Financial Changes and Optimal Spending Rates
Among Top Liberal Arts Colleges
1996-2001
Roger T. Kaufman
Professor of Economics
Department of Economics
Smith College
Northampton, MA 01063
(413) 585-3612
rkaufman@email.smith.edu
Corresponding Author
Geoffrey Woglom
Richard S. Volpert '56
Professor of Economics
Amherst College
Amherst, MA 01002
(413) 542-2433
grwoglom@amherst.edu
Financial Changes and Optimal Spending Rates
Among Top Liberal Arts Colleges
1996-2001
Abstract
The changes in the financial situations among the top 49 liberal arts colleges between
1996 and 2001 are documented using Integrated Postsecondary Education Data System
(IPEDS) financial and enrollment data. These data show large disparities in net assets
per student, expenses per student, and the subsidies per full-paying student and the
average student. Differences in comprehensive fees are considerably smaller. In addition
the wealthiest six institutions have been able to maintain relatively greater spending and
still increase their net assets faster than their peer institutions. Two views of the optimal
rates of spending are then presented and these spending rates are calculated for each
institution. Despite current claims of financial crisis, these calculations show that most of
these institutions have spending rates well below the rate that would be required to
achieve inter-generational equity.
In this paper we describe some of the dramatic changes in wealth and spending
that occurred among the nation's top liberal arts colleges between 1996 and 2001. We
find this exercise instructive for several reasons. First, there are substantial financial
differences among these colleges that are often masked in the national rankings, and the
financial hierarchy has undergone some interesting changes. Secondly, it is useful to
examine the substantial subsidies that liberal arts colleges give to both full-paying
students and, even more so, to those receiving financial aid. Thirdly, since current levels
of wealth far exceed what was expected just a decade ago, it is useful to see how colleges
have changed their spending and saving patterns and how well they prepared themselves
for the most recent decline in financial markets.
Finally, we believe that these data shed light upon several additional questions
about the future of liberal arts education at the top colleges in the United States. How
will colleges adapt to their new financial positions? Are they spending too much or too
little of their total wealth? What difficulties are colleges facing as some of their financial
gains dissipate? Are we experiencing a kind of "arms race" among the top colleges and
universities? Is it possible for colleges to accumulate "too much" wealth?
The Financial Status of Top Liberal Arts Colleges FY2000/2001
We selected our sample using the top 50 national liberal arts colleges as ranked by
U.S. News and World Report in their September 23, 2002 issue. Since there was a threeway tie for last place, we include only the top 49 colleges in our analysis. We recognize
that this is an imperfect ranking of the best schools. As we illustrate, however, the most
dramatic changes occurred among the very top colleges, which we believe would be
included in anyone's ranking of the top fifty. Our principal sources of financial and
enrollment data are the Integrated Postsecondary Education Data System (or IPEDS)
annual surveys, conducted by the U.S. Department of Education. Unfortunately, the
accounting methods used by most liberal arts colleges changed significantly in 1996. In
order to achieve consistency we are restricted to annual data beginning in the fiscal years
1996/97. Even in the five-year period ending in 2000/01, however, substantial changes
occurred. We should also note several data inconsistencies in the IPEDS data base that
are probably due to reporting errors.
In Table 1 we list the top 49 schools and several key variables. The schools are
ranked according to net assets per full-time student at the end of the fiscal year 2000/01,
typically June, 2001.1
The data in Column (1) reveal an enormous variation in wealth
among the top 49 schools and a substantial gap between the top six colleges – Grinnell,
Pomona, Swarthmore, Williams, Amherst, and Wellesley – and the remaining 43 schools.
Since five of the wealthiest six are also consistently listed among the "best" 5 or 6 liberal
arts colleges and Grinnell is typically ranked in the top ten, we find it useful to separate
the data for these six schools from the others in much of our analysis. Therefore, at the
bottom of our tables we present the averages for these six colleges and the quartile
boundaries for the remaining 43. Thus, Q2 measures the median among all remaining 43
while Q1 and Q3 measure the medians of the top and bottom halves of these 43 colleges
ranked in order of the variable in question.2 Net assets per student averaged $745,046 in
the top six colleges, amounting to 294%, or almost three times, the median among the
remaining 43. Thus, even among the top 49 schools there are substantial hierarchies at
least with regard to wealth (see Winston (1999) for more on education hierarchies).
2
Colleges can use their wealth in a variety of ways. They can increase spending
on, among other things, instruction, academic support, research, student services, and
institutional support. Secondly, wealthier colleges could maintain spending but increase
educational subsidies in one of two ways. They can reduce the "sticker price" or
comprehensive fee they charge to full-paying students. Alternatively, they could increase
financial aid by either attracting a less affluent student population and/or offering more
generous financial aid packages. Colleges could also use their wealth to construct new
buildings or purchase new land, equipment, and collections.3 Finally, colleges could let
their financial wealth accumulate, which would eventually increase the differences in
wealth between themselves and less affluent colleges.
In the second column of Table 1 we present data on total expenses per student
during the fiscal year 2000/01. Operating and maintenance costs on plant and equipment
are included in expenses, while construction expenditures on new buildings and other
capital budget items are not. The largest component of expenses is employee payroll and
benefits. Expenses will be greater for schools that have lower student-faculty ratios,
more supporting staff per student, higher wages and salaries per employee, or a greater
capital stock (per student) to maintain. According to the IPEDS data, spending among
these 49 colleges ranged from $67,316 per student at Wellesley4 to $26,983 at Whitman.
The differences in spending, and hence the costs of education, among these
colleges are considerably smaller than the differences in wealth. The average spending
among the wealthiest six was $54,232 per student in 2000/01, 139% of the median of
$39,138 among the remaining 43.5 While the difference in net assets per student between
the poorest and richest college was 1,129 percent, the maximum difference in spending
3
per student was only 149 percent. Furthermore, the standard deviation in net assets was
75 percent of the median among all 49 colleges, compared to a comparable figure of 22
percent for expenses.6
As the third column of Table 1 illustrates, the differences in the gross
comprehensive fee, or "sticker price" among these schools is considerably smaller than
the differences in expenses or wealth.7 Even if we exclude Grinnell, which ranks 1st in
wealth and 45th in comprehensive fee, the average "sticker price" among the remaining
top five schools was $33,230, which is only three percent more than the median sticker
price among the remaining 43. Only four schools charged less than $26,000. Full-paying
students pay similar amounts at almost all of these institutions even though the cost of
their education (as reflected in expenses per student) varies considerably.
The operating subsidy provided to each full-paying students is equal to the
difference between total expenses (per student) and the comprehensive fee.8 The wide
variation in expenses but relatively similar comprehensive fees is reflected in Column (4)
by large differences in the estimated subsidy per full-paying student. In general, the
wealthier colleges provide larger subsidies to full-paying students. Although the
estimated operating subsidy of $33,922 at Wellesley is even larger than its
comprehensive fee, the subsidy at 16 of the 49 colleges is less than $3,000! Indeed, the
average subsidy to full-paying students among the wealthiest six colleges is 358 percent
of the median subsidy at the remaining 43.
While the wealthiest schools spend more per student but charge a comparable
amount, they also use some of their greater wealth to keep their net comprehensive fees
below those at many of their peer institutions. The net comprehensive fee may be viewed
4
as the amount paid by the "average" student. It is approximated in Column (5) of Table 1
by adding the IPEDS figures for net tuition (plus fees) and net revenue from auxiliary
enterprises. The former is calculated as the price for tuition and fees minus the total
amount of aid (institutional and governmental) that is devoted to tuition relief. The latter
consists of total charges for auxiliary enterprises, of which room and board are the largest
components, minus the amount of aid devoted to auxiliary enterprises.
Based on other information about net comprehensive fees at several of the schools
in our sample, we know that these data are only approximate and contain several errors.
At Wellesley and several others auxiliary enterprise revenue consists of substantial
amounts other than room and board.9 At Middlebury and Oberlin, furthermore, the
calculated net comprehensive fees are greater than the comprehensive fees themselves
despite the fact that both schools devote considerable amounts to financial aid. These
discrepancies may also reflect large auxiliary expenses (such as Middlebury's Bread Loaf
programs and Oberlin's Conservatory), but they also suggest reporting errors. Although
these approximate estimates of net comprehensive fees vary considerably among
institutions, the variations are not closely connected to wealth. Even excluding
Wellesley, the average net comprehensive fee among the remaining wealthiest five
colleges was $21,566, which is actually less than the median of $23,421 among the
remaining 41 schools for which we believe we have reliable data, and the correlation
between net assets per student and net comprehensive fee among all 46 colleges with
reliable data is –0.21. Note that greater amounts spent on financial aid may reflect a less
affluent student body and/or a more generous financial aid policy.
5
In the sixth column of Table 1 we calculate each college's "subsidy" for the
average student, in terms of the amount it spends minus the amounts it receives from
students and governments.10 This subsidy comes from the financial funds of the college
by using gifts to the alumni fund or funds taken from the endowment. Consequently, we
call it expenditure from financial funds, or EXFF. As we explain in the next section, it
can be calculated readily from aggregate data in the IPEDS survey that appear to be
reliable and avoid some of the aforementioned anomalies.
By providing a more expensive education and more financial aid, the wealthier
schools give greater subsidies to the average student. Even in the top group, the variation
is substantial. Wellesley provides an average subsidy of $36,543,11 while Amherst's is
only $20,306. Even at Amherst and Pomona, however, the average subsidy is 161
percent of the subsidy at the median school.
The data in the first six columns of Table 1 suggest an interesting pattern. The
wealthiest colleges have higher expenses, but the differences in expenses among these 49
institutions are considerably smaller than the differences in wealth. Because prices
charged to full-paying students vary much less, the wealthier colleges provide greater
subsidies for their full-paying students. The correlation between net assets per student
and the estimated subsidy per full-paying student is 0.73. Since the wealthier colleges
also provide more financial aid, the subsidy for the average student also varies directly
with wealth, with a correlation of 0.80.
Even though wealthier schools have greater expenses and provide higher
subsidies per student, their wealth is so much greater that spending as a percentage of net
assets is inversely related to wealth. As illustrated in the last column of Table 1, the
6
average subsidy among the wealthiest six for fiscal year 2000/01 was a much smaller
percentage of net assets (3.77 percent) than the median subsidy (5.16 percent) among the
remaining 43 schools. The correlation between net assets per student and EXFF as a
percentage of net assets is –0.40.
Overall, these data indicate that among the elite liberal arts colleges:

There are enormous differences in wealth.

There are much smaller differences in comprehensive fees.

The wealthiest institutions spend more on their students and provide more
financial aid, but these disparities are not as great as the disparities in wealth.

The wealthiest schools provide larger subsidies per student, but their spending as
a percentage of wealth is smaller.
Changes since 1996
Most educational institutions have experienced dramatic changes in their financial
positions during the last few years. The stock market boom and partial bust has led to
substantial increases in wealth for most. In this section we document these changes in
terms of some of the variables defined in the preceding section. We then extend our
discussion to talk about long-run trends and sustainability.
In Column (3) of Table 2 we illustrate the dramatic changes in wealth among our
49 institutions between 1996 and 2001.12 Once again, the schools are listed in
descending order of their wealth, or net assets per student at the end of fiscal year
2000/01, as in Table 1. The average percentage increase in net assets per student among
the six wealthiest colleges over this five-year period was 93.18 percent, compared with a
7
median of 55.98 percent among the remaining schools. Thus, the initial differences in
wealth became even greater during this period.
Column (2) in Table 2 depicts the percentage changes in expenses per student
from fiscal year 1996/97 through fiscal year 2000/01. While the correlation between the
changes in wealth and expenses is 0.37,13 expenses at Grinnell and Amherst rose much
less rapidly than the median increase of 23.88 percent among the other 43. During this
same period, the higher education price index, or HEPI, rose by 15.7 percent.
Consequently, most of these colleges either increased the amounts of resources they used
or the price of their inputs rose more rapidly than elsewhere in higher education.
Finally, Column (3) presents the percentage changes in the subsidies per average
student, or what we have called expenditures from financial funds. The mean increase
among the six wealthiest schools was 51.07 percent, which is less than the median
increase among the remaining 43. Williams was the only college among the wealthiest
six that had faster growth in subsidies per average student than the median among the
others, while Amherst had one of the slowest rates of increase.
Thus, the data in Table 2 indicate that between 1996/97 and 2000/01:

The wealthiest six schools enjoyed rapid increases in wealth.

Spending at the wealthiest schools increased, but not by as much as the
increase in wealth.

Subsidies per student rose less rapidly at the wealthiest schools.
The Determinants of Saving
Educational institutions, like individuals can increase their net assets, or save, by
spending less than their total income:
8
Saving = Gifts + Investment Income – EXFF
(1)
Equation (1) illustrates that colleges can increase their wealth (i.e., save) in a variety of
ways. First, they can receive gifts.14 Secondly, they can receive investment income
from their endowments in the form of interest, dividends, other endowment income, and
both realized and unrealized capital gains. Finally, they can spend less. EXFF represents
what we have called expenditures from financial funds. It is equal to total expenses
minus the sum of net comprehensive fees, government grants, and other revenue.15
To determine the affordability and sustainability of various spending patterns we
express all the variables in equation (1) as percentages of net assets in Table 3. The
numerators for the variables are the average annual financial flows for the 5 fiscal years
1996/97–2000/01. Net assets over the entire period are approximated by averaging net
assets at the beginning of fiscal year 1996/97 with those at the end of fiscal year 2000/01.
Column (1) of Table 3 illustrates that gifts to wealthier schools represent a smaller
percentage of their net assets than at their competitors during the 1996/97-2000/01
period. Some of these differences may be misleading because they reflect variations in
the levels of net assets rather than total gifts. Both Swarthmore and Grinnell, for
example, receive substantial gifts, but these are a relatively small percentage of net assets
because these two schools are so wealthy.
Investment returns (in Column (2)), on the other hand, were higher among five of
the wealthiest six colleges (all but Swarthmore) than all but two of the other 43. This was
primarily the result of decisions by trustees of four of these five institutions to invest a
considerable portion of their endowments in "alternative assets," which include real
estate, private equity, venture capital, oil and gas projects, and hedge funds. In the fiscal
9
year 1999/2000 alone, investment returns as a percentage of long-term investments were
40.8, 48.4, 41.3, and 39.7 at Pomona, Williams, Amherst, and Wellesley, respectively,
compared with an average of 12.9 percent at the others.16 At Swarthmore, on the other
hand, trustees were more conservative, perhaps because it began the period wealthier than
any other liberal arts college. Yet even Swarthmore's annual return during this five-year
period of 9.64 percent (of net assets) was greater than all but 11 of the remaining
colleges.17 Another reason the wealthier colleges had higher investment returns on net
assets is because financial wealth at these institutions comprise a larger fraction of net
assets. Schools at which net assets consist primarily of physical capital in the form of
college buildings and equipment will ceteris paribus have lower reported investment
returns as a percentage of net assets.
The sum of gift and investment income, is represented in Column (3) of Table 3.
The totals for the wealthiest six colleges are much closer to the median among the top
half of the remaining schools, reflecting lower gift rates but higher investment returns.
The last two columns of Table 3 depict the rates of spending from financial funds and
saving. Although the wealthiest schools spent greater amounts than their competitors and
gave greater subsidies to both the full-paying and average student, these generally
comprised a smaller percentage of their net assets than at most of the other institutions
(with the exception of Williams and Wellesley). Expenditures from financial funds
averaged 5.31 percent among the wealthiest six, compared with a median of 5.86 percent
among the remaining 43.
Recall from equation (1) that saving increases with gifts and investment returns
and decreases with spending. As a result of high investment returns, five of the six
10
wealthiest schools were able to save a substantially higher portion of their net assets than
almost all of the remaining schools. Thus, the wealthiest schools were able to provide
more services to their students (reflected by higher expenses), provide more financial aid,
and still save a greater percentage of their assets, resulting in a widening gap between
themselves and the others.
Recall that colleges can also use some of their increased wealth for capital
spending, thereby converting financial assets into physical assets. The IPEDS survey
provides data on the value of each of the following at the beginning and end of the fiscal
year: land, buildings, and equipment, where the last category also includes the value of
art, library, and other collections.18 The value of plant, land, and equipment among the
six leading institutions rose by an annual average of 9.32 percent during the four-year
period 1997-2001.19 These growth rates are slightly smaller than the median growth rate
among the remaining 43 schools. Yet gross investment in physical capital as a
percentage of net assets for these six colleges was 1.82 percent, less than the median
percentage of 3.34 percent among the remaining 43, and less than the physical capital
investment rates at all but 14. Since the wealthiest schools' savings rates were so much
greater than the others, the fraction of total savings that went towards physical investment
was considerably smaller among the wealthiest colleges. This suggests that the relative
financial positions of the wealthiest institutions improved even more than their higher
saving rates imply.20
Overall, the data in Table 3 indicate that the most affluent schools were able to
save more during the 5 year period from 1996-2001 because:

In general, they enjoyed higher investment returns.
11

The affluent schools have so much greater wealth that their higher subsidies per
student comprise a smaller fraction of net assets.
Sustainability and the Current "Crisis" in College Finances
As college endowments rose during the late 1990's in response to burgeoning
financial markets, we have seen how many schools increased their expenses and the
subsidies they provided to both the full-paying and average student. When financial
markets fell, many colleges experienced declines in the amounts of money from
endowment available for the operating budget, resulting in what many college officials
characterize as a "crisis."21 Staff and, in some cases, faculty reductions have been
announced at Oberlin, Smith, and Yale. Significant budget shortfalls have been declared
at Stanford, Dartmouth, Mt. Holyoke, and Skidmore, among others. But what is the
nature of this "crisis?" Did these institutions spend too much during the boom years? Do
they need to slash spending now in response to declining endowments? What are the
appropriate long-run saving and spending rates?
The financial ratios for fiscal year 2000/01 that are presented in Table 4 illustrate
the current dilemma. Four of the wealthiest six colleges experienced negative investment
returns in 2000/01, and the median investment return among the remaining 43 colleges
was -2.19 percent of beginning-year net assets. Although positive gift rates buffered the
negative investment returns, saving rates became negative at most schools, resulting in a
decline in even nominal net assets. Negative saving rates are unsustainable, but the
appropriate response depends critically upon one's view of college endowments.
On that issue we find two strains of thought that differ largely in their treatments
of new gifts to endowment. Massy (1990), for example, describes two principles for
12
spending and accumulation that are sometimes in conflict. The first principle is to
maintain endowment's share of operating budget support. Since the financial resources of
the college include both annual gifts and the endowment, we interpret this principle as
requiring that the ratio of EXFF (or total spending from gifts and the endowment) to
Total Expenses remain constant. A common justification of this principle is the desire to
maintain equality of educational services across generations of students. Assuming no
change in the intensity of resources required to provide these services, this principle
requires the nominal value of net assets to increase by the same rate as the higher
education price index, or HEPI. This would allow nominal spending to rise at the same
rate without changing the percentage of net assets used for spending. Today, for
example, the consumer price index is projected to increase by 2.5 percent for the next
decade.22 If HEPI is expected to rise by an additional 2 percentage points23, the nominal
value of the endowment should rise by 4.5 percent.
Recall that the growth rate of net assets is equal to the saving rate. The data in
Table 3 indicate that saving rates during the 1996-2001 period exceeded 4.5 percent in all
but four of the 49 colleges in our sample. The median saving rate was almost twice that
amount! According to this model, the top liberal arts colleges had spending rates during
this period that were too small rather than too large.
But the 1996-2001 financial climate was unusual. What is the appropriate long-run
spending rate for a more typical period of "normal" investment returns? In order to
determine whether current spending rates are sustainable we divide all the variables in
Equation (1) by net assets (N.A.) and rearrange them to obtain:
EXFF/N.A. = Gifts/N.A. + Inv. Income/N.A. – Saving/N.A.
(2)
13
Suppose annual gift rates are expected to continue unchanged at rate g, the long-run
"normal" rate of return on net assets i is equal to the expected real rate of return r plus the
expected rate of CPI inflation πe, and the desired saving rate is s, which may be greater or
less than the aforementioned 4.5 percent. Equation (2) can then be re-arranged to
calculate the long-run sustainable spending rate (EXFF/N.A.)s
(EXFF/N.A.)s = g + i - s = g + (r + πe ) – s
(3)
In Columns (1) and (6) of Table 5 we reproduce the actual gift and spending rate data
for the 1996/97-2000/01 period from Table 3, and in Column (5) we calculate the
sustainable spending rates for inter-generational equity using a nominal investment return
of 8 percent on long-term financial assets, a desirable saving rate of 4.5 percent, and the
actual gift rate for each school during this period. The 8 percent return represents a real
return of 5.5 percent, which is the rate Massy (1990) suggests for an endowment
consisting of 70 percent stocks and 30 percent bonds, and CPI inflation of 2.5 percent.24
Each college's predicted rate of return on net assets is calculated by multiplying 8 percent
by its ratio of long-term (financial) investments to net assets in June 2001. Note that the
sustainable spending rates are independent of the projected rate of CPI inflation since
changes in inflation would affect both i and s in equation (3).25
In Column (7) we calculate the difference between the calculated sustainable rate of
spending and the actual spending rate during this period. Using our assumptions, the
long-run sustainable spending rates were greater than the actual spending rates during this
five-year period at all but 5 of the 49 colleges. At Swarthmore, for example, the
sustainable spending rate would be 2.37+7.73-4.5=5.60 percent, which is 0.72 percentage
points greater than its actual spending rate of 4.88 percent during this period. At Centre
14
College, on the other hand, the gift rate was larger but its ratio of financial to total net
assets was smaller, and its sustainable rate of 3.97 + 6.01 – 4.5 = 5.48 percent is 2.95
percentage points below its actual spending rate of 8.43 percent.26 Furthermore, reexamination of the data in Column (4) of Table 4 indicates that the actual spending rates
in fiscal year 2000/01 were generally below the five-year averages. As a result, the
actual 2000/01 spending rates exceeded the sustainable rates in only two schools. This is
hardly suggestive of a crisis.
These calculations assume that each college's gift rate during this five-year period will
continue, and the gift rates among these schools vary considerably. Gift rates, however,
will be unusually high during capital fund drives. Some of these schools, like DePauw,
have received unusually large gifts during this period. Consequently, in the last two
columns of Table 5 we present another calculation of each college's sustainable rate of
spending based on an estimate of each school's "normalized" gift rate. The normalized
gift rate is the predicted rate of giving for each school using its actual wealth per student
at the end of fiscal year 2000/01 and the coefficients from a cross-section regression
among our 49 colleges during the 1996/97 – 2000/01 period in which we regress the
logarithm of actual gift rates on a constant and the logarithm of net assets per student. In
order to reduce the effect of extreme values (e.g., at Sarah Lawrence and Bard), we used
a regression that minimized the sum of absolute deviations (called LAD, or least absolute
deviations) rather than ordinary least squares.
In most cases the normalized sustainable spending rates are similar to the unnormalized rates, and the correlation between the two is 0.47. As expected, the actual
gift rates at Sarah Lawrence and Bard far exceeded their "normalized" rates. The number
15
of schools whose actual spending rates exceed their normalized sustainable rates
increases to 15. Williams, Carleton, the University of the South, and Centre are the only
colleges whose actual spending rates exceed their sustainable rates calculated both ways.
Nevertheless, the data in Tables 4 and 5 imply that most of these colleges have spent
prudently during this five-year period. Even though their saving rates in fiscal year
2000/01 were negative in many cases, their overall spending rates are still lower than
their sustainable rates. As a result, their net assets per student will continue to rise faster
than HEPI and they will be able to hoard their wealth and/or increase the amount of
resources they provide to future generations. Ceteris paribus, the ratios of expenditures
from financial funds to their operating budgets will increase. In order to preserve intergenerational equity and keep the ratio of EXFF to Expenses constant over time, actual
spending rates would have to increase!
Treasurers' View of Sustainability and the Arms Race
If the preceding analysis is correct and spending rates are not excessive, why do
many college officials and trustees see a crisis? After all, the real value of net assets per
student at most of these institutions had never been greater! We suggest that the answer
lies in the alternative way in which some college treasurers and trustees view their
obligation. Massy's second principle for spending and accumulation is to "maintain the
purchasing power of each existing endowment fund."27 Although some gifts, like those
to the alumni fund, are earmarked for the operating budget, this principle implies that the
real endowment should grow in response to new gifts to endowment. As Tobin (1974)
avers, real "consumption rises to encompass an enlarged scope of activities when, but not
before, capital gifts enlarge the endowment."28 Consequently, the nominal value of new
16
gifts to the endowment (as well as the existing endowment) should rise by the increase in
HEPI.
One can compare the two views formally by distinguishing between new gifts (as
a percentage of net assets) that are used for the operating budget, and gifts to the
endowment. Under the treasurer's view, the sustainable spending rate in equation (3)
should include only gifts for the operating budget and not gifts to the endowment. At this
spending rate, existing endowment funds will grow at 4.5%, and the total endowment will
grow at (i.e, the saving rate will equal) 4.5% plus the endowment gift rate.
In Table 6 we use the treasurers' view to present another set of sustainable
spending rates. Based on conversations with college officials and a cursory examination
of the treasurers' reports at several of the schools in our sample, we assume that
approximately one-fourth of all gifts (mainly annual giving to the alumni fund) are meant
to support the operating budget and three-fourths are intended to increase the amount of
real educational services provided to future generations of students. As before, we
assume a long-run real investment return on financial assets of 5.5 percent, CPI inflation
of 2.5 percent, and HEPI inflation of CPI inflation plus 2 percent, or 4.5 percent. As in
Table 5, one set of estimates uses the actual gift rates during this period and another uses
the normalized rates from the aforementioned regression.
The implications of the treasurers' view are dramatic. Using either the actual or
the normalized gift rates, we calculate that the sustainable spending rates lie below the
actual spending rates at all 49 colleges except Grinnell, Colorado College, and Rhodes.29
The average difference between the actual and sustainable spending rates (using the
17
normalized gift rates) is 1.84 percent of net assets among the wealthiest six colleges, and
the median difference among the remaining 43 is 2.73 percent of net assets.30
Even in the absence of the stock market's decline, the treasurers' view suggests
that financial restraint is necessary at almost all of the top liberal arts colleges assuming
that the future real rate of return on long-term investments remains equal to 5.5 percent.
If the trustees' objective at these colleges is to increase the purchasing power of the
endowment in response to new gifts in order to provide additional services to future
generations of students (or hoard the increase) and maintain the real value of each new
gift to endowment, current spending rates are probably too high and need to be reduced.
It is important to understand the long-run implications of both views. Critics of
the treasurers' view argue that it leads to what many people see as an arms race among
the top liberal arts colleges (and universities).31 Although their wealth has grown during
the past decade more rapidly than they ever expected, many colleges still feel poor
because they compare themselves not only on the basis of the educational services they
provide, but on the size of their endowments. Instead of allowing some of the principal
from new gifts to the endowment to be used to improve the quality and quantity of
educational services provided to current as well as future generations of students, these
gifts must be added to an ever-increasing endowment.
Recall that the desired saving rate in the treasurers' view keeps net assets growing
at the rate of increase of HEPI plus the endowment gift rate. The first component
provides a constant stream of educational services to future generations of students while
the additional growth in net assets resulting from new gifts to endowment could either be
hoarded or used to increase the amount of educational services provided in the future. As
18
an example, suppose three-fourths of all gifts are intended to increase the purchasing
power of the endowment. This assumption along with the normalized gift data in
Column (8) of Table 6 implies that the average annual increase in the purchasing power
of net assets per student among the remaining 43 colleges would be ¾(4.76%) = 3.57
percent. At this rate the amount of educational services that these institutions could
provide to future generations of students would double every 20 years!
Conversion to Endowment Takeout Rates
Some readers may find it useful to convert our sustainable spending rates to
approximate endowment takeout rates. In the treasurers' view, the takeout rate would
equal the long-run nominal rate of return on the endowment minus HEPI inflation. If, for
example, HEPI grows at 4.5 percent and the nominal rate of return is 8 percent, the
endowment takeout rate should be 8 – 4.5 = 3.5 percent, regardless of the gift rate. This
would keep the existing endowment, exclusive of new gifts, growing at the rate of HEPI
inflation. The real value of the endowment (deflated by HEPI) would then grow by any
new gifts to the endowment. Most colleges currently have target takeout rates between 4
and 5 percent (Cambridge Associates (2000)). While these takeout rates allow the
existing endowments to rise more quickly than the CPI, they will rise by less than HEPI
(and therefore provide fewer educational services) in the absence of new gifts. This
conclusion, of course, depends critically on our assumption that HEPI inflation exceeds
CPI inflation by two percentage points.
Conversion from spending to takeout rates in the inter-generational equity model
requires two adjustments. Recall that our spending variable includes spending from both
gifts and endowment. Consequently, in order to calculate spending from endowment we
19
need to subtract new gifts that support the operating budget, which are typically annual
contributions to the alumni fund. We approximate this as one quarter of all gifts. Next,
we need to express spending as a percentage of endowment, rather than net assets.
In Column (9) of Table 5 we calculated that the average normalized sustainable
spending rate is 5.22 percent of net assets for the wealthiest six colleges using the intergenerational equity model. The average normalized gift rate among these six schools (in
Column (8) of Table 5) is 2.33 percent, one quarter of which will be used to support the
operating budget. Finally, the average ratio of net long-term investments to net assets for
these schools was 92.4 percent at the end of FY 2000/01. Thus, our estimate of the
average normalized sustainable endowment takeout rate for the wealthiest six schools
would be (5.22 – 0.58)/0.924 = 5.09 percent, which is larger than the typical effective
target takeout rates for most of these colleges.32
The comparison for the remaining 43 colleges is more dramatic. The median
normalized sustainable spending rate is 7.14 percent of net assets in Table 5. The median
normalized gift rate among these schools was 4.76 percent, and the median ratio of net
long-term investments to net assets was 81.85 percent. Consequently, our estimate of the
median normalized sustainable endowment takeout rate using the inter-generational
equity model would be [7.14 – 0.25(4.76)]/.8185 = 7.27 percent. Obviously, this is
substantially greater than the typical target takeout rate.
Conclusion
By providing a more expensive education than their peers without charging
substantially higher comprehensive fees, the wealthier colleges among the top 49 liberal
arts colleges provide greater subsidies to even full-paying students. They also provide
20
more financial aid, resulting in even greater subsidies to the average student.
Nevertheless, the differences in wealth exceed the differences in spending and
subsidization. If current trends continue, the differences in wealth will widen.
Although many college treasurers and trustees believe their schools are in a crisis,
the reality depends upon one's view of inter-generational equity and the treatment of new
gifts to endowment. If the goal is to maintain the ratio of expenditures from financial
funds to total expenses, there is no crisis. On the contrary, current spending rates for
most schools are lower than their sustainable rates.
If, however, the objective is to increase the purchasing power of the endowment
in response to new gifts in order to provide additional services to future generations of
students and maintain the real value of each new gift to endowment, current spending
rates are probably too high and need to be reduced. This policy, however, implies that
college endowments will on average grow much faster than total expenses, and an everincreasing share of total expenses will be financed from endowment. Since this will
appear like an arms race, college trustees must be prepared to justify ever-increasing
tuitions to an increasingly skeptical public. In either event, college trustees need to
recognize the long-term implications of the spending rules they adopt.
21
References
America's Best Colleges, 2003 Edition. (September 23, 2002). U.S. News and World
Report, p. 60.
Cambridge Associates, Inc. (2000). 1999 NACUBO endowment study. Washington, DC:
National Association of College and University Business Officers.
College Entrance Examination Board. (2002). The college handbook. Washington, DC:
College Entrance Examination Board.
Coiner, H. M. (1992). How large a fraction of university endowment may safely be
spent? Journal for Higher Education Management, 8 (1), 57-67.
Federal Reserve Bank of Philadelphia (November 22,2002). Survey of professional
forecasters. Philadelphia: Federal Reserve Bank of Philadelphia.
Hansmann, H. (1990). Why do universities have endowments? Journal of Legal
Studies,19 (1), 3-42.
Hopkins, D. & Massy, W. (1981). Planning models for colleges and
universities. Stanford, CA: Stanford University Press.
Kaufman, Roger T. & Woglom G. (2003). Incorporating non-financial wealth in
college and university investment strategies. Journal of Educational Finance,
29 (1), 61-82.
Massy, William F. (1990). Endowment: perspectives, policies, & management.
Washington, DC: Association of Governing Boards of Universities and Colleges.
National Center for Education Statistics (various dates). Finance survey of the NCES
integrated postsecondary education data system. Retrieved, March 9,2004, from
http://www.nces.ed.gov/.
Swensen, David. (2000). Pioneering portfolio management. New York: The Free Press.
Tobin, James (1974). What is Permanent Income? American Economic Review. 64 (2),
427-32.
Winston, Gordon C. & Lewis, E.G. (1993). Physical capital and service costs in US
colleges and universities: 1993. Eastern Economic Journal, 23 (2), 165-89.
Winston, Gordon C. (1999). Subsidies, hierarchy and peers: the awkward economics of
higher education, Journal of Economic Perspectives, 13 (1), 13-36.
22
Table 1: Summary Financial Statistics FY 2000/01
Table 2: Percentage Changes in Financial Variables FY1996/97 and FY2000/01
Table 3:Financial Ratios Fiscal Years 1996/97-2000/01
Table 4:Financial Ratios FY 2000/01
Table 5: Sustainable Spending Rates
Table 6: Treasurers' View of Optimal Spending Rates
[These tables are on the Excel file, "Tables Mar 7 2004.xls" on the diskette
accompanying the hardcopy of the paper]
23
1
Net assets are assets minus liabilities. The major component of the former at most
schools is the endowment, but it also includes the value of life funds and the book value
of plant, equipment, and collections. Prior to 1996 private colleges and universities
completed the same IPEDS survey as public institutions (the GASB survey). In this
survey respondents are asked to estimate the replacement value of their buildings and
equipment. Since 1996, however, private institutions complete the FASB survey, which
does not ask these questions. The major liability at most colleges is the value of the
outstanding debt from bond issues. As denominator, we chose to use the total full-time
student population. Undergraduates comprised more than 95 percent of the total in
2000/01 at 41 of these 49 colleges. At another three (Union, the University of the South,
and Wesleyan), undergraduates comprise between 90 and 95 percent, and at the
remaining five (Bard, Bryn Mawr, Sarah Lawrence, Smith, and Washington and Lee)
they comprise between 80 and 90 percent of the full-time student body.
2
When quartiles do not divide evenly, EXCEL uses interpolation to calculate medians.
3
Since physical assets are illiquid, once they are built a college loses much of its
flexibility in reallocating that wealth to other uses.
4
This is higher than the $60,510 figure for "educational and general costs per student”
that is reported in the Wellesley College Annual Report. Most of this difference reflects
our decision to include the costs for auxiliary enterprises, most of which comprise the
costs of room and board. We decided to include this category for several reasons, one of
which is the apparent practice of some schools to classify room and board costs as
educational costs while others classify them as auxiliary enterprises. Consequently, the
IPEDS data do not allow us to separate educational and general costs from other costs in
a consistent and/or reliable manner. A small portion of our estimate of total expenses
may also include costs for other, unrelated auxiliary enterprises.
5
More comprehensive measures of total costs, such as those developed by Winston and
Lewis include an estimate of the implicit cost of physical capital (1993). Inclusion of
these costs would increase the differences in our sample.
6
Although the coefficient of variation, calculated as the standard deviation divided by the
mean, is more frequently utilized as a summary statistic, we used a summary statistic
with the median as the denominator because a few of the extreme values in our sample
skew the mean.
7
Comprehensive fee data for these 49 colleges were taken from The College Board
College Handbook, published by the College Entrance Examination Board (2002).
8
Most, but not all, of this amount is a subsidy from the institution to the students. The
cost of services paid by federal and state grants and contracts and the costs of running
auxiliary enterprises, however, are included as expenses even though they may not be
provided for (or paid by) the full-time students.
9
While imputed data for net tuition seem to be more accurate, several schools mistakenly
reported their comprehensive fee as their tuition.
10
Our computed subsidy includes grants from private entities, like foundations, but these
amounts are small for almost all of these liberal arts colleges.
11
Because of the substantial size of Wellesley's auxiliary enterprises, not all of this
subsidy is spent on the full-time students.
24
12
To provide a slightly longer period we calculated the change in net assets per student
from the beginning of fiscal year 1996/97 (which is usually July 1, 1996) until the end of
fiscal year 2000/01, which is usually June 30, 2001. The starting point for the remaining
variables in Table 2 is the fiscal year 1996/97.
13
Two colleges, Dickinson and Vassar, reported suspicious declines in expenses per
student. At both schools, however, enrollments rose -- by 28 percent at Dickinson and by
5.5 percent at Vassar. Thus, total expenses increased at both schools.
14
The IPEDS data do not separate gifts from private grants and contracts. Furthermore,
the surveys include two items representing "other specific changes in net assets,” which
often represent changes in institutions' accounting methods. Consequently, our saving
variable does not always correspond with the reported change in net assets.
15
Other revenue includes government appropriations, revenue from hospitals and
independent operations, and sales and services of educational activities and auxiliary
enterprises that are not counted elsewhere. Much of the revenue from auxiliary
enterprises is included in the room and board component of net comprehensive fees. An
appendix that indicates how each of the variables in this paper was derived from the
IPEDS data is available from the authors upon request.
16
These returns are similar to those earned by the top Ivy League institutions and the
other top national universities that also devoted a large part of their endowment to
alternative assets.
17
Incomplete data indicate that the wealthiest schools experienced larger declines in their
endowments during fiscal year 2001/02 than most of the other top colleges, but none of
the declines among the wealthiest six exceeded ten per cent.
18
According to the IPEDS instructions, accumulated depreciation is not included (or
subtracted) in these estimates of the disaggregated categories of physical assets although
it is subtracted in the calculation of total and net assets.
19
The IPEDS survey for fiscal year 1996/97 only provided data on the book value of
plant, equipment, and collections for the end of the fiscal year. Thus, we only have four
years of data.
20
This conclusion, however, may be premature if the wealthiest six colleges have
recently embarked upon constructions project based on their newly acquired wealth.
21
Almost all of these colleges are obliged to run a balanced operating budget in most
years. Our observations and discussions with college personnel indicate that colleges
seem to fall into one of two categories concerning the relationship between spending
from endowment and the operating budget. Some that have fixed takeout ratios calculate
the amount that will be available to spend and then formulate their operating budgets
based on this takeout. The formula for each school is given in the annual NACUBO
Endowment Study, prepared by Cambridge Associates, Inc. for the National Association
of College and University Business Officers. The most common formula allows for
spending a specific percentage of the endowment's value, either last year's value or some
rolling average. Colleges with more flexible takeout rates first construct their operating
budgets (subject to some flexible constraints about spending from endowment) and then
withdraw funds from the endowment sufficient to balance the budget (up to some limit).
Consequently, another common formula allows for spending from endowment to grow at
some fixed rate, often equal to the rate of inflation plus a small percentage.
25
22
Federal Reserve Bank of Philadelphia (2002).
It seems unlikely to us that HEPI inflation will be almost double that of CPI inflation
for the indefinite future although this would accommodate 2% increases in real wages for
continuing employees, assuming no changes in productivity. Part of the additional two
percentage points might also reflect requisite future increases in resources required by
advancing technology, as discussed in Hopkins and Massy (1981) or trustees' beliefs that
their college will need to increase the real (inflation-adjusted) subsidies provided to
future students, either full-paying students or those on financial aid.
24
The expected rate of return would obviously depend upon the portfolio allocation of
the endowment and would be higher at those institutions that have invested heavily in
alternative assets. In Kaufman and Woglom (2003), we investigate this allocation in
more detail for several of these colleges.
25
Throughout this paper we have ignored the effects of volatility and uncertainty. These
effects have important implications for determining optimal spending rules, which are
discussed in Coiner (1992). He shows that sustainable spending rates can be affected by
as much as 1 percentage point because of volatility and uncertainty.
26
These numbers are slightly different that those in Column (7) because of rounding.
27
Massy, (1990), p. 47.
28
Tobin (1974), p. 427.
29
The correlation between net assets per student and the excess of the treasurers'
sustainable spending rate over the actual rate is 0.32 (using the normalized gift rates).
The sustainable spending rate, of course, is very sensitive to the assumption that one
fourth of all gifts are earmarked for the operating budget.
30
Although the median (normalized) sustainable spending rate of 3.28 percent of net
assets (among the remaining 43 colleges) may seem low, recall, that the median ratio of
long-term investments to net assets among these schools is 0.82. Consequently, a
spending rate of 3.28 percent of net assets is equivalent to 4 percent of long-term
investments. This figure is much closer to the target endowment payout rates at most of
the schools in our sample when adjustments are made to account for the effects of using
rolling averages.
31
See, for example, Hansmann (1990).
32
Although many schools have statutory takeout rates in this range, they usually use a 2-3
year rolling average of the endowment as their base. When the endowment is rising over
time, this results in lower effective takeout rates.
23
26