Day 8: Finance
A series following my new class: The Economics of Higher Education
Today we get to talk about a subject that has captured much of my attention for the last 5 years: how exactly do you finance a small liberal arts college?
But first, another update on Day 4: The Returns to Higher Education: I came across a Twitter thread about this newly updated working paper by Zachary Bleemer and Sarah Quincy title “Changes in the College Mobility Pipeline Since 1900” and I’ll consider adding it to the Returns to College conversation next year. Long story short: they find that the college wage premium has been increasing less for low-income students than for high-income students for three reasons: 1) public universities have been declining in funding, retention, and economic value and that’s where low-income students go to college most often; 2) low-income students have also been diverted to community colleges and for-profit colleges; 3) higher-income students are majoring less in humanities and more in computer science which has increased their returns to college.
Please keep the suggestions for improvement coming!
Today’s readings
Colorado College’s AY23-24 Financial Report
Did you know that you can easily look up financial information about pretty much any private college or university in the US?
It’s true! Most private institutions of higher education are 501(c)3 non-profit organizations, which means they have to publish their audited financial statements and 990 tax return forms publicly. For class, I asked my students to take a gander at our college’s most recent financials. I encourage you to look up the college that most interests you! Search “College Name Financial Statements” and you should find them easily.
This post will focus most on the money coming in. On Day 16 we’ll talk about our College Budget Project and get deeper into expenditures.
Below you’ll see a table of Colorado College’s operating revenues in our most recently posted financial statement. The third column shows total revenues by category for AY23-24, while the final column shows information for the previous academic and financial year (financial years at colleges usually run July to June, to match the academic year). All of the numbers are listed in thousands of dollars.1
In AY23-24, Colorado College was working with $186.6 million in revenues. You can see that number on the bottom row of this table in the third column. We have about 2200 students, so that’s just under $85,000 per student.
Where does all that money come from? Two major sources: 1) current students and families, through tuition, fees, room, and board, and 2) the endowment.
The top line of the table shows what’s called “gross” tuition and fees. That’s tuition and fees before subtracting out discounts for financial aid. In AY23-24, that was $156.8 million. The next line of the table shows how much we spent on/gave out in discounts/financial aid. That totaled $60.2 million. If you only count the actual dollars coming in after financial aid, you get “net” tuition and fees, shown on the third line. That’s $96.6 million.
Room and board is counted separately. I think this is because some schools either don’t have on-campus housing or dining or maybe some schools fully contract out housing and food service. Some schools run additional things as fully separate businesses, like sports teams and health centers, and those would show up in auxiliary also. At my school, this category is room and board and the bookstore. In AY23-24, Colorado College took in $21.9 million for these auxiliary enterprises.2
That means that of the $186.6 million in total revenues, $96.6+$21.9=$118.5 million came from current students and families. That’s 63.5% of total operating revenues, about $54,000 per student.
This is what it means to be a tuition (and fees and room and board) dependent school. If our enrollments decline, especially among students and families that can afford to pay full or nearly full price, we will have to cut services, pay, programs, and people. There would be no way around it. That’s why the yield models we discussed on Day 7 are so important.
The other big number in revenues is the endowment distribution. For CC in AY23-24, that was $42.6 million: 22.8% of total operating revenue or about $19,300 per student.
“Wait a second,” I hear you thinking. “I thought colleges like CC were rich, like they had $1 billion in the bank. That’s why Congress is talking about taxing you all a lot more. Why is CC only using $42 million of endowment money? Why not a whole lot more?”
A while back I wrote a post all about endowments and why we’re legally not allowed to use much more than we do already. The long and short of it is that we’re required to try to maintain the principal of the endowment so it can continue to support all future generations of students at the college. This limits the amount we can take out each year. The average nominal rate of return on the S&P 500 is about 10% per year; after inflation that’s about 7-8%. Colleges and universities tend to invest more conservatively than other organizations (again because they want to be around for a very long time), so our real rate of return is closer to 5%. We’re not allowed to use more than that because then we would risk shrinking the principal of the endowment. Therefore,
The College has a Board approved spending policy for appropriating funds for expenditure each year. For fiscal year 2024, the College appropriated 5% of its endowment fund’s average market value over the prior 12 quarters through the calendar year-end prior to the year in which expenditure is planned.
Side note on that endowment tax: Some members of Congress have proposed that schools like ours should have their nominal endowment returns taxed at a rate of 21%. Say our nominal rate of return averages around 8% (because we invest conservatively and the economy is not booming). Now subtract that 21% tax. Our after-tax nominal return is then 6.32%. Subtract inflation, which the Fed targets at 2% but in recent years has been averaging 4ish% and lots of economists (including me) think that we’re going to have another big inflation over the next 5-10 years. That leaves at best 4.32% or maybe 2.32% or maybe 0% that we can safely take out of the endowment and still comply with the Uniform Prudent Management of Institutional Funds Act. You can understand why my college’s administrators are in Washington lobbying a lot this season, and why college economists like me are very worried about both the federal debt and Federal Reserve independence.
Where does the last 13.7% of revenue come from? Some from gifts/contributions ($7.4 million). We’ll talk more about fundraising on Day 11: Advancement. A bit from government grants and contracts ($1.6 million). Some operating revenue comes from other investment income ($6.6 million) and some from other revenue ($9.8 million).3
That’s the revenue side! How about expenditures?
In total, CC spent $181.4 million in AY23-24, or about $82,400 per student. Of that, $77.5 million (42.7%) went to instruction.4 A tiny bit ($854,000) went to research. $22.1 million (12.2%) went to academic support, $31.2 million (17.2%) to student services, $29.4 million (16.2%) to institutional support, and $20.3 million (11.2%) to dorms and food. We’ll have much more to talk about on the expenditures side when we get to our College Budget Project on Day 16.
Take a look at the financial statements of your favorite college! I’d love to hear what you find interesting or surprising.
Caskey, J. P. (2018). The awkward economics of private liberal arts colleges. Working Paper.
I really like this article as a complement to reading financial statements. It’s very provocative! Here’s how he starts: “The main goal of liberal arts colleges is to enhance their prestige, which comes from a reputation for producing high-quality graduates.” BAM.
This author argues that while college’s may have goals in addition to maximizing prestige, you can explain most of their odd behaviors by assuming they care a lot about prestige. What is prestige? “‘Quality’ is a multi-dimensional concept that includes intellectual ability, knowledge, creativity, leadership skills, etc. This is a mouthful, so for linguistic convenience I will say that they seek to maximize their ‘prestige.’” And while colleges may care about goals in addition to prestige, many of those things are wrapped into a school’s reputation and therefore can be considered an element of its prestige. For example, “if people think that colleges with more diverse student bodies produce better educations than similar colleges with less diverse student bodies, then colleges that seek prestige will want to become socioeconomically diverse.”
What odd behaviors can be explained by prestige seeking?
“Why don’t (colleges that have more qualified applicants than they have space for) raise their price (tuition) and use the revenue to enhance their academic or extracurricular programs?”
As we noted on Day 7, acceptance rates have been falling across the industry. In 2003, the percentage of applicants accepted at Top 20 private institutions was 30%. For a firm in any other industry, this would be odd. Why don’t they raise prices until demand meets supply? “The colleges could use the additional tuition income to enhance their academic or extracurricular programs. In fact, prestige-maximizing colleges would do this if prestige came only from the quality of the academic and extracurricular programs. But prestige also depends on the quality of incoming students, and colleges attain high quality students by attracting large numbers of applicants and being selective about whom they admit.” Ah ha, that’s right, peer effects.
Why don’t wealthy schools use additional donor gifts to reduce tuition?
“Earnings from the endowment enable this school to increase per-student expenditures without raising tuition. This increases the prestige of the school. In addition, there is a positive feedback effect over time since the increased prestige will increase applications in the subsequent year, raising student quality and further enhancing prestige.”
Just how much do endowment payouts and gifts provide per student? We already talked about what’s happening at CC. What about other schools? The table below shows total donor support for the top 5 and lowest 5 liberal arts colleges in 2014.
If you’d like to learn more, I wrote about endowments using data from the top 100 liberal arts colleges from 2000 to 2023 in a previous post.
Why do selective colleges offer need-based scholarships?’
Because they’re non-profits with a social mission, duh.
Yes. And.
“The general public believes that colleges have an obligation to ensure some minimally-acceptable percentage of students come from less-affluent households, and any school that does not meet this social expectation pays a cost in terms of its reputation. If that cost is sufficiently high, even colleges that only care about prestige will strive to enroll an acceptable share of students with need-based scholarships.”
Yes. And.
“There is a third reason that colleges might use need-based scholarships to enroll less-affluent students. This reason is also consistent with the notion that colleges do so to enhance their prestige. The idea is that they can raise the average quality of their student body by displacing some full-pay students with need-based scholarship students. … As the school admits more and more High Income students, it must begin to admit lower-quality High Income students. At some point, the college may find that admitting a high-quality Low Income student, even at a lower tuition, does more for its prestige than would admitting a lower-quality High Income student who pays the full tuition. This is because prestige comes from the quality of incoming students as well as college financial resources.”
“If it is costly to provide need-based scholarships, how can many tuition-dependent colleges provide them to higher percentages of students than do the rich colleges?”
“Selling some seats to lower-income students at a discount can provide revenue to improve the school’s academic and extracurricular programs as long as the tuition paid by the scholarship students exceeds the marginal cost of educating them.” How can they actually finance this? “They can because they post comprehensive sticker prices that are notably higher than their per-student expenditures. They don’t actually ‘lose’ money enrolling a scholarship student who pays a discounted tuition unless that student pays less than what the school spends on the student’s education.”
The figure below shows the gap between the sticker price and the average expenditures per student on the y-axis and the per-student donor support (endowment payout + gifts) on the x-axis. You can see that schools with very little donor support usually list a sticker price that is higher than their actual expenses, while schools with high donor support list a sticker price that is lower than their actual expenditures.
Why do some colleges offer merit aid?
“Selective colleges offer merit scholarships to raise the average quality of their student body.” They offer merit aid to full pay students with higher academic credentials to increase the overall academic average of the group.
Does offering merit aid really increase yield rates at selective schools? (Remember why yield is so important? And remember that it’s harder to yield students with good high school grades and test scores? See Day 7.) Monks (2009) reports the results of a randomized experiment at a selective liberal arts school (presumably the University of Richmond, where the author works) and shows that students who were randomly offered $7000 in merit aid (17.5% of the sticker price) were 3.9 percentage points more likely to enroll than those who were not offered merit aid. In a world with yield rates around 30-35%, a 3.9 percentage point increase is enormous.
“Less-selective colleges often use them to fill empty seats.” This I found really interesting: “In the fall of 2015, 37 of the 125 schools in my data set provided tuition discounts to 98 percent or more of entering students. In effect, these colleges provided merit scholarships to any student who did not receive a need-based scholarship.” This means that almost no one paid the full sticker price at those colleges. I had no idea that sticker price was such a fiction! Which leads us to…
“Why don’t these colleges cut their sticker prices to reflect actual tuition payments?”
“First, students who are admitted to a college and notified that they qualify for a scholarship may feel wanted or honored, and they may think that they are ‘getting a good deal’ since they are paying less than the sticker price. This could well increase the chances that they will enroll in that school.”
“Second, student applicants and others may take a school’s sticker price as a signal of quality --- what is often called the ‘Chivas Regal’ effect. … Were a school to cut its sticker price significantly below the posted prices of the schools it competes with, or aspires to compete with, people might assume that its educational services are inferior.”
“Third, the lack of transparency in what students pay to attend a college can give the college more pricing flexibility. Beyond giving colleges the ability to discount tuition based on how much they want particular students, it enables colleges to change tuitions(/revenues) from year to year without changing sticker prices. A college could, for example, raise the effective tuition(/revenue) from the previous year without changing the sticker price by reducing the average value of the tuition discounts it provides.”
Class discussion
As usual, we had a fascinating class discussion today.
We talked a lot about the ethics of merit aid. Some students were in favor, in part because they believe the idea that money can convince high scoring students to come and those students provide positive peer effects. On the subject of peer effects, some said they wished there were other criteria for merit aid rather than just pure academic rating. After looking at the financial statements, they better understand why yield is so important and they believe that merit aid can convince some students to come, so that’s a plus too. Merit aid could also be a reason why students stay at a college and don’t transfer; this is an argument that even students who are admitted Early Decision should be eligible for merit aid too. They were curious to know if students and families who received merit aid were more likely to donate to the college later on. (More on that on Day 11: Fundraising.) However, other students thought that when resources are limited, all aid should go to students who financially need it. They noted that the Caskey article didn’t talk about access basically at all.
They had some great questions about what “prestige” really means. They fully believe the idea that a high sticker price is interpreted as a signal of a high quality education. However, reading and discussing in this class, they also believe that high priced schools are admitting lots of rich kids just to pay their bills and therefore they cannot all be the most academically able students. So then why do those schools still carry so much prestige for being academically rigorous schools? (I’m looking at you, Harvard.)
Like many in their generation, these students are getting nervous about their post-graduation career outcomes. They think that a good Career Center can be an investment in prestige because it generates connections and high returns for low income or otherwise less well connected students. The quality of a school’s Career Center should therefore be upweighted in people’s estimations of prestige in the future.
Lastly, they think that students and families should be paying much more attention to expenditures per student as a measure of prestige. Why don’t they?
There is a LOT more to say about how liberal arts colleges finance and run themselves. You might even say there’s enough material for a whole Substack. But that’s all we could do in one day!
Next up: The Demographic Cliff. If you haven’t heard of it before, well then boy do I have some unpleasant news for you…
For today we’re going to ignore columns 1 and 2, which show 1) revenues that can be spent however we like and 2) revenues that must be spent specifically as a donor stated in their deed of gift.
Is this gross/before financial aid or net/after financial aid? I think net, but someone who knows better than me please correct me if I’m wrong.
What exactly is in “other investment income” and “other revenue”? Lots of small things! A diligent accountant could take a look at CC’s 990 tax returns to learn more (here’s the one from AY22-23; AY23-24 isn’t posted yet, they usually pop up over the summer). For the sake of brevity I’m not going to dig into it here.
The footnotes in this previous post detail what all is included in these major expenditure categories. The post itself shows how the share of expenditures spent on each category has changed, and not, over the last 20 years.