Why are University Endowments Large and Risky?
University of Washington - Department of Finance and Business Economics
Christopher M. Hrdlicka
University of Washington - Michael G. Foster School of Business
April 11, 2014
We model universities as producers of social dividends to analyze their chosen endowment size and asset allocations. As producers, universities take risk by investing in internal projects that generate a stochastic stream of donations or by investing externally in financial markets. If the university's decision makers maximize total output, then the more productive the internal projects, the smaller the endowment is, since the university primarily invests internally in new projects. If instead the decision makers maximize a pro rata payment, then they choose not to invest internally and the endowment is risky and grows without bound. Adding the UPMIFA-mandated 7% maximum endowment payout constraint does not induce internal investment in universities that value pro rata payments. The constraint actually limits all universities' ability to buffer adverse shocks with their endowment, which increases the volatility of their internal capital stock. In addition, the constraint prevents universities from converting new resources into internal capital quickly, leading to larger and riskier endowments, and lowering the growth rate of the most productive universities.
Number of Pages in PDF File: 68
Keywords: University endowments, portfolio choice, investment policy, governance, agency, UPMIFA
JEL Classification: G11, G32, G23working papers series
Date posted: March 19, 2011 ; Last revised: April 12, 2014
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