THE CHRONICLE OF PHILANTHROPY
May 27, 2004
Prudent Management or Outright Greed? Critics Ask How Big
Endowments Should Be
By BEN GOSE
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
"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,
"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
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
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
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
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
"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
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
"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
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."
Volume 16, Issue 16, Page B9
© 2004 The Chronicle of Philanthropy