Prudent Management or Outright Greed? Critics Ask How Big Endowments Should Be

Harvard University is sitting on nearly $20-billion in cash and wants much more. Guide Dogs for the Blind has cash reserves of roughly $260-million, nearly 10 times its annual budget. And Shriners Hospitals for Children maintains an endowment of more than $7-billion, a sum so vast that it covers 90 percent of the annual operating costs at the organization’s 22 hospitals.

Nearly everyone agrees that it makes sense for nonprofit organizations to set aside money for a rainy day, or to provide some reliable income. Yet as more and more charities seek to increase endowments or bolster cash reserves, and donors continue to earmark multimillion-dollar donations for endowments, critics are beginning to ask some tough questions. Among them: How much is enough? When does prudent management turn into outright greed? Should Congress require nonprofit groups to spend a certain minimum percentage of their assets each year to benefit the public good? Should the federal government continue to offer the same tax subsidies to Harvard and its endowment donors that it provides to struggling charities and their supporters?

Some scholars and others in the nonprofit world believe that big organizations with huge endowments need to be just as accountable as small charities in explaining how gifts will be used, to ensure that tax-deductible donations aren’t being socked away for some nebulous purpose 100 years from now. The endowments at the 10 richest universities are already worth $78-billion — more than the gross domestic product of the 75 poorest nations combined, according to a recent study by the Institute for Jewish & Community Research, in San Francisco.

“The equity of federal, state, and local tax policies for these institutions should be examined,” says Gary A. Tobin, the institute’s president. “In essence, what’s happening is the transfer of publicly subsidized dollars into endowments in perpetuity.”

Donors also bear some responsibility, Mr. Tobin says. “I would call on donors to carefully examine how their gifts are being used,” he says, “and to make sure that the gift they think is needed is really needed.”

But officials at some universities with large endowments argue that their swelling coffers are a boon, rather than a burden, to the average taxpayer. Andrew K. Tiedemann, a spokesman for the development office at Harvard, notes that some public universities receive nearly half their revenue from state treasuries (though several also have billion-dollar endowments). “That’s sort of like their endowment income,” he says. “Private universities are raising money to supply the kind of income that taxpayers supply to state schools.”

An endowment serves two main purposes. First, it provides a consistent source of income that lessens an organization’s dependence on outside donors for annual support. The United Way of Greater Rochester, in New York, for example, has an endowment of $105-million, nearly twice as large as any other United Way that responded to The Chronicle’s endowment survey (10 of 13 reported having endowments). The endowment covers nearly all of its operating costs, which allows the Rochester group to advertise to donors that 100 percent of their donations go directly to the programs and organizations it supports.

“The first 10 years I was here the income went to programs in the community,” says Joseph G. Calabrese, president of the United Way of Greater Rochester, who was hired in 1987. As upstate New York’s economy turned sour, he added, the United Way used its endowment earnings to cover expenses — a move that surely rankled some organizations that received support from the United Way, but one that Mr. Calabrese believes has led to more funds for Rochester charities over time.

“Because of the income from the endowment, we did not have to lay off staff, despite tremendous losses in the manufacturing base in Rochester,” he added. “We were able to avoid a downward spiral, where you reduce staff, and as a result the United Way campaign results fall off, and then you have to reduce staff even more. We’ve been able to maintain or even gain some increases in our campaign results because we didn’t have to cut staff.”

An endowment also serves as a bulwark against rough financial times. “It’s a life-insurance policy on the existence of the organization,” says Woods Bowman, an associate professor of public service at DePaul University. “Unlike an individual’s life-insurance policy, it doesn’t pay off when they die. It prevents them from dying.”

Mr. Bowman points to Northwestern University’s decision in March to abolish its organ and church-music degree as an example of what can happen to programs or organizations that lack financial strength. Northwestern will still offer some organ classes as electives, but university officials said they decided to eliminate the program because declining enrollment was putting a squeeze on its budget; the program’s only full-time faculty member had recently departed; and other programs deserved higher priority.

“If someone 100 years ago had endowed organ teaching at Northwestern, they probably wouldn’t be cutting it out now,” Mr. Bowman says. “Who knows? Two decades from now, the organ may undergo a renaissance. Certain kinds of knowledge are worth preserving across generations even if a particular generation doesn’t see the value of it.”

Other scholars have a different view. Michael Klausner, who teaches nonprofit law at Stanford University, agrees with Mr. Bowman that colleges and other nonprofit organizations with large endowments don’t have to bow to the whims of the economy and the marketplace. But he is not convinced that that is such a good thing.

Mr. Klausner argues that a cash cushion might lead a nonprofit group to maintain business as usual even if its service no longer provides much value. What if it is accepted wisdom in another 100 years that the most effective way to deliver education is via the Internet, rather than gathering students from all over the country at a liberal-arts college in the Northeast, he wonders.

“A public charity needs an endowment that could sustain the organization for three to five, maybe 10 years,” Mr. Klausner says. “If a school can’t get tuition payments, alumni gifts, and foundation gifts through its normal sources of funds for a long period of time, and has to continue to live off the endowment, that’s no longer tiding over. It’s perpetuating an organization that doesn’t need to be perpetuated.”

While scholars argue over the purposes of an endowment, in reality the traditional safety-net function of endowments is virtually obsolete at the wealthiest nonprofit institutions. The institutions with the biggest endowments are often least likely to use them to combat budget troubles.

During the economic slide from 2000 to early 2003, budget problems led some private institutions, including Middlebury College and Oberlin College, to tap a bigger share of their endowment assets for operating costs than they typically do. But when Dartmouth College, whose $2.4-billion endowment is roughly four times as big as either Middlebury’s or Oberlin’s, faced similar budget challenges, it chose to make up the shortfall solely through budget cuts. It eliminated about 50 positions, mostly through attrition, and announced that it would cut its intercollegiate swimming program — a plan it dropped when a group of parents and alumni raised enough money to keep the program alive.

Julie Dolan, associate vice president for fiscal affairs at Dartmouth, notes that the endowment provides the college’s second largest source of income after tuition, and that its endowment lags far behind that of other Ivy League institutions against which it competes for students, including Harvard, Princeton, and Yale Universities. Dartmouth’s decision will more easily allow it to preserve the purchasing power of its endowment — something that may prove challenging for organizations that have increased the percentage of endowment they spend.

Tapping the endowment to make up for a shortfall “works great in the short term, but is really hard in the long term,” Ms. Dolan says. “We’ll see a number of institutions in the next few years, particularly those that increased their payouts, feel the downside of that and have to take larger expense reductions than Dartmouth did. It’s ‘pay me now’ or ‘pay me later,’ and we chose ‘pay me now.'”

Even so, Dartmouth recently revised its endowment-spending formula to avoid sharp drops in cash flow from the endowment following periods of poor investment returns.

The new formula is designed to be somewhat conservative with the payout percentage when the endowment’s investments are performing well, and allow for a bigger percentage of assets to be spent when the investments tumble. “In years when the market value of endowment declines or the return is poor, we’ll actually distribute slightly higher amounts than you might think,” Ms. Dolan says.

Other nonprofit organizations say that it is wise to think twice before aggressively tapping into an endowment or reserve. In 2002 the Pine Street Inn, a homeless shelter and job-training and housing center in Boston, increased the spending from its $15-million reserve to offset budget cuts by the State of Massachusetts. But critics wrote angry letters calling for greater distributions from the reserve when an article in The Boston Globe revealed the six-figure salaries of the charity’s executives.

Lyndia Downie, president of the Pine Street Inn, says she was forced to weigh the needs of the charity’s clients against the importance of sustaining her organization through a long period of tight budgets.

“Had we done what some folks suggested — use our reserves more aggressively — we’d be faced with a $3-to-4-million deficit today,” she says. “And with a deficit that big, we’d have no choice but to start cutting programs. It’s all about whether or not people want to take a long-term view. You can plug a hole with reserves for a year or two, but if you do it consistently, you’ll face fairly catastrophic service cuts.”

Other charities offer similar reasons for keeping large amounts of capital in reserve.

Distributions and capital gains from the Shriners Hospitals’ $7.27-billion endowment cover 90 percent of the charity’s $596-million budget. The charity, whose headquarters are in Tampa, Fla., charges nothing for its services, primarily orthopedic and burn care for children, nor does it receive any insurance or government reimbursement. The charity’s sole sources of revenue are endowment income and annual donations.

Its endowment was hit hard during the stock-market downturn, and remains well below the peak — $8.61-billion — reached at the end of 1999.

“We realized with the losses we sustained during the lean years — 2000 to 2002 — that we in no way are so well funded that we could not be in jeopardy,” says Paul Gramblin, director of giving for the Shriners Hospitals. “If we’d had a couple more bad years, we’d be closing hospitals.”

Guide Dogs for the Blind, a San Francisco-based charity that trains dogs and matches them with about 360 blind people per year, maintains an operating reserve of roughly $260-million. Earnings from the fund cover less than half of the charity’s $28-million annual budget.

Andrew Eber, Guide Dogs’ development director, says the reserve is important because the charity makes a lifetime commitment to each of its clients. As dogs are replaced every nine years or so, the charity pays for another round of training with a new dog. The commitment to current clients alone will cost roughly $600-million over their lifetimes, he says.

Critics say such charities are worrying too much about distant goals and obligations, given the tremendous need for charitable aid today.

Daniel Borochoff, president of the American Institute of Philanthropy, a char-ity-watchdog group in Chicago, is a prominent critic of nonprofit organizations that keep large reserves. He believes that stashing away more than three years’ worth of operating expenses is excessive. Such groups often flunk the ratings that the institute issues to help donors decide which organizations to support (although Mr. Borochoff notes in his watchdog reports that individual donors should make up their own minds about what level of reserves is appropriate).

“A charity might say, ‘Oh, it’s great, we can just live off the interest,'” he says. “But if money is put into an endowment, it’s not available to another charity that may need it more. There’s just not enough money going around.”

He criticizes the Shriners Hospitals for “stockpiling” money, saying, “If they can’t use it, there are plenty of other kids with health problems that need the care.” And he says that Guide Dogs for the Blind should either broaden its mission or disburse its reserves to other organizations that aid the blind. “There are so many blind people who can’t get jobs,” he says. “It’s a tragedy that they can’t get money to help with that.”

Officials at both groups say that the institute should make greater allowances given their missions. Mr. Borochoff’s group “doesn’t understand what we do and what our obligations are,” says Mr. Eber of Guide Dogs.

“Seven billion seems like a lot,” says Mr. Gramblin of the Shriners Hospitals, “but we’re spending a half-billion dollars a year and we have no other revenue coming in” besides annual donations.

Few laws exist to deter colleges and other nonprofit institutions from hoarding contributions, rather than spending them. While grant-making foundations must distribute at least 5 percent of their assets to charitable causes each year, nonprofit groups aren’t required to spend a penny of their endowments.

Aside from the legal requirements, investment experts are also pushing colleges to keep as much money in their endowments as possible. Because of the turbulent stock market of recent years, three executives at Commonfund, which manages investments for colleges and other nonprofit organizations, wrote an essay in The Chronicle of Higher Education in February in which they argued that colleges should drop their annual endowment spending rates from 5 percent of assets to 4 percent.

Doing so, they said, would be the best way for a college to achieve “intergenerational equity” — that is, preserve the purchasing power of the endowment so that current students and future students will benefit from it equally.

Perry G. Mehrling, a professor of economics at Barnard College, in New York, believes the Commonfund officials are putting too much emphasis on preservation — and not enough on excessive accumulation — in their discussion of intergenerational equity.

“If the endowment shrinks, you’re being unjust to the future, but if it grows, you’re being unjust to the present,” Mr. Mehrling says. “The middle road is when it doesn’t grow or shrink. It’s when the real value of the endowment, except for new giving, is constant over time.”

Although his approach may seem logical, it is apostasy in the world of higher education, where many colleges try to tap as little as possible from the endowment, with the goal of having more assets to invest. Some private institutions, including Harvard and Stanford Universities, have achieved real returns, after inflation, of 10 percent annually over the past 20 years, while spending an average of 5 percent or less of assets.

“When you ask, Why aren’t those numbers the same?” says Mr. Mehrling, “the answer is: ‘We were surprised again and again'” by the investment return.

“This endowment arms race just makes no sense,” he says. “We always want to keep up with the Joneses, but that’s why we have rational policies to protect us from our baser instincts.”

Other scholars note that the pool of money going to charities, and particularly to colleges and universities, is a renewable resource. “I’m not sure what they’re saving for,” says Evelyn Brody, a professor at Chicago-Kent College of Law who specializes in nonprofit tax law. “People are going to keep giving you money. In higher education, you’re almost guaranteed to have an alumnus that hits it big every once in a while.”

Just ask Harvard, where the $19.3-billion endowment (as of June 30, 2003) seems to be spurring gifts rather than deterring them. In the 2003 fiscal year, Harvard raised $558-million, its second-best year ever. And the university is in the early planning phases for a new capital campaign, which will help pay for the development of 120 acres adjacent to the campus, and a new financial-aid policy in which parents who make less than $40,000 per year will no longer be asked to pay anything toward their children’s education. The financial-aid change will cost Harvard about $2-million per year, and the university hopes to raise $50-million for the endowment to pay for it over time.

“We always encourage our alums to support their own local organizations, communities, and hospitals,” says Donella Rapier, Harvard’s vice president for alumni affairs and development. “But we think that if they have the means, they should also support Harvard. We do believe that the work that Harvard does has a profound impact on the world.”

Mr. Bowman, of DePaul, sees some logic to the torrent of cash pouring into Harvard: “If you had a million dollars and you had your choice of giving it to a small college or to Harvard, where it would be a drop in the bucket, you might be inclined to give it to Harvard because you know its big endowment will ensure it’ll be around in the future.”

But Mr. Mehrling and others believe giving patterns may change as more donors learn the real story about where their money resides.

Harvard, for example, could cover the full cost of tuition, room, board, and fees — nearly $40,000 per year — for all 6,600 of its undergraduates by spending less than 1.4 percent of its endowment each year. That’s less than a tenth of its average annual endowment return, 14.7 percent, over the decade that ended last June 30. Harvard officials will tell you that is impossible because a large portion of the endowment is restricted, but perhaps its six highest-paid money managers could help out: They personally pocketed more than $100-million in 2003 — a sum that would cover the cost of attendance for 38 percent of undergraduates.

“Most donors want their money to be spent in a way that will affect the world,” Mr. Mehrling says. “They don’t want it to be put in a bank account and grown.”
Section: Endowments
Volume 16, Issue 16, Page B9

© 2004 The Chronicle of Philanthropy