Endowment Payouts Fall Short of University Quotas

In an office on the first floor of University Hall, Associate Dean of Harvard College, Georgene B. Herschbach and her staff wade through millions of dollars of financial requests from divisions within Harvard College. They face decisions like whether to expand staffing at the Office of Career Services or to replace six-year-old computers used by assistants to the House Masters.

Across the Yard, members of the Progressive Student Labor Movement use Mass. Hall as a rallying point to demand that Harvard pay its workers a living wage.

And on the second floor of the Littauer Center for Public Administration, Oliver Hart, Furer professor of economics and chair of the economics department, watches as economics departments at competing universities woo away promising scholars with higher salary offers.

Funding for these initiatives—and the hundreds of others that are considered each year—is hard to come by, even for a University with a $19.2 billion endowment.

Thanks to the fat wallets of Harvard’s benefactors and the incredible economic boom of the 1990s, Harvard’s burgeoning endowment—and not student tuition and fees—has recently become the largest source fueling Harvard’s financial engine.

The University uses no specific formula though for deciding what percentage of the endowment to spend each year. The result, over the past few years, has been that hundreds of millions of dollars theoretically allotted under University policy toward the yearly budget never materialize.

Thus, while Harvard continues to accumulate billions upon billions of dollars of financial reserves, needs within the University continue to go unmet.

Dispersing the Wealth

Harvard made headlines last fall when its endowment reached $19.2 billion—making the University $9 billion richer than any other.

That endowment is the sum of thousands of funds, which are listed in the “Fund and Gift Supplement to the Financial Report”—700 pages of small print that lists every gift from the Lamont Library endowment fund to the Taipei Paper Factory Book fund.

Since most donations are made directly to Harvard’s separate schools, those schools—and not the University’s central administration—actually control the vast majority of the endowment.

But those donations are by no means equal across the University. While the Faculty of Arts and Sciences (FAS) controlled $7.99 billion as of June 30, 2000, the Dental School controlled a mere $124 million.

Ultimately, however, that money is useless until it is spent. To the student or researcher at Harvard, the fact that the University controls a $19.2 billion endowment is insignificant—it is the yearly income provided by that endowment that makes the day-to-day difference.

The yearly income is what enables FAS to hire new faculty, the Medical School to build new laboratories and the Law School Library to buy new books.

The endowment income plays a different role in the budget of each school—at the Divinity School it accounted for 56 percent of the 2000 budget. But across the river at the School of Public Health, the endowment provided a mere 13 percent.

No Strings Attached?

Restrictions placed by donors on their gifts significantly limit the flexibility enjoyed by the various schools in spending endowment income.

“We are legally obligated to meet donors’ requirements,” says Elizabeth C. “Beppie” Huidekoper, the University’s vice president for finance.

Three quarters of Harvard’s assets are subject to such restrictions, which some administrators say are a hindrance to setting their own financial priorities.

“We’d love it for donors to say their gifts are simply for the benefit of FAS,” says David L. Murphy, assistant dean for finance in FAS. In fact, few donors are willing to give such broad instructions.

Huidekoper says that recently donors have been asked to include stipulations in their gifts allowing Harvard to use their money for other purposes if the administration deems the original no longer relevant. But for alumni who are committed to specific causes, this can prove a tough sell.

Restricted funds can thus be difficult to spend if their stated purpose does not match the University’s needs. While some University programs are devoid of funding, these unspent funds sit idle, lining the University’s coffers.

In recent years, the University has run significant budget surpluses—$120 million in fiscal 2000—that in large part are produced by the inability to use these funds for their prescribed purposes.

At the same time, administrators recognize that these restricted funds have their purpose, creating an incentive for the University to initiate programs it might not otherwise consider.

“These funds force us to provide the depth and breadth of activities and interests that other universities can’t provide,” Huidekoper says.

The Big Picture

In the University’s annual “Financial Report to the Board of Overseers of Harvard College,” Harvard’s sources of income—only one of which is the endowment—are detailed.

In fiscal year 2000, Harvard had an overall income of $2.0 billion, which came from student payments, sponsored revenues and gifts, as well as from the endowment.

Endowment income made up 29 percent of those revenues while student tuition and fees made up 24 percent. Only seven percent of fiscal 2000 revenue came from gifts intended for immediate use.

Sponsored revenue, the money given to Harvard by outside parties—particularly the federal government—to conduct research, accounted for 21 percent of the University’s budget.

At the height of the Cold War, sponsored revenue accounted for the largest single portion of the University’s income but has decreased proportionately in recent years.

The quadrupling of Harvard’s endowment in the 1990s brought endowment payouts to Harvard’s schools from $193 million in 1990 to $556 million in 2000.

“It’s been truly unexpected what’s happened over the last 10 years,” Huidekoper says.

In 1990, endowment income accounted for only 17 percent of University revenue whereas today that number has risen to 29 percent—lessening the University’s dependence on other sources of income.

“The growth of endowment income keeps us from having to increase the burden on students,” Huidekoper says.

As a result, Huidekoper notes that students have seen less rapid tuition increases over the last decade. After an 8.5 percent increase during the 1980s, undergraduate tuition has only gone up 5.4 percent during the 1990s.

Setting the Rate

Each year, the Corporation sets the endowment distribution, for which the “targeted spending rate” is between 4.5 and 5 percent of the endowment’s market value, according to official University policy.

But University Treasurer and Corporation member D. Ronald Daniel says that percentage is actually not the starting point in determining the distribution.

Instead, the Corporation indirectly arrives at its own percentage through consideration of the previous year’s distribution and decision on how much that distribution should increase.

And while Daniel says the Corporation makes efforts to keep the endowment payout within the 4.5 to 5 percent range, in recent years the distribution has consistently fallen well below that mark.

For fiscal 2001, the spending rate was only 3.34 percent. The University has not met its payout goal since 1995, and has not exceeded it since 1983, prompting concern from its schools that they are being denied funds.

“I think all of the schools would say that they would like the payment to be at the target,” says Paul W. Upson, assistant dean for finance and operations at Harvard Law School.

Had the Corporation met the 4.5 percent goal for fiscal year 2001, distribution from the endowment would have grown by $200 million—an increase of nearly a third.

Moreover, despite having the largest endowment of any university in the nation, Harvard’s distribution rate is below the average of other universities.

According to data collected by the National Association of College and University Business Officers (NACUBO), the average university endowment payout rate was 4.2 percent in fiscal 1999—a year in which Harvard’s rate was 3.32 percent.

The study also determined that 72 percent of universities use a rigid formula to determine endowment distribution. But Harvard’s system allows for much more discretion, which can result in a lower endowment payout.

The Rationale

Huidekoper says part of the reason Harvard does not meet its target rate of endowment spending is that the Corporation sets the distribution rate in November—10 months before the start of the fiscal year. Thus an amount that seems generous before explosive market growth during the following months may appear unnecessarily small come July.

Yet, even if the endowment had seen no growth during fiscal 2000, the spending rate still would have fallen below the 4.5 to 5 percent target.

Huidekoper says the low distribution rate is also the result of a desire to maintain a reasonable pace of growth in the University.

“You have to balance how much you want the University to grow,” Huidekoper says, noting that even during fiscal 2000, when the spending rate was only 3.97 percent, the University added 700 employees, creating a strain on the University’s infrastructure.

And given the current volatility of financial markets, the Corporation has sought to keep distribution conservative to make sure that future market downturns will not force the University to lower endowment payout—something the Corporation has not had to do in the last 20 years.

“Never does [the Corporation] want to increase the distribution and then have to lower it,” Huidekoper says.

“It’s a debate between spending money now or planning for the future or when economic times are tough,” says Cheryl Hoffman, associate dean for finance in FAS. “We wouldn’t want to have to go through budget cuts.”

In fiscal 2002, endowment payout will increase by 21 percent, but even then the spending rate will likely not approach the 4.5 to 5 percent target. Indeed, a nearly 30 percent increase in the distribution amount in fiscal year 2000 still left the spending rate below 4 percent.

“Even when we are increasing the number of dollars [Dean of FAS] Jeremy [R. Knowles] can have, the [return on the] endowment is so strong that it drives the spending rate down,” Daniel says.

Funding the Yard

Harvard’s individual schools ultimately decide the fate of endowment payouts. In the Faculty of Arts and Sciences—Harvard’s largest school—turning the pot of gold into a currency that students and faculty can use is the job of University Hall, the administrative headquarters of FAS.

The recent explosive growth of the endowment controlled by FAS has made it more dependent on this source of income. While endowment payout accounted for only 25 percent of FAS revenue in fiscal 1990, it made up 39 percent in 2000. In the same time period, student payments declined from 35 to 28 percent.

Within the FAS operating budget—$521 million in fiscal 2000—these funds are distributed among six broad categories of spending, the largest of which encompasses faculty and staff salaries, department operation costs, and faculty recruitment.

Each January, the FAS Financial Office sends to the departments a target budget for these expenditures for the following fiscal year. Departments have until May 1 to request more funds than were laid out in this target budget.

“For the most part, departments are able to live within this target budget,” Murphy says. “The [additional] requests we get are fairly modest.”

Department chairs note that the growing endowment income of the University has helped to increase the success of making such requests.

“It’s more likely that if we’ve got a sensible proposition to put before the dean that we will get a sympathetic ear,” says Roderick MacFarquhar, Williams professor of history and political science and chair of the government department.

But Hoffman says on occasion requests are denied—particularly when they do not fit with long-term FAS goals.

“Sometimes it’s just not congruent with Faculty initiatives,” Hoffman says.

Hoffman says these initiatives—expressed in Knowles’ annual letters to the Faculty—are at the center of all funding decisions made by FAS.

Departments are often also helped by restricted endowment funds—which are the responsibility of the department’s financial personnel to manage.

But funds to employ faculty are controlled directly by University Hall, and departments must appeal to the FAS central administration to obtain new faculty appointments.

“Every department always wants more positions,” William A. Graham, Jr., professor of the history of religion and Islamic studies and chair of the department of Near Eastern languages and civilizations, says in an e-mail. “Large undergraduate enrollments tend to enable departments to get more positions or a specific initiative by the faculty, such as that a few years ago in [the Department of Afro-American Studies].”

FAS also makes significant expenditures on capital projects like the ongoing renovations of Widener Library and the construction of the Bauer Life Sciences Building. Such projects are one of the greatest tangible benefits of the last decade’s tremendous growth in the endowment, Hoffman says.

Supporting the Center

While Harvard’s individual schools can generate income through student tuition, endowment payouts and sponsored research, the Central Administration places a “tax” on each school to support the administrative functioning of the University as a whole.

In fiscal 2000 FAS was forced to pay $20 million to the Central Administration—11 times what it spent on faculty recruitment and 36 percent of all money paid to the Central Administration.

While Murphy says FAS administrators, like any “good red-blooded Americans,” do not enjoy paying the tax, he says they acknowledge that it does serve a valuable purpose.

Similarly, while law school administrators are less than enthusiastic about sending a portion of their funds to Mass. Hall every year, they consider themselves fortunate compared to other law schools, Upson says.

He notes that administrators at some universities consider their law schools “cash cows” and tax them disproportionately.

The Central Administration also generates revenue by paying individual schools a lower interest rate on their cash holdings than the University actually earns on the money.

Challenging Conventional

Wisdom

Even if Harvard actually met its 5 percent endowment payout target, it still might not be spending all that it reasonably could—or should.

Perry G. Mehrling ’81, the chair of the economics department at Barnard College, Columbia University and an expert on the spending practices of private foundations, says university endowments should pay out income at virtually the same rate they make money.

“As a general principle, [a university’s endowment] should pay out sufficiently so that it doesn’t increase except through new gifts,” Mehrling says. He notes that donors do not give money to universities so that the university can grow its endowment, but so it can spend money on worthy causes.

Mehrling says the 5 percent standard is based on the historical average return of a portfolio between stocks and bonds. But with the endowment’s high returns in the past two decades, he says such logic is outdated.

“What is the point of letting them [make risky investments], if they don’t pay them out?” Mehrling says.

In a paper Mehrling wrote in 1999, he argued that foundations could pay out 8 percent of their endowments annually and see no decrease in their capital, and says he believes the same analysis should apply to university endowments.

Mehrling says universities will often place a nearly total focus on increasing the value of their endowment, to the detriment of payout to yearly budgets.

“What’s the point of [the effort to increase endowments] other than to say, ‘mine is bigger than yours,’” Mehrling says.

No Complaints Here

Despite the Corporation’s failure to meet the target spending rate on the endowment, there is little pressure on the Corporation from top faculty members and administrators at Harvard’s schools to increase payouts.

The tremendous growth in the endowment income in recent years has helped to diminish concerns over the spending rate among faculty.

“Many faculty would like to see a higher payout rate, but it must also be remembered that we have [seen] some substantially higher payout years recently,” Graham says.

And if faculty members do consider the matter, they rarely take the issue to the Central Administration or the Corporation, the various bodies that could change the policy.

“We know that the university is very conservative about [managing the endowment] and occasionally we ask each other questions about that,” says Gerald Gabrielse, professor of physics and chair of the department. “But on the other hand, on balance they’ve made it work quite well.”

Ultimately, the complacency of many faculty members comes from the fact that they have faith in the expertise of the Corporation and the central administrators.

“I’m not a financial wizard in the stock market,” Gabrielse says. “[The Corporation] has to be prudent in averaging out the hills and the valleys. I haven’t tried to second guess them because, quite frankly, they’re better at it than I am.”

—Staff writer Daniel P. Mosteller can be reached at dmostell@fas.harvard.edu.

—Staff writer Kathryn L. Rakoczy can be reached at rakoczy@fas.harvard.edu