After the stock market’s disastrous downturn in fall 2008, four academics and researchers decided to analyze how financial shocks to endowments affect university operations.
The working paper, “Why I Lost My Secretary: The Effect of Endowment Shocks on University Operations,” was prepared for the National Bureau of Economic Research, where two of the authors are research associates.
Using 1986-2008 data from 200 doctoral universities, including the University of Minnesota, the team found predictable and not-so-predictable reactions to seesawing investments. It’s important to note that the data from the after-effects of the 2008 crash were not available.
The last negative shock analyzed in the study was the tech bust in 2002, which was “half as bad” as the 2008 crash, according to co-author Jeffrey Brown, professor of finance at University of Illinois (Champaign-Urbana).
“Anybody who works in a university knows that as a result of the recent crisis, it seemed like a natural question for us to figure out,” Brown said. “We realized there wasn’t a whole lot written about this,” at least from the economic standpoint.
The study’s authors didn’t perform a university-by-university analysis, so it’s not possible to break out how one university in particular responded, he said.
Just about everybody feels the pain, except …
These findings stand out to me even though they might not surprise the rank and file in higher education:
• Universities with the largest negative shocks to their endowments were more likely to cut support staff and maintenance staff but not administrators.
• Less-selective institutions cut spending on tenure-system faculty while increasing salaries for adjuncts and instructors.
• Universities that invested in hedge funds or other risky assets made larger cuts to tenure-system faculty and secretarial staff.
• More-selective universities reduced student financial aid for the first fall semester after the decline and they accepted fewer freshmen.
Go figure. Nearly everyone but a university’s administrators was more likely to feel the pain of a decline in the endowment’s value. I asked Brown why administrators were spared.
“I’m smart enough to not overly speculate beyond what the data say,” he said, chuckling. “We document that it (administration cutbacks) doesn’t happen. We leave it to others to speculate why that is. There are both positive and negative spins you can put on that finding.”
A reluctance to part with cash in tough times
What did Brown find particularly noteworthy? Universities didn’t tap their endowments for more cash in tough times, even though their rules allowed bigger withdrawals.
“One reason to have an endowment is to smooth over the shocks,” he said. “It’s a rainy-day fund so that when things go bad, they can dip into those reserves. What we found is they deviate from their own policy.”
Among the reasons for this behavior: Endowment managers who are more concerned about the “prestige” of building the endowment’s value and “implicit contracts” with donors to maintain the size of the endowment.
“What our paper shows is that universities are behaving in a way to grow the endowment rather than using it to support the activities of the university,” Brown said. “The point is that if you think endowments exist to smooth over the shocks in bad times, they’re not doing that. … They’re maintaining the value of the endowment for its own sake.”
As a result of tightening endowment spending during downturns, Brown said, universities with larger negative shocks turned to their biggest expense: personnel. Well, personnel minus the administrators.
That was the case after the last big shock. This time around, anecdotal evidence suggests that “given the magnitude of the current change universities would respond in a different way,” he said.