NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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How the Great Recession Affected Higher Education

September 27 and 28, 2012
Jeffrey Brown of the University of Illinois and Caroline Hoxby of Stanford University, Organizers

Caroline Hoxby

Financial Rules for Universities Based on their Objectives and Constraints

Hoxby proposes a positive model of the university that generates many apparently peculiar features, such as endowments and tuition subsidies. The model puts forth a specific objective function: a university maximizes its contribution to the intellectual capital of society, valued as social returns. The objective function is enforced within the model-- that is, it leads to actions that reinforce the initial selection of the objective function. Endowments also arise naturally within the model: they are a necessary feature of certain universities, not an accident. The model has important implications for the decisions that universities make on many fronts, but Hoxby focuses on the implications for financial decisions, especially universities' endowment spending rules and portfolio allocations. Her model is designed to explain America's great private research universities and very selective liberal arts colleges and--with modest adaptations--institutions like America's and Britain's great public research universities. Indeed, an ancillary benefit of the model is that it provides a justification for existence of the aforementioned institutions by assigning them a unique role in the creation of the world's intellectual capital.


Keith Brown, University of Texas, and Cristian Tiu, SUNY at Buffalo

The Interaction of Spending Policies, Asset Allocation Strategies, and Investment Performance at University Endowment Funds

Using data for more than 800 college and university endowment funds over 2003-11, Brown and Tiu provide a comprehensive analysis of the spending policies used in practice, as well as how frequently and why those mandates are revised over time. Given the long-term and relatively static nature of the investment problem faced by the typical educational institution, the permanent portion of the stated spending policy should be highly stable. However, the researchers find that half of the endowments revised their rules at least once and, on average, about a quarter of the sample changed their spending policies each year, implying a retention rate far lower than expected. They show that larger endowments with lower historical portfolio returns and lower past payout levels are more likely to alter their future spending formulas, but that institutions having the ability to invoke special appropriations on a temporary basis are less likely to make adjustments to their permanent rules. Further, they document that both spending rule changes and asset allocation adjustments persist over time and that the former tends to lead the latter. Finally, while there is some evidence that endowment funds as a group produce superior returns relative to their policy benchmarks, this paper shows that there is no difference in benchmark-adjusted performance between institutions that either did or did not change their spending rules.


William Goetzmann, Yale University and NBER, and Sharon Oster, Yale University

Competition among University Endowments (NBER Working Paper No. 18173)

The asset allocation of university endowments recently has shifted dramatically towards alternative investments. Goetzmann and Oster examine the role played by strategic competition in motivating this shift. Using a metric capturing competition for undergraduate applications, they test whether endowment performance relative to a school's nearest competitor is associated with the likelihood of changing investment policy, and conditionally, whether the nature of that change is consistent with the goal of "catching up" to its closest rival. Conditional on indicating a policy change, the authors find that endowments appear to use marketable alternatives – that is,. hedge funds – to catch up to competitors. More generally, they find that endowments with below-median holdings of alternative investments tend to shift policies in that direction. Besides herding behavior, they find trend-chasing behavior. Endowments with recent positive experience with various alternative asset classes tend to increase exposure to them. Finally, the long-run implications of this competitive and trending behavior for the ability of endowments to deliver inter-generational equity are considered.


Jeffrey Brown; Stephen G. Dimmock, Nanyang Technological University; and Scott Weisbenner, University of Illinois and NBER

The Supply of and Demand for Charitable Donations to Higher Education (NBER Working Paper No. 18389)

Charitable donations are an important revenue source for many institutions of higher education. Brown, Dimmock, and Weisbenner explore how donations respond to economic and financial market shocks, accounting for both supply and demand channels through which these shocks operate. In panel data with fixed effects to control for unobservable differences across universities, they find that overall donations to higher education – and especially capital donations for university endowments or for buildings– are positively and significantly correlated with the average income and house values in the state where the university is located (supply effects). They also find that when a university suffers a negative endowment shock that is large relative to its operating budget, donations increase (demand effects). This is especially true for donations earmarked for current use. They conclude by discussing the importance of understanding how donations respond to economic shocks for effective financial risk management by colleges and universities.


Eric Bettinger, Stanford University and NBER, and Betsy Williams, Stanford University

Federal and State Financial Aid during the Great Recession

During the Great Recession, the maximum federal Pell award grew by over 32 percent in three years, at the fastest rate in its history. Bettinger and Williams examine how states' need-based financial aid policies responded to the economic downturn and to this Pell program. Documenting trends in state and federal policies, the authors show a pattern: as many as half of the states have reduced the generosity of their financial aid programs during the Great Recession. This pattern of reducing generosity in the wake of increases in the Pell grant program is not new, and the research here shows that this potential fiscal federalism has become more common since the year 2000. The authors highlight specific policies in three states that illustrate this trend. They also use student-level data from Ohio to illustrate how students' net aid packages changed in response to the combined changes in federal and state aid policy, finding that the state policy had disproportionate effects on the students with the most need.

Bridget Terry Long, Harvard University and NBER

The Financial Crisis and Declining College Affordability: How Have Students and Their Families Responded?

For families, the economic crisis has negatively affected post-secondary affordability in many ways. Colleges have raised their prices and some have also reduced their institutional aid. Meanwhile, the recession has reduced family income and economic stability. Long examines the effects of these trends in terms of college access, choice, and expenditures. Using data from the Consumer Expenditure Survey and exploiting differences in the severity of recession by state, she investigates how students have altered their decisions about enrollment, attendance intensity, how much they spend, and how they finance higher education. While theory suggests that reductions in family income and home ownership are likely to have a negative impact on post-secondary enrollment, past research has shown that college attendance typically increases when unemployment increases, thereby making the predicted effects of the recession unclear. The analysis suggests that the overall effects of the Great Recession on college enrollment were negative, especially in terms of full-time enrollment and among potentially traditional-age college students.


Sarah Turner, University of Virginia and NBER

Financial Crisis and Faculty Labor Markets

Turner points out that the impact of the recent financial crisis -- as well as prior cyclical downturns – on faculty hiring and wages is not well understood. An important first step is to document the basic short-term relationship between budget cuts, employment levels, and wages among different types of colleges and universities. The fiscal crisis brought a collision of contractions in budgets and increased student enrollment demand. As a result, faculty hiring in the junior ranks contracted sharply while student-faculty ratios increased commensurately. The magnitude and duration of these effects differs markedly across institutions. For private research universities that draw substantially on endowment income, the financial crisis produced a short – though significant – shock to revenues and, in turn, hiring. For public universities, the effects of the financial crisis are longer-lasting, with appropriations in many states continuing downward to 2012, and the impact on hiring lasting longer. The Great Recession has further widened differences between public and private universities in faculty staffing and, to some degree, salaries. As student-faculty ratios have increased notably at public-sector institutions, it is natural to ask whether this decline in resources per student will adversely affect student attainment and research output in the coming years.


Michael Dinerstein and Pablo Villanueva Sanchez, Stanford University; Caroline Hoxby; and Jonathan Meer, Texas A&M University

Did the Stimulus Work for Universities?

Dinerstein, Hoxby, Meer, and Villanueva investigate how stimulus-motivated federal funding directed to universities affected their expenditures, employment, tuition, student aid, endowment spending, and receipt of state government appropriations. They also investigate how these funds affected the economies of the counties in which the institutions are located. To overcome the potential endogeneity of federal funds (for instance, federal student aid rising when students become poorer), the authors use: 1) an instrument that applies nation-wide rates of increase in research funding by agency to universities whose initial dependence on these agencies differs; and 2) an instrument that applies the change in the maximum Pell Grant to institutions with varying initial numbers of students eligible for the maximum grant. They find little evidence that federal funds directed to universities propped up aggregate demand or generated economic multipliers in the classic Keynesian sense. However, their results suggest that federal funds induced private universities to increase research, reduce tuition, raise student aid, spend a bit more on many categories of expenditure, and slightly reduce endowment spending rates. These results are consistent with private universities maximizing objectives that require them to allocate funds over a broad array of research, instructional, student support, and other activities. For public universities, the results suggest that federal funds induced decreases in state appropriations and increases in tuition. These findings suggest that public universities used federal funds as part of a "package deal" in which they gained independence from state governments. They appear to have used their greater independence to orient their expenditures more toward research and instruction. Overall, it appears that the stimulus caused universities to increase their investments in research and human capital. It remains to be seen how those investments pay off in the long run.


David Chambers, University of Cambridge; Elroy Dimson, London Business School; and Justin Foo, University of Cambridge

Keynes, King's, and Endowment Asset Management

Chambers, Dimson, and Foo note that King's, founded in the mid-fifteenth century, was one of Cambridge University's wealthiest colleges, endowed with an agricultural real estate portfolio that stretched the length and breadth of England. For almost five centuries these estates formed the bulk of endowment assets until Keynes took over their management just after WW1. He immediately undertook a substantial re-allocation of the portfolio away from real estate into the new asset class, equities. Oxford and Cambridge (“Oxbridge”) colleges have a natural concern for preserving their wealth for future generations (Tobin, 1974) and are the ultimate long-horizon investors. Keynes spotted an opportunity for such patient, long-term investors in making a substantial allocation to equities, an innovation at least as radical as the commitment to illiquid assets in the late twentieth century by Yale and Harvard. As a result, King's benefited from earning an emerging risk premium on U.K. equities despite the economic turbulence of the 1930s. Furthermore, Keynes radically shifted from a top-down, market-timing approach to investing in equities towards a bottom-up, stock-picking one. This enabled King's to earn additional risk premiums through tilting the portfolio towards both value and smaller-capitalization stocks, as well as to trade less and thus lower transaction costs. Keynes' investment strategy benefited the endowment considerably, to the extent that upon his death, King's had at least drawn level with Trinity, the richest of the colleges.


 
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