The managing editor of Minding the Campus, Jared Gould, recently wrote an essay on the University of Chicago (UChicago). He thoughtfully summarized its finances, providing a factual overview of a problem faced, in one form or another, by nearly all universities. As an alumnus of UChicago’s Booth School of Business, his essay caught my attention, but it also suggested a broader point: for any university—like any company—its finances reflect the management team making the underlying decisions that produce those accounting and financial results and trends. Below are some additional considerations in that regard.
It’s tempting to think of finance as some kind of autonomous phenomenon that somehow exists outside of human control. But it isn’t. Finance is first and foremost defined by accounting. That means revenue and expense.
The good news is that expenses are under direct managerial control. Revenue is not a constant; it is subject to factors such as consumer choice, business cycles, inflation, regulation, competition, war, and obsolescence. Revenue also lags investment, so, by the accounting matching principle, a company’s financial position can appear lopsided in one period and healthy in another.
Our universities all face some kind of revenue challenge, but no amount of revenue ever seems to be enough, while no amount of expense ever seems too high. Expenses then become “sticky:” they constantly increase and stay there. That is a management effect: it didn’t happen by itself.
The expectation otherwise is that tuition increases can always be made to cover rising costs; that a steady supply of federal grants will fund research, along with large premiums to cover “general” expenses. Universities assume that private and corporate donors will remain generous, and that somehow it will all come out in the proverbial wash.
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Unfortunately, university administrations are often drawn from the faculty leagues of Ph.D. researchers who then make an “amateur” foray into executive management. The track record in this regard is not outstanding, and a roving band of university administrative bureaucrats rotates around the entire country, from one university to the next, first as tenured faculty, then to dean titles, then on to provosts, chancellors, and presidents. It’s an “insider” market, and an effective monopoly, and with a general culture of progressive political allegiance that restricts ideological diversification—over 98 percent of Yale faculty donations went to Democrats.
But this points to a key problem that prevents universities from operating at higher levels: administrators are rarely held accountable. The president of Northwestern University is an example. He transitioned from faculty to law dean to regional university president on the West Coast, then returned to the Midwest. He recently resigned under pressure, but instead of facing any consequences, he is merely taking a paid sabbatical before returning to a full professorship in the law school. How can this kind of widespread insulated career practice result in positive institutional development, without the basic management tools of risk, reward, and punishment?
To expect managers to take risks, they must have incentives—good and bad. In business, one way is through equity or stock ownership. And either you deliver or you’re out—all the way out. In universities, phantom stock can be similarly tied to various results. In private and family business, the incentives to perform are even more effective—it’s your own actual money. Instead, our university administrators are “hobby” managers, facing no specific upside or downside, and therefore, the university as a sector tends to remain stagnant.
University trustees feel comfortable with this because it is tied to the same executive headhunter or recruiter market they are accustomed to. Corporate trustees feel comfortable doing things the way everyone else does them, because that means less risk, and less risk means less accountability, and less liability. Liability management is arguably the biggest concern among trustees because they have assets to protect, as well as corporate careers, family businesses, and political aspirations.
This model of university management and governance may work under static conditions of institutional competition or when technology is changing incrementally. But can we say that universities are operating in a relative equilibrium among predictable social, economic, technical, and political realms that together allow them to remain stable and unchanged?
Interestingly, for the first time in a long time, universities are getting a taste of what it means to have shareholders who can make real demands, backed by a credible threat, from a White House acting like a shareholder activist—and universities don’t like it. That tells you a lot. Not only do universities not like it, they react with irrational and hostile legal action against their primary capital provider: taxpayer-based federal funding. Imagine, if you will, a corporation suing one of its shareholders or primary bondholders for raising legitimate, responsible questions over operations, costs, and expenses, and for putting perfectly rational and customary conditions on access to further capital. This tells you even more.
In most ways, our universities remain the same, but specific factors, in addition to what political party happens to be in office, are bearing down uncomfortably on the university sector. They include decreases in domestic enrollment velocity, risks to federal tuition finance, comprehensive digital alternatives for teaching, efficient foreign university options, community colleges, the military, trade schools, and pressure for degree program acceleration, which call into question all the incredible fixed costs that are strangling higher education.
The last five years have obscured many sins of university expense control, as the COVID-19 program and related finance under Biden showered universities with free money. For R1 universities with big hospital schools and with molecular and bioengineering programs, it was a financial heyday, including hospital insurance billing premiums.
UChicago was, in many ways, the epicenter of such distortions and activities, supported by local and state political interests, several global private foundations, and by Board members and their related commercial investments.
It is clearer, however, how sensitive universities are to federal finance when the Trump administration suddenly disrupts their government finance expectations. Regardless of whether you agree or disagree with such a government stance, or whether enrollment numbers are up or down, or endowment revenue is under- or over-performing, the one thing that all smart companies do in good times and bad is watch their expenses and their expense growth.
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But they do more: capable managers are ready to lower costs immediately when conditions call for it—not merely make pledges to adjust future budget levels, as UChicago’s provost recently did. Indeed, the definition of a “deficit” is expenses exceeding revenue—it is not defined by revenue falling short of expenses. A company’s finances should ideally be in balance—that’s why it’s called a balance sheet. Balance is the dependent variable. Revenue and expenses are independent variables, and expenses are ultimately discretionary. That’s why it remains the most important managerial tool, and why management is the ultimate independent variable in university finance.
It is in managerial accounting that universities such as UChicago and nearly all others continue to fall short. The things under the control of a university president include faculty headcount, faculty wages, staff and management overhead, marketing and legal costs, real estate operations, debt, and the status of their professional schools, including some, such as public policy and law, that could be closed and completely reorganized.
UChicago is not alone. Harvard, Yale, Columbia, UC Berkeley, NYU, and Northwestern are among the hundreds of other institutions. Like businesses, these changes might ideally come voluntarily, or they could be imposed on universities by the realities of consumer preference and willingness to pay; by larger education markets; by technology disruption, and by a political economy that increasingly reflects the interests of university constituents, rather than universities; that is, students, parents, donors, and employers.
Universities have historically enjoyed an unusual degree of insulation from external accountability. Combined with the rapid growth of post-war technology and related research, their expectations of state support are fully institutionalized. This has affected administrative-faculty behavior in negative ways, including a culture anchored in excessive self-reference, professional self-interest, and effective economic self-dealing. The path to improvement is fairly obvious: more outsiders, more outside pressure, more accountability, more risk-taking, and stronger incentives.
Image: “Paul Alivisatos University of Chicago President September 2021” by The University of Chicago Office of Communications on Wikimedia Commons
