How University Finances Work in a Crisis

Photo Illustration by Kevin van Aelst

Covid-19 has destabilized university finances, something particularly stressful for faculty members, who often find themselves left out when budgets are rationalized. Professors seek explanations about the administration’s response, and sometimes those administrative explanations lack transparency, spreading mistrust and misconceptions.

Administrative responses to lost income during a financial crisis follow a fairly standard protocol. The first response is to slash discretionary expenditures: stop unnecessary travel, defer routine maintenance, freeze hiring, etc. This modest short-term step slows cash outflow, but for severe crises, such as the one we now face, it seldom solves the problem. Large nondiscretionary expenditures continue unabated: salaries, pension-fund contributions, health insurance, loan repayments, building leases, and so forth. This first response simply buys time.

Inevitably, rumors about large, centrally controlled pools of money will circulate. In fact, the rumors may be true. Many governing boards mandate the creation of a discretionary rainy-day reserve account containing several months of normal operating expenses. Certainly, these rainy-day funds can be used to offset reduced income due to the pandemic, but not all of it; some money must be retained in reserve for other possible emergencies, such as a broken water main or HVAC system. The amount retained will depend on each university’s exposure to risks like aging campus buildings, tornadoes, floods, and earthquakes.

Universities have more money in restricted reserve accounts. They must maintain sufficient funds in reserve to cover required debt payments (interest and principal), pension-fund liabilities, health-care plans, and other nondiscretionary expenses. Some bond covenants even require a reserve fund to cover repairs and maintenance of campus facilities financed by the bonds. Stated simply, this restricted reserve money is unavailable for routine operations.

Endowments are a highly visible pool of money. Faculty members inevitably wonder: Why can’t the university use its endowment to compensate for lost income during this crisis? The university can, indeed, increase income from its endowment in a fiscal emergency, and many will — but only reluctantly and only for a limited period of time.

This can occur in three ways. First, the university may withdraw any unrestricted funds that it has deposited into the endowment, providing a one-time source of cash. For example, to mitigate Covid-19-related revenue losses, Stanford University approved plans to withdraw up to $150 million from its unrestricted endowment. Second, a university can adjust its payout rate from the typical 5-percent target rate to as high as 7 percent without incurring suspicions of imprudent fiscal management. In addition to its withdrawal, Stanford increased its payout from endowment funds that support student financial aid by approximately 3 percent. However, extended payout rates exceeding the target rate jeopardize the sustainability of the endowment’s long-term benefits, especially during periods of investment-market volatility. Third, and least desirably, a university can dip into its restricted endowment principal during a demonstrably dire emergency. Because this violates trust agreements with donors, some states require court approval or an attorney general’s review.

As a rule of thumb, dipping into the restricted principal manifests desperation. For example, to mitigate its “grave” financial situation, Harvard University just announced plans to take 3 percent of all restricted funds in the endowment and make them available for immediate use, including room-and-board rebates, financial aid, and protective supplies needed to reopen the campus. Extraordinary steps like this will provide one-time relief, but they cannot provide a recurrent source of revenue without jeopardizing the endowment’s mission. Ultimately, universities must find long-term solutions for restoring financial stability. Two options typically fit this bill: generating new sources of revenue and reducing core expenditures.

Obviously, the first option, generating new revenue, is preferable. It is also unrealistic in a moment like this, with sudden losses of revenue. A primary source might be new academic offerings designed to tap into a particular market niche: new degree programs, certificates, online outreach, et cetera. The University of Massachusetts system recently announced it was moving forward with a partner in an online-education initiative aiming to derive $300 million over five years. However, these initiatives generally materialize slowly, requiring one time-consuming review after another, regardless of the urgency (the UMass program was announced over a year ago and is just now moving forward).

Plus, revenue-generation often requires resources that may exceed potential gains, at least in the short term. A hypothetical example: A university hires an expensive research team that fails to generate grant revenue needed for an expected positive return on the institution’s investment. Or, as in the case of Concordia University, investments designed to attract students fail to generate the anticipated positive return on investment due to declining enrollment. Another source might be more sponsored research, with its indirect-cost reimbursement. However, this scenario actually costs the university money. On average, universities recover only about 70 percent of the indirect costs incurred by sponsored research; that is, universities lose money on every grant. In short, this first option — generating new revenue — sounds good in principle but is rarely viable in practice.

Therefore, to stabilize their finances, universities tend to favor the second option: reducing core expenditures. These reductions follow a fairly standard sequence. After the initial cuts in discretionary expenditures, operational cuts come next. Smaller expenditures, such as contributions to employee-retirement accounts, may be suspended, as they were this summer at the Johns Hopkins University. The largest expenditures, personnel salaries, are reduced through lay-offs, furloughs, and decreased appointment levels (from 100 percent to 75 percent, for example). In situations not involving tenure, contracts are not renewed. In a chilling example, Ohio University first notified 140 union employees and then, two weeks later, 149 administrators that their positions would be eliminated and 53 instructional faculty members that their contracts would not be renewed beyond the 2020-21 school year. (Fifty-five administrators would be rehired in new positions.) The remaining employees would be furloughed (without pay) for as long as 18 days, depending on their base salary; senior administrators would take a 10- to 15-percent salary reduction. All of this was followed by an announcement that 200 additional employees would be cut later this year.

As a last resort, universities declare financial exigency, signaling that they no longer have the funds to meet salary obligations to tenured faculty members. In one example attributed to local government-mandated “stay at home” orders to inhibit Covid-19 spread, Central Washington University proclaimed a state of financial exigency. In another example linked to Covid-19’s exacerbation of a long-term downward trend in enrollment, Lincoln University, in Missouri, also declared financial exigency. This does not equate to bankruptcy, which is settled in the courts, and debt obligations are not renegotiated. Nor does it presage weakened concepts of tenure or academic freedom; those fundamental tenets remain intact.

Idealistically, financial exigency announces that the university will solve its structural financial crisis with careful deliberation and full due process. In practice, it implies the potential termination of tenured faculty and academic programs. In this context, it is worth noting that the American Association of University Professors recognizes this eventuality: “A tenured appointment is an indefinite appointment that can be terminated only for cause or under extraordinary circumstances such as financial exigency and program discontinuation.”

This last resort is always the most contentious. Unions, faculty senates, alumni groups, government officials, recalcitrant presidents, and governing boards all become involved in questioning the need for such a draconian step. Tactically, they draw out the process for as long as possible, hoping that the financial crisis will resolve itself before terminations occur. That approach is not always successful. For example, Missouri Western State University did not address years of deficit spending, rendering it particularly vulnerable to the economic impact of Covid-19. As a result, it is now laying off roughly 70 staff and administrative employees and 50 faculty members (20 with tenure) over the next two years and phasing out nearly 50 academic majors.

With faculty terminations now beginning, and more on the horizon, one core question inevitably comes up: Why doesn’t the university reduce the number of administrators instead?

The conventional answer is that universities must retain a team of administrators to ensure compliance with an ever-growing array of regulations imposed by federal agencies. Failure to comply can result in hefty penalties, sometimes in the multimillion-dollar range. Another conventional answer is that universities must retain a group of administrators to raise money: enrollment managers to recruit and retain students, development officers to generate donations, counselors to advise students, and so forth.

Irate faculty members often find these answers unconvincing. Frankly, many senior academic administrators who come from academic backgrounds — presidents, provosts, deans — share that viewpoint; they would prefer to invest resources in more faculty members. However, their duty of loyalty, their fiduciary responsibility, requires them to ensure the university’s financial well-being. And that necessitates adequate administrative personnel to minimize the risk of noncompliance or of insufficient income.

Fortunately, the overall economic meltdown due to the pandemic confers two potential financial benefits for most universities. First, enrollments generally increase as economic conditions decrease, stabilizing tuition revenue. This rule of thumb may not hold true for all academic units within a university (such as a business school), but it has held true over the years for higher education in general. And second, the cost of borrowing money decreases along with interest rates. As such, the pandemic offers universities an opportunity to refinance as much of their outstanding debt as they can. And indeed, institutions of all sizes and missions are taking advantage of the historically low rates in the volatile bond market. The Mt. San Antonio Community College District refinanced about $91 million in bonds earlier this year, saving taxpayers nearly $14 million in future debt payments. Iowa State University recently refinanced nearly $18 million in debt, saving $2.4 million in fiscal year 2021.

After the pandemic has passed, all will not immediately return to normal. Universities must restart suspended operations, reinstate furloughed employees, and restore on-campus instruction in a changed reality. They must also realign budgets with post-pandemic strategic priorities. Ironically, this may provide opportunities for profound change, as well as for new priorities, business models, and operational strategies. Until those strategies bear fruit — if they do — higher ed will continue to feel the financial pain.