prisoner’s dilemma scenario where each
school’s incentives are to mask itself as a good school while providing an education at a
higher cost than its value. This would transform the education market into an example of
George Akerlof’s paradigm of the used car market for “lemons”. Used car salesmen will
only sell at a price that is above what they know to be the car’s actual value. Buyers who
become aware of this tendency will respond by resetting their expectations lower at
which point the quality or bargain products will exit causing the remaining pool of goods
for sale to deteriorate further (Akerlof, 1970). Under this same premise, schools that
know the quality of their education will only sell when the price exceeds the actual value.
This adverse selection theory does not perfectly apply to schools. Schools
possess a competitive advantage when it comes to education: they can educate a student
at a lower cost than the student can educate herself. Therefore, the two parties can assign
the same value to an education that will offer a surplus to each. Nevertheless, Akerlof’s
theory underscores a school’s incentive to sell “lemons” at the same price as quality
goods. Geoffrey Heal responds to Akerlof by arguing that only in transactions without
the potential for the two parties to meet again is there an incentive to deceive (Heal,
1976). In repeat transactions, there is an incentive to be honest to form a reputation to
remain sustainable in the long run. Because attending college is not a repeat transaction,
50
these incentives for schools to behave honestly will not hold. I would add that the
amount of time it takes to establish a reputation alongside a reputation’s significance
provides an important barrier to entry in the education market that does not exist in most
competitive markets. Furthermore, schools also face asymmetric information when
providing their good. When schools decide the rigor and quality of the education they
will provide, schools with open enrollment will not know the exact number of students.
Therefore, they choose to provide a certain level of education under uncertainty and then
must recruit as many students as possible to ensure that revenue covers the upfront costs.
The marginal cost of teaching an additional student can be very low for certain
institutions, but the average cost can remain very high due to the costs of initial inputs
like professors and classroom space. Since colleges cannot store excess “inventory”,
education is much like a sporting event or concert. Schools face incentives to provide a
low cost education product to protect themselves from low attendance and excessive
upfront investment. The economic theory of decision making under imperfect
information reemphasizes the importance for colleges to establish a reputation for
honesty and quality: two fields where nonprofits and publics have an assumed advantage
and for-profit market entrants face skepticism.
The fifth breakdown in the market is due to education’s status as an “associative
good”. A large portion of an education’s benefit derives from the quality of the students
attending the school. Being around smart and dedicated students increases the gains of
attendance which is why the schools with the best students often try to promote
interaction as much as possible between students. Interaction is not as important where
student quality is low which partially explains the use of online or commuter programs at
51
poorer schools. The “peer effects” in college complicate the market further because the
customer is both an input and an output (Rothschild, 1995). Winston’s last argument for
a market breakdown is that schools vary greatly in price and product offered. However,
price does not necessarily correspond to product quality because of the sizeable subsidies
that come from endowments and state governments. This effectively divorces the price
of attendance from its cost because students choose the option with the lowest price even
though it may not represent the lowest actual cost. I would add that because of extensive
institutional aid programs, the tuition sticker price is different for each student. This
price discrimination allows schools to offer a cheaper education to certain students which
reduces producer surplus and the potential entry of for-profits.
I will add a final market failure Winston and Hansmann do not mention: the
presence of the principal-agent dilemma in education. Consider the role of society as the
principal who bears part of the cost of attending a postsecondary school through tax
breaks, subsidies, grants, and loans. The agency who provides this service, namely the
school, does not have an obligation to behave in a way that most benefits society or the
individual. The presence of a moral hazard arises—non-profits schools are more
accountable to the donors than they are to the students. At for-profits, students and
society feel the consequences of a poor education more than the school does. For-profits
may face incentives to give students degrees and grades they do not deserve because this
will raise student satisfaction and could increase profitability even though it does not
achieve the principal’s goal. The resulting contract failure occurs because the school
does not bear the total costs of a positive or negative educational experience.
52
Winston explains that all these failures result in a market that is not flat and
competitive but is instead dominated by hierarchy. Existence is easy for schools with
prestige, exclusiveness, and large amounts of capital. These schools can use their
resources to subsidize tuition for students and provide services that increase student
demand. With high demand and limited size, the schools can choose the best students to
attend who will benefit from being around one another and go on to succeed. Student
success forges a reputation and school brand that future buyers will recognize and past
students will want to contribute to in the form of donations that make the school stronger.
These schools may possess a “secret” to education but more likely it is their past success
which breeds future success. The need for a history of success creates a significant
barrier to entry that interferes with the industry’s competiveness and traditional market
forces.
53
THE REAL MARKET FOR EDUCATION
The structure of the higher education market reduces competiveness and
efficiency giving way to hierarchies between schools that are difficult to break. Even
though market forces do not produce the most efficient outcome, the market may possess
some level of efficiency especially in competition between for-profits. Theoretically, an
efficient market rewards the schools that best serve their students with high demand and
financial success. Although this applies to the top non-profit schools, it is not clear if it
applies to the for-profit sector. In fact as Heal asserted, the low quality schools may drive
out the good. Using the Senate HELP Committee’s data, I will determine if profitability
is related to the quality of the education. Although wage gains would be the best
determinant of an education’s effectiveness, I will gauge institutional quality by
instruction expenditures, default rates, and withdrawal rates. These are suitable
representations of a school’s quality because instruction expenditures measure the
amount of schooling a student receives per tuition dollar, default rates measure how well
a student’s income can handle the school’s cost, and withdrawal rates measure the portion
of students that believe the school is a good investment after spending up to one year at
the school. 1 Schools with high levels of instruction expenditures and low default and
withdrawal rates should theoretically be in highest demand and the most successful.
However, the data shows that the relationship between institutional quality and
profitability is low and even negatively correlated. Default rates showed a weak positive
1
These measures do not account for student population differences across institutions. If an institution
accepts wealthier students, these students would have lower default and withdrawal rates. Also, default
rates are an endogenous variable because students who cannot pay off federal loans will also struggle to
pay off any institutional loans resulting in lower profit margins for schools. However, institutional loans do
not comprise a large portion of for-profit balance sheets (IPEDS). Although these schools do not claim to
be an accurate random sample of the sector, the average rates for all of these measures are representative to
the industry as a whole.
54
correlation with profitability, but withdrawal rates and instruction expenditure levels
favored the less profitable schools. (Figures 4.1, 4.2, 4.3).
2007 & 2008 Profit Margins vs. 3-Year
Default Rates (Figure 4.1) HELP,
35%
30%
Profit Margin
25%
20%
15%
10%
5%
0%
0%
-5%
5%
10%
15%
20%
25%
30%
35%
40%
3-Year Default Rate
40%
2009 Profit Margins vs. Withdrawal
Rates (Figure 4.2) HELP
Profit Margin
35%
30%
25%
20%
15%
10%
5%
0%
20%
30%
40%
50%
60%
70%
80%
90%
% of Associate Degree Students Withdrawing Within 1 Year
55
2009 Profit Margins vs. Instruction
Spending Rates (Figure 4.3) HELP
40%
35%
Profit Margin
30%
25%
20%
15%
10%
5%
0%
5%
10%
15%
20%
25%
30%
Instruction Expenditure Rate
35%
40%
When regressing profit margins on instruction and default rate, there is a
significant correlation between higher instruction rates and lower profitability but no
statistically significant interaction between default rate and profit margin. The results
suggest that firms are better served keeping an additional dollar as profit rather than
spending it on instruction. The interaction between withdrawal rates and default rates is
also low which suggests that the students who withdraw are not more likely to fail to
repay their loans.
There is very little expenditure on marketing at publics and non-profits while it is
a very large portion of the for-profit budget. In 2009, for-profits spent a higher portion of
revenue on marketing than on profit: 22.7% vs. 19.3% (HELP, 2012). Theoretically, forprofits can overcome asymmetric information through marketing campaigns that help
students make informed decisions. In order to verify themselves as one of the “good”
56
institutions, schools can disseminate information about the success of their programs. To
see if marketing correlates with better quality schools I used the same data but regressed
the school quality measures on marketing expenditures. (Figures 4.4, 4.5, 4.6)
2009 Marketing Rates vs. 3-year
Default Rates (Figure 4.4) HELP
Marketing Expenditure Rate
35
30
25
20
15
10
5
0
0%
35%
5%
10%
15%
20%
25%
2006-2008 Average 3-year Default Rate
30%
35%
2009 Marketing Rates vs. Withdrawal
Rates (Figure 4.5) HELP
Market Expenditure Rate
30%
25%
20%
15%
10%
20%
30%
40%
50%
60%
70%
80%
% of Associate Degree Students Withdrawing Within 1 Year
90%
57
2009 Marketing Rates vs. Instruction
Spending Rates (Figure 4.6) HELP
35
Marketing Expenditure Rate
30
25
20
15
10
5
5%
10%
15%
20%
25%
30%
Instruction Expenditure Rate
35%
40%
The results show little correlation between marketing expenditures and default
rates and a slightly larger negative correlation between marketing expenditures and
instructional spending. Most concerning is the positive correlation of 0.6 between
marketing rates and one-year withdrawal rates in associate’s degree programs. The
marketing levels relative to school quality suggest that the lower quality schools depend
more heavily on marketing. It appears the “lemons” use marketing the most. A possible
explanation is they use marketing to disguise the true quality of their education. The real
market for education reflects the lack of efficiency that economic theory predicts. To
maximize welfare, intervention is necessary to correct these market inefficiencies. The
next section will show how for-profits compete in light of these market failures.
58
Understanding how for-profits stay profitable in an inefficient market will inform
regulation that tries to redesign firm incentives to maximize benefit.
59
Chapter 5
HOW FOR-PROFITS COMPETE PRODUCTIVELY
The education market possesses significant barriers to entry, a hierarchal rather
than flat structure, and heavily subsidized non-profits and publics that are able to provide
services below cost. From the limited data examined, a school that offers a better quality
education is not more likely to be profitable. For these reasons, successfully entering the
market should be difficult for proprietary schools. To be sure, many for-profits are not
successful. Despite the fewer for-profit institutions, the industry has the highest amount
of school closures. Between 2006 and 2011, 60 for-profits shut down compared to 42
non-profits and just one 1 public institution (IPEDS Table 282). Nevertheless, the
growing enrollment and the strong earnings reports suggest that the sector is healthy.
This section will discuss the ways that for-profits gain competitive advantages against
traditional schools and one another. The infiltration of markets where public and nonprofits do not meet student demand is an example of a productive way for-profits
compete for profitability. Conversely, some of the firms compete in unproductive ways
that may raise profitability but do so at a detriment to students and taxpayers.
For-profit schools are more responsive to market tendencies and more willing to
take advantage of a particular market. While states can be slow to adjust to educational
demand, if there is a lack of postsecondary schools in an area where student demand is
high, for-profits are more likely to view this as an opportunity. The largest for-profit
conglomerate, the University of Phoenix, is capable of erecting a new institution in
approximately six months (Sperling, 1997). Between 1995 and 2000, the change in forprofit enrollment correlated with the percent change in the population between the ages
60
of 18-24 more strongly than public enrollment figures. For-profits are also more ready to
capitalize on macroeconomic shifts that increase the demand for education. During
recessions which usually bring cutbacks to school budgets, need-based financial aid
becomes more available as incomes decrease. Economic downturns cause students to
return to school (Pennington, 2002), public schools to face budget cuts, and aid to
become more readily available allowing for-profits to take advantage of their
countercyclical competitive advantage. Sarah Turner found that a percentage point
increase in the state unemployment rate is linked to an increase in enrollment at forprofits of 7-9% (Turner, 2004). Turner offers two reasons why the for-profits outgain
traditional schools: first, for-profits specialize in offering skill development that may be
especially attractive to displaced workers. Secondly, for-profits have lower fixed costs
and rely on variable inputs like rented space and untenured faculty that allow schools to
make short-term responses to market demand. For-profits respond during economic
downturns in a way that profits companies while providing excess capacity for the
educational system.
For-profits can also maintain profitability by exiting the markets where
competition is greater from public and non-profit schools. Stephanie Cellini studied the
effect of increasing funding at community colleges on for-profit institutions in her paper
“Crowded Colleges and College Crowd-Out” (Cellini, 2009). Using a regression
discontinuity approach, Cellini compared the enrollment changes in California counties
after approving community college debt financing. Cellini found that for every $100
million of debt issuance, roughly 700 students exited the private school sector to attend a
community college and the number of proprietary institutions decreased proportionately.
61
Although Cellini did not test the inverse relationship, the study suggests that since
students view for-profits and community colleges as substitutes, a decline in the support
for public colleges would cause a student exodus into the private sector. For-profit
sensitivity to the competitor’s supply allows the industry to avoid unprofitable markets
where competitors are strongest. For-profits are capable of more immediate responses to
demand because they are not subject to the lengthy decision making process at publics
and non-profits. The schools’ dependence on variable costs but steady revenue from
enrollment allows them to enter and exit markets with greater flexibility.
Another way for-profits are able to attract students to their campuses is through
the flexibility and convenience of their programs. Even though the quality of a for-profit
education is often inferior, the for-profits do an effective job of tailoring programs to
student tastes. Some students prefer an education without the “frills” that do not directly
contribute to employability like course distribution requirements or varsity athletics
facilities. For-profit schools also make use of convenient scheduling during evening
hours and long blocks on the weekend. They avoid isolated campuses and instead prefer
easily accessible locations like strip malls with abundant parking. Students can enroll at
more times during the year, and for-profits make it easy to re-enroll and generously
accept transfer credits. For-profits also unbundle their costs and charge students based on
the amount of resources consumed. Instead of a “one price” model that features
consistent tuition prices regardless of program cost, for-profit tuition prices vary by
program cost and demand (Breneman, 2006). The University of Phoenix charged thirteen
different tuition prices for a Bachelor’s degree in business depending on the campus
(HELP, 2012). By paying a fee-for-service, students ensure they do not absorb the costs
62
of the unessential components of their education. Unbundled costs and convenience
lower the total cost to students and also allow them more time for work or leisure while
enrolled.
Entering markets where student demand is strong and tailoring programs to
student tastes is an effective way to increase enrollment, but sustaining profits is
contingent upon low costs. For-profits can improve efficiency by keeping costs low and
generate profits by increasing the scale of these margins. An important expense that forprofits keep low is faculty costs. They do not hire as many administrative and secretarial
staff as traditional schools and average fewer professors per student (IPEDS). While 4year non-profits and publics pay their professors $82,351 and $76,861 respectively, forprofits tend to hire adjunct professors with lower levels of education that earn an average
salary of $53,736 (IPEDS). Even if the professors are teaching part-time, many can still
take on a larger course load because they do not spend time conducting research (Bennet,
2010). Facilities are another major college expense that for-profits minimize. For-profits
do not invest in large brick and mortar facilities. Instead, they rely on leaner offices and
large conference rooms or auditoriums that office buildings offer for lease (Bennet,
2010). They tend to have smaller campuses, and if they already possess a campus
presence, they will rent satellite classroom space rather than build another campus
(Silber, 2012). For-profits even share campuses between their college brands by using
the same campus for a night school program that also functions as a college during the
day. For-profits do not spend revenue on research facilities or hospitals which often
account for large portions of the budgets at traditional schools even though they may not
directly serve students (IPEDS).
63
For-profits also make use of distance (online) education and chain schools that
benefit from production scale. For-profits standardize their curriculums centrally and
then replicate and distribute to their branches nationwide. For example, University of
Phoenix’s rEsource platform contains all of the school’s course materials creating savings
on book and instructions costs as well as increasing mobile access (University of
Phoenix, 2013). Online courses are another effective way to keep profit margins high
while increasing volume. After an initial investment, online schools have extremely low
marginal costs and require very little physical presence and labor. For a school that is
unwilling to compromise their level of instruction in the online experience, the internet
can be an extremely costly way to simulate traditional results. For a for-profit that may
not be as concerned with education quality, offering basic courses online is an easy way
to increase enrollment without large increases in costs.
64
HOW FOR-PROFITS COMPETE THROUGH CIRCUMVENTION
Responding to market forces, offering a flexible and convenient product, and
driving down the costs of inputs are all ways that for-profits can compete with the
traditional postsecondary education sector. For-profit schools also compete in a more
nuanced respect: they avoid the markets saturated with existing postsecondary
institutions. One example is the lack of elite for-profit universities. As discussed
previously, this market is well-insulated from market forces and its luxury appeal could
potentially be very profitable, yet for-profits do not attempt to compete here because of
the strong existing non-profit and public presence. Instead, for profits target students that
the typical college student body excludes. If access to a for-profit school provided a
strong benefit, then increasing access by targeting the underserved students would be
very encouraging.
The open enrollment for-profits automatically provide access regardless of a
student’s academic background. For-profits also avoid competition in certain
geographical markets while capitalizing on other markets where competition is thin. If a
program has national application and appeal, then for-profits can reach markets in less
inhabited areas of the country through the proliferation of chains or distance education.
If the program is more specific to an industry like fashion design, then the for-profit can
locate itself in close proximity to other schools that specialize in different fields or cities
where the industry is prevalent. Like hospitals specializing in different treatments,
schools within close proximity that have different specializations are less likely to
compete for students. For-profits also tend to teach more vocational and practical courses
for two reasons. First, publics and non-profits do not meet the demand for these
65
programs partially because these programs do not achieve some of the public education
goals beyond productivity increases. Secondly, for-profits find it useful to teach these
skills because they are easily certifiable. If a mechanic receives training that enables the
mechanic to pass a license test to become eligible to practice, then the employer cares
more about the mechanic’s ability to work rather than the mechanic’s educational
background. The employer is more likely to assume that passing the licensing process
sufficiently vets employees. Finally, while traditional colleges mostly fill their student
bodies with recent high school graduates, for-profits serve an older population (IPEDS).
These are the students in search of a “no frills” expedited education that can return them
to the workforce or offers them the autonomy to attend school while working and living
at home. More for-profit students work during college and a greater portion identified
themselves as workers enrolled in classes than students also working (Wine, 2009).
Much of the time, for-profits understand they cannot compete with the heavily endowed
non-profits and government supported traditional universities, as a result, they will teach
different programs in different locations to different students.
66
HOW FOR-PROFITS COMPETE UNPRODUCTIVELY
The most dangerous aspects of for-profits are the unproductive ways that they
compete with the traditional higher education institutions. It is difficult to recognize
whether a behavior is productive. For instance, is spending less on teachers efficiently
pushing down the price of inputs or does it generate savings at the expense of student
learning? The answer varies on a case basis. Nonetheless, there are many reported
instances where for-profits use methods that boosted profits but hurt individuals or
taxpayers. Some of these methods entice students to make poor investments. Misleading
students about the returns and costs to enrollment and predatory recruiting are profitable
ways schools can increase enrollment. Also, for-profits can take advantage of the limited
information available to students by charging high tuition without losing much student
demand. Third, for-profits find it profitable to target the students who face the relatively
cheapest tuition costs thanks to well-funded need-based financial support programs.
Finally, for-profits can exist by appealing to less motivated students who prefer to earn
degrees for less work. Some of these methods are fraudulent while others simply respond
to existing market forces in a disingenuous manner; regardless these tactics help forprofits survive without having to increase the quality or decrease the cost of the product
they provide.
Market forces should generate positive behavior from for-profits that encourages
advertising to publicize the positive benefits students receive. Applicants should be
immune to sales pressure, wary to unsubstantiated claims, and punish schools that fail to
meet perceived value. These types of informed and rational applicants are not the
predominant consumer in the education market. In “The (forthcoming?) Emergence of
67
For-Profit Higher Education Institutions” , Julien Jacqmin creates a mathematical model
that shows how a for-profit can maintain profitability in a market where it offers an
inferior good. Jacqmin’s two assumptions are that traditional schools are better and that
they cost less. Under these terms, for-profits find it more profitable to induce enrollment
by increasing a student’s perception of school quality rather than increasing school
quality. Jacqmin relies on previous literature that demonstrates that the persuasive effect
of advertising is more salient for disadvantaged students and applies this effect to the forprofit sector (Jacqmin, 2012). Under the current market forces of asymmetric
information, for-profits face incentives to increase the opacity around a school’s quality.
Because of the incentives to demonstrate growth and attain profitability by
increasing enrollment, for-profit colleges face temptations to use illegal or ethically
ambiguous methods. The Government Accountability Office sponsored an investigation
that sent actors posing as students into a nationally representative sample of fifteen
colleges. One student was eligible for Title IV aid while another student had a financial
background that did not qualify for aid. The report discovered that four of the admissions
departments engaged in fraud while every school made questionable or deceptive
statements. On multiple occasions admissions representatives counseled the aid
ineligible student to falsify his Free Application for Federal Student Aid (FAFSA)
document by hiding $250,000 in savings and reporting nonexistent financial dependents
to become eligible for financial aid (Kutz, 2010).
Admissions representatives made misleading statements regarding school
accreditation with one representative claiming that the school was accredited by the same
agency that accredited Harvard and the University of Florida. Schools were reluctant to
68
comply with a federal statute that requires providing graduation rates upon request and
there were several instances where the school representatives overstated the possibility of
employment. One beauty college told an applicant that barbers earn $150,000-$250,000
per year when 90% of barbers earn less than $43,000 annually according to the Bureau of
Labor Statistics (Kutz, 2010). The schools also misled the potential students about the
cost and duration of the programs. Nine colleges stated program completion dates based
on year-round attendance yet quoted an annual cost based on attending classes for nine
months per year. The investigation also reported several counts of misleading
information about financial aid. There were six instances where representatives told
applicants they could not speak to a financial aid representative until the applicant
completed the enrollment form even though federal regulations require that schools make
information about financial aid programs available to all current and prospective students.
Representatives also made statements suggesting applicants not worry about the amount
borrowed either because the future salary would be sufficient to repay loans or that there
were no consequences to defaulting on loans. For-profit applicants cannot make an
informed enrollment decision if they do not understand the actual costs and potential
benefits to attendance. If misleading students about the value of an education will
increase enrollment and schools are unlikely to be caught or severely punished, profitseeking companies will continue this practice.
The failure of for-profits to provide the necessary information to inform
applicants was not a mistake due to negligence. Marketing and advertisement are integral
to for-profit subsistence. The Senate HELP committee found that among the companies
surveyed, the average school budget spent 23% of revenue on marketing, sales, and
69
advertising equating to an average of $2,900 spent per student and one recruiter for every
53 students enrolled (HELP, 2012). The internal documents and interviews with former
employees revealed instances of for-profits encouraging staff to exploit applicants.
Internal training manuals purposefully instruct recruiters to behave in misleading ways.
National American University training materials instructed recruiters to “not give out the
complete program cost” and to give non-answers when asked about cost. If the applicant
persisted, recruiters should give the cost per credit hour without stating the required
number of credit hours (HELP, 2012). The GAO report found instances where recruiters
became hostile towards applicants that expressed concerns about being able to afford the
tuition. Many schools pay websites to generate leads by collecting the student
information of those who express inquiries to these “unaffiliated” websites. With these
leads, recruiters use aggressive techniques to try to close sales. The GAO undercover
students reported hundreds of phone calls after entering their information to an online site
(Kutz, 2010). Even if schools do not withhold important information or actively mislead
students, advertising can still have a negative effect if it persuades students to attend a
school they would otherwise not want to attend.
An even-minded person may be able to resist the advertising practices of these
institutions. As a consequence, recruiters target a more susceptible demographic. One
former recruiter reported to the HELP committee (HELP, 2012):
It’s a boiler room…selling education to people who don’t really want it [sic]. We
are trained specifically on how to work the angle of psychology . . . we tell
students this is the right thing to do it will make their parents proud, it will make
them a role model for their kids, it will help them fulfill lifelong goals. If we
don’t have a degree they want, we are supposed to convince them that one of
ours will work for them anyway.
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The schools target people in vulnerable circumstances likely to make impulsive
decisions. One recruiter training manual profiled the targets as: welfare mothers,
pregnant ladies, recent divorces, people with low self-esteem, people with low-income
jobs, someone who experienced a recent death, the physically/mentally abused, recent
incarcerates, and drug rehabilitants (HELP, 2012). Recruiters make trips to social
services agencies and welfare and public housing offices (HELP,2012 ). These students
never considered attending college and recruiters do offer them new opportunities, but
they may also be too unprepared to receive a gain from attending the school. These are
the students who fall outside the traditional public and non-profit postsecondary system
because of costs and academic preparedness, but for-profit school recruiters will counsel
these people to enroll with the help of federal money to create a better opportunity for
themselves.
Federal aid programs reduce tuition prices and increase demand for higher
education. Consequentially, the increased demand for higher education is one of the
largest reasons for-profits are able to stay competitive. By subsidizing the consumer, forprofits can enroll these students with the help of a third-party payer. Cellini studied the
impact of increasing the maximum benefit from the federal Pell Grant and G.I. Bill grant
programs as well as the Cal grant programs on for-profit entry in California. In her paper
“Doe Aid Encourage Entry?” (2010), Cellini concludes that for all of these programs
besides the G.I. Bill, the increases in the maximum student award increased the net
number of for-profit colleges in a county (Cellini, 2010). The effect is even stronger in
low-income counties suggesting that for-profits enter to capitalize on the new elevated
aid levels that disproportionately help low-income students.
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Cellini finds that increasing aid increases the quantity of education consumed
because the supply of education is relatively elastic. However, it is also possible that the
aid increases translate to higher tuition prices. For-profits may charge higher tuition
prices to keep student out of pocket costs constant and transfer the higher grant revenue
to themselves. In a 1987 New York Times opinion piece, Secretary of Education
William J. Bennett hypothesized that schools absorbed grant increases with higher tuition
prices that actually made colleges less affordable (Bennett, 1987). There has since been
debate over the evidence supporting the Bennett Hypothesis, but at for-profit schools it
seems plausible that schools will use grant increases to bolster profits rather than provide
a higher quality product or increase the volume of students.
Cellini and Goldin test the Bennett Hypothesis in their paper “Does Federal
Student Aid Raise Tuition”. They compare Title IV eligible for-profits with for-profit
schools that do not receive Title IV aid but offer similar degrees. The authors find that
the Title IV institutions charge tuition that is about 75% higher than tuition at comparable
institutions even after controlling for reputation and quality measured by the performance
on state licensing exams. Their findings suggest that for-profits pocket grant increases
through increased tuition costs (Cellini and Goldin, 2012). Anecdotal evidence from the
Senate HELP committee supports this conclusion. Internal Bridgepoint Education
executive e-mails discussing tuition prices revealed that management based tuition costs
on the Stafford loan benchmarks. Likewise, internal Alta Colleges pricing strategy
documents recommended restructuring semester lengths to get a larger portion of
students’ Stafford loans (HELP, 2012). Higher tuition costs with stable demand translate
to more revenue for schools, but higher costs mean larger amounts of dependence on
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federal aid for students. Schools prioritize increasing revenue and are indifferent to
student debt levels because loan defaults come at little cost to the schools. Defaulting on
federal loans comes at little cost to for-profits but can be very costly to students as well as
the government.
Subsidizing student tuitions would seem like a positive way to promote
competition within the higher education sector by protecting student institutional choice
while increasing access. It appears that the increase in aid does have some positive effect
on for-profit enrollment and the number of institutions (Cellini, 2010). However, these
subsidies also encourage for-profits to enter the market and exploit the inflated demand
lending credence to the Bennett Hypothesis (Cellini and Goldin, 2012). Since students
do not show strong benefits from attending a for-profit and federal support increases
profits in addition to attendance, then Title IV funding to for-profits does not help
maximize social well-being. The funding makes it easier for students to purchase
something that dos not ultimately benefit them. Also, the aid makes these corporations
more profitable than they would otherwise be. The federal government crowds out
private investment to support federal aid programs for these schools. To make matters
worse, these lucrative businesses consume top management talent and additional private
investment because of their profitability buoyed by the government.
For-profits can attract students and increase revenues by offering enrollment to
students who do not want to study at a demanding institution. If these are customer
tastes, a for-profit will likely respond. Students who do not want to or do not have the
time to complete a rigorous program will prefer attending a school that is not challenging
even if it means their future earnings gains are lower. Girogio Brunello and Lorenzo
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Rocco provide the mathematical framework behind an equilibrium where private schools
offer lower degree benchmarks at a higher price to students who have a higher cost of
effort and thus prefer less demanding schools (Brunello, 2005). The schools are able to
take advantage of student shortsightedness and profit by behaving in a way that
traditional schools will not.
Although there is not strong suspicion that schools are selling degrees to students
who do not deserve them, there is evidence that for-profit schools provide a less rigorous
curriculum than comparative schools. Whether this is the intent of schools is unclear, but
the possibility exists that schools find it profitable to deliberately lower the standards
attached to a degree. In 2011, the Government Accountability Office enrolled
undercover students into twelve online for-profit colleges. These students submitted
blatantly plagiarized work, photos instead of essays, or incomplete work and still
received full credit (Hillman, 2011). The coursework was oftentimes excessively easy.
One question on a quiz for a computers class titled “Introduction to Productivity
Software” read “Software that is used primarily with text to create, edit, and format
documents is known as ________ software.” with multiple choice answers of “relational
database”, “word processing”, “electronic spreadsheet”, and “presentation” (Hillman,
2011) (HELP, 2012). The Senate HELP committee uncovered internal e-mails that
expose administrators instructing teachers to ignore the poor performance of students.
One teacher complained (HELP, 2012):
I hear students tell me that they have encountered employers that point
blank tell them that they do not hire NTI students because of consistent
poor performance. Meanwhile we at NTI are being told to pass students
who should fail because we are ‘training entry level technicians who paid
for the certificates like everybody else.’
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Determining the intention of for-profit schools requires being privy to the innermost
management discussions. However, it is very possible that there are “bad players” who
act as degree peddlers to students who want degrees without expending much effort.
Markets traditionally punish cheaters and producers of overpriced, inferior
products. They also have the ability to push costs down and respond to demand in a way
that eludes central planners. Market forces necessitated that for-profits become fast
responders to student demand and find innovative ways like distance education and
massive scale to keep costs down. However, there are also many instances where the
current market structures incentivize for-profits to behave in unproductive ways that can
improve corporate margins without helping students. The incentives for unproductive
behavior exist in economic theory, and there are numerous examples that confirm their
practice. For-profits exploit the informational asymmetry between the students and the
school through deceptive statements that students cannot verify. They also employ
aggressive sales tactics to induce enrollment from students who are unsure about
enrollment. For-profits take advantage of federal aid by adjusting tuition prices
according to grant size and they target students who are eligible to receive the most
financial aid. Finally, because many students demand a degree but do not want to exert
themselves in the process, schools that do not prioritize academic prestige can lower
quality while maintaining high tuition prices. The productive ways that for-profits
compete are reasons for optimism and are why the sector is able to handle massive
growth. It is the harmful ways for-profits can affect students that make the government
institutions around them wary of their existence. The failure of a competitive higher
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education market to produce efficient outcomes has prompted the government to heavily
regulate the industry to try to correct some of the perverse incentives.
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Chapter 6
WHY DOES GOVERNMENT INTERVENE?
Many for-profits welcome more intense regulation. They feel that identifying and
punishing the “bad players” will help their brands by weakening the competition and
removing the schools that tarnish the industry’s reputation among prospective students
(Kingkade, 2012). To appease their concerns as well as the concerns of many others, the
states and federal government actively regulate the education sector and will likely
increase regulation in the near future. Using the industry’s past response to regulation as
a reference, this section will critically evaluate the ability of current and future regulation
to correct the unproductive ways that allow low quality for-profits to exist. Finally, the
chapter will conclude by designing an accountability framework that realigns industry
incentives to maximize the potential benefit from for-profits. Given society’s educational
goals, the for-profit sector needs government interference that remedies for-profit
shortcomings and redirects the schools in a positive direction.
The current market failures lend justification to government intervention in the
for-profit industry. The market failures exist because of a lack of information provided to
students about school effectiveness. The cost of education is artificially cheap due to
state aid, alumni support, and federal aid programs that can support schools across sectors
independent of academic quality. A principal-agent dilemma exists among schools,
students, and taxpayers because a for-profit’s corporate success does not depend on a
student’s personal success. As a result, the higher education market is unable to
efficiently function like most other industries. These market failures allow for the entry
of for-profits schools that do not provide a net positive benefit to graduates or society.
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Students and taxpayers associate college degrees with positive private and public
outcomes, and have been right to do so: completing college correlates with higher
incomes, lower unemployment, reduced reliance on public assistance, better health, and
higher civic values (Snyder, 2012). However, because for-profits do not always achieve
these same outcomes, the government must intervene to ensure that students attending
for-profits are making a worthwhile investment.
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THE CURRENT REGULATORY ENVIRONMENT
There are three entities that are responsible for the oversight of the for-profit
industry: institutional accreditors, the states, and the U.S. Department of Education.
Federal government enforces regulation mostly by threatening to withhold Title IV
funding or by pursuing legal action in case-by-case instances. Otherwise, government
cannot verify school quality except by subjecting graduates to occupational licensing
exams or certification requirements. The Higher Education Act of 1965 and its
subsequent reauthorizations are responsible for the majority of federal regulations
affecting postsecondary institutions. Following a reauthorization of the Higher Education
Act, a period of negotiated rulemaking follows. The rulemaking process constructs the
text for new regulations with the help of a committee of industry stakeholders led by the
Department of Education. After issuing a Notice of Proposed Rulemaking, the
committee accepts comments before issuing a final ruling. The Obama administration
led a highly contentious round of rulemaking following the 2008 reauthorization of
HEOA that focuses on maintaining program integrity at for-profits. The most
contentious issue proposals are the new rules on misrepresentation, state authorization,
incentive compensation, and the gainful employment rule.
The Department of Education does not accredit institutions, instead it recognizes
private, non-profit accreditation agencies based on certain criteria. Accreditation status,
state authorization, and two years of operational experience are the prerequisites for
access to Title IV funding (Department of Education, 2012). These accreditation
agencies conduct their own quality assurance processes. They charge the schools they
accredit a fee which makes them financially dependent on the institutions they review.
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For-profits select the agency that that will conduct the institution’s review. As a result,
accrediting agencies may face incentives to keep accreditation standards at the minimum
level that will maintain government recognition if they value earning enough revenue to
subsist above reputational excellence. States also possess a role in the oversight process,
although standards can vary greatly between states relative to consumer protection laws
and openness to new businesses. In the Department of Education’s final version of its
Program Integrity rules (Department of Education, 2010), it strengthened state power
over for-profits and gave them more agency to respond to student complaints.
The federal government is the most important piece of the higher education
oversight. The size of the federal government’s financial investment makes them the
regulatory body that has the most at stake in for-profits. The Department of Education
conducts occasional program reviews and institutions must maintain minimum financial
responsibility scores for the government to declare them financially healthy and not a
liability to go out of business while students are enrolled. The government also tries to
minimize loan losses. To safeguard its investment, the government disallows funding
when a school’s 2-year or 3-year cohort default rates exceed 40% or when a school
reports three consecutive years of default rates above 25% for the 2-year CDRs or above
30% for the 3-year CDRs (U.S. Department of Education, 2012). To limit the
government’s role in funding colleges, the 1992 HEA reauthorization capped federal
contributions toward for-profit school revenues at a ceiling of 85% (S. 1150--102nd
Congress, 1992). In 1998, Congress amended the 85/15 rule to its current 90/10 form
(H.R.
6--105th Congress, 1998). The rationale behind the rule is that if these schools are
worth federal money, then there must be some other source (private loans, scholarships,
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cash payments, state grants, and Department of Defense tuition assistance) willing to
invest at least 10% of the costs. Should a campus exceed the 90% rule in two
consecutive fiscal years, that campus loses its Title IV eligibility. In 2006, Congress
overturned a rule requiring that 50% of enrollment be campus-based to allow more online
institutions to receive Title IV funding (S. 1932--109th Congress, 2005).
The “skin in the game” 90/10 rule intends to deter the entry of low quality
colleges. Arguments against the rule contend that it forces for-profits to admit fewer
low-income students who cannot afford or do not have the ability to borrow 10% of costs.
To avoid exceeding the 90% threshold, grant and loan increases may force schools to
raise tuition prices so that a student’s aid does not occupy a larger portion of cost.
Arguments against the rule also feel that the 90/10 ratio does not correlate with school
quality and that community colleges who are not subject to the rule would fail if the limit
considered state grants as well as federal student aid (Kantrowitz, 2013). A 2010 GAO
report on the 90/10 rule found that large chain schools with publicly traded ownership
were more likely to have a higher 90/10 rate. The investigation also found these schools
were more likely to offer distance education, enroll a higher proportion of low-income
students, and specialize in healthcare (Scott, 2010). The report did not attempt to
measure a relationship between the proportion of funding from federal sources and school
quality.
The 1992 reauthorization of the Higher Education Act stated that for-profits could
not, “provide any commission, bonus, or other incentive payment based directly or
indirectly on success in securing enrollments” (S. 1150--102nd Congress, 1992). The
reauthorization effectively outlawed incentive based compensation for recruiters and lead
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generators. These restrictions were later loosened in favor of twelve “safe harbors” that
ruled enrollment could not be the sole factor in determining compensation for recruiters
(Department of Education, 2012). These “safe harbors” were later removed in the
Program Integrity rules that ban incentive compensation based on factors like solicitation,
targeted information dissemination, and helping students fill out enrollment or financial
aid applications (Department of Education, 2010). The regulations also attempt to combat
misinformation disseminated by for-profits. False or misleading statements pertaining to
information about a school’s educational programs, financial costs, and employability are
grounds for the return of Title IV funds or the payment of damages (Department of
Education, 2010). Finally, the Department of Education makes for-profits publish
information on a program’s costs, the graduation and placement rate, and the median
student loan debt.
Accompanying the rules on incentives for recruiters, misinformation and state
authorization, the most impactful component of the Program Integrity legislation is the
gainful employment rule. This rule defines a program as leading to gainful employment
if it satisfies one of the following: a student repayment rate (as little as $1) of at least
35%, a debt-to-annual earnings ratio of 12% or less, or a debt-to-discretionary income
ratio of 30% or less for program completers (Department of Education, 2011). These
restrictions reflect more lenient changes from earlier proposed rulemaking
announcements and include no restrictions until a school has failed to meet one of these
metrics in three out of four consecutive years. The regulation is currently at an impasse
since a U.S. District Court for the District of Columbia struck down parts of the gainful
employment rule because the 35% repayment rate threshold appeared arbitrary (Career
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College Ass’n v. Duncan, 2011). On June 26, 2012 the Department of Education
released “informational rates” on the vocational programs it reviewed—5.2% of the
programs under review failed all three tests and would have been ineligible for funding
were the rule in effect (Department of Education, 2012). All of these programs were at
proprietary schools. As of March 2013, the same court denied the Department of
Education’s motion to make for-profits release debt-to-income ratios on the grounds that
it would require a federal database of personally identifiable student information which is
outside the department’s authority under the Higher Education Act of 1965 (ASPCU v.
Duncan, 2013). An appeal to the decision that struck down the gainful employment rule
remains forthcoming at the time of this paper’s publication.
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A CRITICAL EVALUATION OF CURRENT AND PAST REGULATION
The ongoing discourse over how to best improve the industry confirms this
paper’s assertion that the private education sector is not maximizing well-being and past
regulations have not corrected industry misbehavior. This section will include the effects
of some of the most important and recent regulations like the Higher Education
Opportunity Act of 2008 (HEOA) and aspects of the Department of Education’s
rulemaking initiatives. I will also provide explanations of why the legislation falls short
of its intended impact and can create even further problems. Finally, this section will
discuss the forthcoming gainful employment rule and its potential impact should a form
of the rule pass. Most regulation attempts to remedy the student failure to effectively
weigh the costs against the benefits of attending a postsecondary institution. Some of the
regulation tries to support consumers with information that will create a more open and
competitive market, but the more impactful regulation relies on paternalistic measures to
keep students from making poor investment decisions.
Some of the new rules in higher education attempt to overcome the asymmetrical
information deficits that students face. New regulations raise transparency in for-profits,
but it is uncertain whether students armed with more information will be able to make
effective decisions. As of February 2013, the college scorecard on the Department of
Education’s website allows prospective students to see a college’s typical cost,
graduation rate, loan default rate, and a student’s median federal borrowing amount
(College Affordability and Transparency Center, 2013). The department also presents
students with listings of the most and least expensive schools sorted by school type as
well as a list of colleges and costs sorted by program and degree type (College
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Affordability and Transparency Center, 2013). Congress’s reauthorized HEOA forces
schools to promulgate cost-related information. The law includes a provision that all
institutions receiving Title IV funding include net price calculators on their websites by
2011 based on student and family information (H.R. 4137--110th Congress, 2007).
Although these changes are recent, their presence and expected arrival have received
complaints and have not resulted in lower tuition costs (College Affordability and
Transparency Center, 2013) (Gasman, 2013). According to the department’s college cost
calculator, for-profit tuition prices increased by an amount of 8%, 12.6%, and 16.2% for
4-year, 2-year, and less-than-2-year programs between 2009 and 2011—public and nonprofit schools increased tuitions at an even faster rate (College Affordability and
Transparency Center, 2013). The demand for postsecondary education could be so strong
that disseminating information and making price shopping easier does not create any
downward pressure on prices. However, the consumer’s failure to use this information to
make informed decisions likely plays a larger role.
Consumer choice increases quality and efficiency in most markets. However,
subsidized consumers facing a menu of postsecondary options may not behave
completely rationally. They do not possess the agency to choose either because of their
own shortsightedness or because college choice is still a decision made under great
uncertainty. For instance, students may understand how much more an elite university
costs than a local public college, but that does not provide any insight into the value of
attending either institution. In 2004, Colorado shifted the funding of its higher education
system from direct appropriations to vouchers. The College Opportunity Fund allowed
Colorado residents to offset their in-state tuition costs with a voucher at public and
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eligible private institutions. Although the first of its kinds at the state-level, the program
is similar to voucher-based Title IV grants and loans that make tuition costs less
expensive while preserving institutional choice. The rationale behind creating the
College Opportunity Fund was that it would put pressure on schools to operate more
efficiently and the stipend would promote access to higher education for
underrepresented populations who could use the value of the stipend to pay for the entire
tuition at one of the less expensive colleges. The Colorado Department of Higher
Education’s evaluation of the program finds that enrollment declined since the
legislation, especially among the low-income and underrepresented minorities. They also
found that schools did not become more entrepreneurial to compete with one another for
tuition dollars although some attribute this to the implementation of the school
reimbursements (Colorado Department of Higher Education, 2009). Increasing the
information available to students may improve decision making, but depending on
student choice to drive out bad colleges and reward good schools has not been effective.
The effect on aggressive sales tactics and misleading information is also unclear.
Although the Department of Education provides accurate school data on their website, it
is uncertain if this information can overcome the influence of for-profit marketing
campaigns. Of the two colleges that report the sources of new students, internet,
television, print, and radio advertisements usually comprise 65-80% of new starts.
Referrals, which are one of the sources of enrollment that depend strongly on positive
consumer experience, declined to accounting for 20% of new students (Silber, 2012). If
students choose institutions based on the knowledge of how much value the institution
will provide, verified success stories should be the strongest marketing component.
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Even if students are vulnerable to marketing campaigns, is this sufficient reason
to try to limit their practice? Is it wrong to compensate recruiters based on how they
perform in the most important aspect of their job? Although neither Congress nor the
Department of Education have passed formal regulation on college marketing or lead
generators, I expect relevant regulation in the near future. The Protecting Financial Aid
for Students and Taxpayers Act was reintroduced to the Senate on March 12, 2013. It
would ban colleges from using revenues from federal sources for advertising, marketing,
or recruiting purposes (S. 528--113th Congress, 2013). Similarly, the Senate HELP
subcommittee approved a version of a 2013 budget that included language that banned
spending federally sourced revenue for the same purposes (HELP Appropriation Bill,
2012). If students performed well at for-profits, incentivized recruiting and large
marketing budgets would be positive influences. Conversely, because the students do not
perform well, I expect there to be regulation to inhibit these “predators”. The restrictions
on marketing are paternalistic, but if they reduce the harm for-profits create, then their
purpose is fulfilled.
The regulations do not seek to improve the schools; instead, they try to diminish
the scope of their negative impact. Deceptive marketing and incentivized recruiting are
internal practices that are difficult to moderate. Students and regulators must “trust” that
for-profits will not engage in these tactics but recent legal cases suggest schools are
dishonest. In 2009, the Apollo Group settled for $78.5 million against a claim they
illegally incentivized recruiting and the Career Education Corporation settled lawsuits for
amounts of $12.4 million in 2008 and $40 million in 2010 for misrepresenting the value
of its educational program to students (Silber, 2012). To catch every instance of
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corporate malfeasance would require extensive access to schools and a demanding
investigative effort, yet if the penalties are not harsh enough and offenders are rarely
found guilty, these schools will not behave differently.
The 90/10 rule similarly tries to contain the for-profit industry rather than make it
more effective. The rule has produced mixed results. It achieves its objective of limiting
federal exposure to the for-profit sector, but it has created unintended consequences. The
exclusion of tuition assistance from the Department of Defense has made for-profits seek
out former veterans as a cheap third party source of funds that does not count against
their 90/10 ratio. It also has the potential to push tuition prices higher. Increases in
federal aid already increase tuitions (Celinni and Goldin 2012), but these increases may
be a response to the 90/10 ratio. Schools that need “wiggle room” beneath the 90%
threshold may raise tuitions after grant or loan increases to keep cash payments from
students at a consistent level. Therefore, instead of keeping costs low, these grants,
combined with the 90/10 rule to push tuition prices and student costs higher. Other forprofit responses to the 90/10 rule include attracting more foreign students ineligible for
Title IV funding or combining the campus identification numbers of high ratio campuses
with low ratio campuses to produce a more stable ratio. If trying to “cheat” the ratio will
not work, then for-profits may refuse the Title IV funds to stay below the 90% threshold.
The way the rule stands, a school that poorly educates veterans can exist entirely from
government funding, but a school that does an excellent job of educating lower-income,
aid-dependent students risks exceeding the 90% ceiling and facing penalties. If the rule
attempts to limit federal exposure, it may fulfill this intention; if it seeks to improve
school quality and keep costs low, it fails.
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The most important assumption behind the gainful employment rule is that
students borrow too much to pay for educations at for-profit schools. Students may
borrow at unsustainable levels because of a lack of information about the costs of debt or
they might not be capable of making long-term decisions. It is not clear if the rule is for
protection or paternalism purposes but the effect is the same. The rule intends to ensure
35% of students reduce their total balance (interest and principle) or graduates do not face
annual debt payments that are too large considering their incomes. The students from atrisk backgrounds are likely to be borrowing the most to attend college and earning the
least after college. If the rule passes, these students will perform worse on debt-toincome metrics and for-profits will exclude them from schools to keep ratio numbers
below the threshold. Thus, the rule provides disincentives for schools to accept lowincome, low-performing students. A report on gainful employment by Jonathan Guryan
commissioned by for-profit lobbyist the Career College Association estimated that over 5
million students between 2011-2020 would exceed an 8% debt-to-earnings ratio (Guryan,
and Thompson 2010). Schools in danger of exceeding the threshold could resort to
rejecting these types of students. Not only does the rule risk excluding students, it does
not measure if the school is a good investment for the student.
If attending a for-profit school causes an increase in earnings, students could
experience a lifetime gain in earnings even if their debt to earnings ratio exceeds the
gainful employment levels. Depending on the school’s wage premium and the student’s
discount rate of future earnings, a student can carry an annual debt of almost $20,000 and
break even over a lifetime with a debt to income ratio of 53% according to the Career
College Association (Guryan, 2010). These calculations count foregone earnings during
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the time of enrollment and suggest that high debt levels are a worthwhile investment for
those who experience strong earnings returns that accrue over a lifetime. Because the
rule focuses on relative earnings instead of wage increases, it risks excluding students
who would have a lifetime benefit to education even if their cost of education was higher.
The department responded that the thresholds are set to reflect debt levels that are
unsustainable for students from any demographic or economic circumstance and that
many schools serving the most disadvantaged students still perform well on these metrics
(Department of Education, 2011). Guryan’s report states that students who financed 80%
of medical school tuition would not pass the rule’s debt-to-income ratio (Guryan, 2010).
If this rule existed, only the affluent would be able to afford certain educational
investments. Nevertheless, the rule deserves recognition for trying to impose regulations
on schools that do not produce graduates with earnings that justify their investment. The
rule’s intention is to make high cost schools pay off in the form of earnings that are able
to pay down student debt. However, there are many who will experience a wage
premium that justifies debt levels far above the rule’s cap. Because these students fail the
second two metrics, schools risk becoming beholden to the student’s attentiveness to
repaying loans. There are legitimate democratic and economic objections to a rule that
incentivizes excluding these students.
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AN EFFECTIVE REGULATORY FRAMEWORK
Most of the regulation tries to control what the firms spend, what they say to
students, and how much they cost students, but these regulations do not directly force forprofits to improve the quality of their schools. I agree that meaningful regulation must
try to change firm behavior rather than consumer behavior. Consumers make decisions
under such limited information and short-sightedness that there is not a high expectation
that they will make the best investments. With the shortcomings of both consumers and
the current for-profit regulations, what should an effective regulatory system look like?
Most importantly, school incentives need to align with student and societal goals. Under
current conditions, schools can attract students, comply with federal regulations, and be a
lucrative investment for shareholders while failing to be a good investment for students
and taxpayers. Regulation tries to balance preserving access to schools for the
underprivileged and protecting students from fraud or bad outcomes. The current state of
the industry suggests that regulation does so unsuccessfully. Disadvantaged students
receive access but not results. Ultimately the regulation attempts to punish firms for
taking shortcuts rather than reward them for producing results that meet the goals of
students and society.
When planning a new regulatory system, an important concession is that not
everyone can or should receive a college education. This concession presumes that we
are comfortable living in an unequally educated society similar to the one we live in now.
To accept this admits that postsecondary schools have a different purpose than primary
and secondary schools. These schools may be essential to instilling certain values and
lessons to students, but postsecondary education is not equally indispensable to
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citizenship. The primary goal of postsecondary education is to create an efficient and
productive workforce. Therefore, having the highest possible number of college
graduates is not a valid goal if it means graduating students at a cost greater than the
associated benefit.
If not everyone must go to college, then who should attend college? These are
normative judgments a society should make. One possibility is an educational
distribution that favors those who can afford it which is easily achieved by withdrawing
taxpayer support, but this allocation sacrifices goals of social mobility for the sake of
protecting taxpayer dollars and an unfettered education market. Second, we could
distribute education to the “smartest” citizens and hope that the result would be gains in
the collective fields of research and knowledge that outweigh training the less qualified
portion of our labor force. Finally, we could try to educate those who want a degree the
most and try to maximize welfare under utilitarian principles at the cost of not
maximizing our knowledge base or productivity. These may sound like extreme choices,
but because of high priced elite colleges, merit-based scholarships, and extremely lowcost local colleges, the current market for education does favor the wealthy, the
intelligent, and the intellectually curious, but this is not the most efficient allocation. The
people who should invest in postsecondary education are the people who will gain the
most relative to cost. Therefore, government should intervene to try to promote the
education of students that will net the largest societal benefit from attendance. It could be
someone from an at-risk background that would later register a cost to society through the
use of social programs, or it could be someone who has an interest and expertise in an
under researched field where a breakthrough would be hugely beneficial to the rest of
92
society. To assign education based on presumed benefit would require two unrealistic
features in our society: complete knowledge of a student’s outcome with and without an
education and a central planner that has the ability to appropriate education based on this
knowledge. Because of the impossibility of gaining such information and the
infringement upon individual freedom it represents, a valid compromise must instead try
to incentivize education for the students that we expect will receive the largest benefit.
The easiest way to incentivize for-profits to improve student earnings would be to
make schools entitled to a portion of a student’s lifetime earnings. Making schools
investors in students would effectively solve the principle-agent dilemma because
maximizing firm profits would depend on maximizing student earnings relative to cost.
This solution would not serve goals of social mobility because schools would compete
for students who are destined for high earnings regardless of the institution they attend.
A solution that deemphasizes selecting on demographics biases will ignore gross incomes
and instead reward wage gains. Rewarding relative wage gains makes schools indifferent
to enrolling at-risk students versus well-off students. Therefore, an accountability system
that incentivizes increasing earnings as well as increasing social mobility will measure
the percentage earnings gains a student receives for attendance.
An obvious complication is that this reward system presupposes knowledge of the
counterfactual which in this case is how much a student would earn if they did not attend
a postsecondary institution. There is no exact way to know this for every individual, but
there are reasonable parameters that lend accuracy to estimates for large cohorts. The
more accurate the formula for estimating earnings is, the more reliable the measurement
of wage gains and the less the likelihood that a firm will “game” the system by looking
93
for ways the formula underestimates a student’s earnings potential. Title IV funding is
the government’s most valuable resource to influence for-profit behavior. The following
explains how the government can effectively use it.
First, the Department of Education provides a transparent formula for how they
calculate the expected earnings after X years of a student without attending college.
Then, for-profits judge applicant gains potential and admit students. Each school’s
cohort of students receives a formal calculation of the estimated total earnings without
attending college. Then the Department of Education establishes a benchmark gain-tocost ratio will serve as the expected return on investment. For example, if the ratio is
1.5:1 and the total tuition revenue for the cohort is $100,000, the department will expect a
difference between the earnings of the college cohort and the estimated non-college
earnings after X years to be $150,000 for the cohort. 2 If the tuition cost is $50,000, the
Department of Education will expect an earnings difference of $75,000 to keep the rate of
return constant. Then the schools will educate their students. After X years, a
recalculation of costs will take place accounting for dropouts and students who repeated
semesters. The department will calculate actual earnings over the X years less the
expected earnings without education. Then the department will divide this gain by the
actual costs to see if the gain-to-cost ratio exceeded the benchmark ratio. If the ratio is
lower than expected, the firms can face sanctions on funding or offer to “make whole”
the department by paying the difference between the cohort’s expected and actual
earnings. If a firm exceeds the benchmark gain, then the department can offer financial
2
The cost does not need to include the opportunity cost of not working while in school. All incomes
during school years will be included when summing total earnings over X years for the college group.
94
rewards relative to how much they surpassed the benchmark. Penalties and rewards will
also consider the volume of the cohorts.
The Department of Education determines access by setting the desired level of
return. Since they still invest Title IV funds to help students pay for school on a need
basis, a logical benchmark ratio is the necessary return for the department to break even
from the expected costs of grants and defaulted loans. Similar to how the Federal
Reserve controls the fed funds rate, the Department can raise or lower the gains-to-cost
ratio depending on whether they want to promote access or raise the returns to education.
A school will stop using Title IV funds if it does not feel it is able to offer its students this
return, which means the department will no longer be subsidizing a low-return school.
There are several complications. If an unanticipated recession occurs, it would
make it very difficult for schools to produce gains that were greater than estimations. In
this case, the department could readjust what they expected the earnings without college
to be or they could observe the earnings of a similar cohort that did not attend college.
Firms are also now at the whim of statistical variation and could face revenue shocks
based on chance. To fix this uncertainty to firms, the target gain-to-cost ratio could be a
range where no penalties or rewards would take place as long as a school fell into a
certain range. It is also difficult to choose when to assess the schools and see how the
firms performed relative to the ratio. A small X may effectively punish bad schools right
away, but a longer X reduces the possibility of statistical variation and gives a better
picture of what a school’s benefit over a lifetime will be. The department can make the
time frame an industry standard or can apply different time frames for different schools.
95
Most importantly, gains are not equal across the board. A 10% earnings gain for
a high earner is more valuable than an equivalent gain for a lower earner when
calculating earnings over time. If all of the low-income students in the cohort beat
anticipated wage gains by a modest amount, but an expected high earner does not do
well, then the cohorts ratio would not be strong even though many students benefited. To
reward social mobility, the ratio can weight relative gains equally between individuals.
In this instance a 5% gain for a low earner is equally valuable to a 5% gain for a high
earner.
Will this system or a similar system send enough students to college? It depends
on the definition of “enough”. If the goal is to see every student attend college, then this
incentive scheme will not work because schools will be unwilling to accept students who
cost too much to produce wage gains. If “enough” refers to every student who will have
a positive benefit relative to the cost of school being able to attend a postsecondary
institution, then enough students will get to attend school. For-profits will make every
effort to enroll students who will receive a large benefit relative to cost. Theoretically,
the firms will compete with each other to enroll the students who will gain the most from
college by lowering the cost to these individuals. The shift from a need-based program to
a benefit-based program will incentivize schools to put the “right” people in college.
Once the schools enroll these students, they will focus efforts on increasing
student earnings potential. A school’s financial success will be dependent on how
students perform after graduation. The most successful for-profit companies will be the
ones that bring the largest gains to students and these schools will have the capital to
grow and replicate their success across the country.
96
Chapter 7
CONCLUSION
There are three main goals we have for our postsecondary education system:
equality of access, low costs, and benefits private and public as well as economic and
social. Although the postsecondary school system shares these goals with the secondary
school system, these two sectors are different. At the postsecondary level, students must
find compelling private benefits to finance their own education because taxpayers do not
consider the public benefits worth the cost of providing every student free education.
Instead, the government uses need-based grants and loans to incentivize postsecondary
attendance at eligible public, non-profit, and for-profit institutions. For-profit colleges
and universities entered the postsecondary market as a choice for students to place their
educational investment. Many students now choose for-profit schools, but these
investments do not pay off at a high rate. The sector’s presence is a welcome relief to the
traditional schools that lack the capacity and responsiveness to provide access to these
students, yet for-profits may not be providing the training the workforce will need.
In efficient markets, firms that do not provide a benefit and consumers that do not
receive a benefit will not reach an exchange. In the education market though, students
frequently purchase educations whose tuition price and total economic cost are greater
than the future payoff. This dangerous reality in the higher education market leaves
students with debt, taxpayers with loan losses, labor markets with untrained workers, and
for-profit schools with profits.
For-profits in other areas of the world like Brazil, India, and Turkey all provide
superior educational products at modest prices compared to their public and non-profit
97
counterparts (Tooley, 2005). While these countries show that benefits from education are
not irreconcilable with profit-seeking firms, U.S. for-profits fall short due to the market
failures that are specific to the United States. The public and non-profit schools in the
United States benefit from reputations that can attract the best students and resources that
can offer educations below cost. These well-established and government supported
institutions put for-profits at a disadvantage. As a response, for-profit schools make use
of third party financial aid programs to reduce student costs and increase enrollment
ultimately generating more revenue. Unfortunately, these students receiving financial aid
are more likely to be unaware of the benefits of traditional schools and less likely to gain
admission to selective institutions which results in them making poor enrollment
decisions that support low performing schools. In an effort to increase the total welfare
education creates by supporting public schools and providing need-based aid, the
government actually distorts the market.
The schools are broke and regulation makes it worse. Increasing aid generosity
while capping federal aid levels can force tuition costs higher. Limiting a school’s
marketing opportunities restricts a good school from informing potential students of its
record for success. Putting a ceiling on a student’s debt limits attendance to the students
who can afford the educational investment upfront. Most of the industry’s regulation is
well-intentioned but it does not incentivize the schools to improve student outcomes.
The students also fail to hold the market accountable. Perhaps it is because
students face an information deficit, but they have been unable to reward the best
performing for-profit schools with their business while starving the underperforming
schools of customers. Therefore, a functioning regulatory system must accomplish this
98
goal. Using the Title IV programs as an incentive, the Department of Education must
place the onus on profit-seeking schools to make sure that the federal funds are going to
the students who will gain the most from attending school. This paper recognizes that
there are reasonable differences on how to define a school that best serves its students,
but one valid interpretation is that the best schools are the ones that provide the largest
economic benefit relative to economic costs. This paper puts forward an incentive
scheme that accomplishes this goal by rewarding the schools that have the largest gains
relative to costs. The logistics of the proposal in this paper are not as important as the
overarching design. Schools should educate the students who will experience the greatest
total societal benefit from school. More importantly, they should bear a portion of the
societal costs of a student that does not do well in school as well as receive some of the
benefit for students who excel. Rewarding schools for producing large returns on
educational investments and punishing the schools that yield negative investments will
solve the principle-agent dilemma and cause schools to compete in ways that keep costs
down and best improve student employment outcomes.
Certain aspects of the for-profit narrative are easy for the media to publicize to
create a sensationalist picture of the industry. Schools trick students into attending
colleges that are more expensive than traditional options. The students afford the high
costs using government money but often achieve poorly because the schools lavishly
compensate recruiters, executives, and shareholders rather than pay for the school’s
educational inputs. By the time the student realizes the degree is meaningless, the student
has left the school and has high amounts of debt that will come at a cost to either the
student or the taxpayer. Meanwhile, the student may not know how or be indifferent to
99
preventing more students from making the same enrollment mistake, so the school
continues enrolling students. There are problems in the education market that allow these
cycles to perpetuate. For-profits do not need more time for the market to function and
properly separate the good schools from the bad. The market’s structural problems and
incentives in place will never allow this efficiency to occur. Instead, government must
intervene to realign the incentives in the for-profit market so that schools will win when
students win.
100
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This thesis represents my work in accordance with University regulations.
Thomas P. Gibbons Jr.
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