UNIVERSITY ENDOWMENT MANAGEMENT: AN EMPIRICAL ANALYSIS OF ENDOWMENT RISKS, ASSET ALLOCATIONS AND DEBT RATIOS

Abstract

This paper investigates the role of non-financial income risk in university endowment risks and asset allocations in addition to the role of endowment shocks and endowment returns in university debt ratios. My analysis is based on a comprehensive data set composed of U.S. college and university endowments’ asset allocations, annual returns, and balance sheet information from 1997-2009. I argue that non-financial income risk is negatively related to endowment risk. Although this hypothesis is supported in the data, I find that with the increasing trend in allocation to alternative assets, universities’ endowment risks have increased over time and that contrary to my original hypothesis, non-financial income risks are positively related to allocations to alternative assets. This indicates that universities are overexposed to alternative assets, and this is driving the trend in increased endowment risks over time. In a second analysis, I examine the role of endowment shocks and average endowment returns on university debt ratios. I argue that negative endowment shocks lead to increased debt ratios, as debt is an instrument that colleges and universities use to smooth spending. This hypothesis is supported in a cross-sectional analysis indicating that the higher education industry does on average increase its debt ratio during negative endowment shocks. However, a panel regression analysis indicates that individual college and university debt ratios are not significantly affected by negative endowment shocks. I also argue that universities with higher medium term average endowment returns and lower debt interest rates use more debt instead of endowment payouts to finance operations in order to reduce the implicit cost of forgoing compound returns in the endowment. This hypothesis is contradicted in the results of the debt ratio analyses, which I argue may support the hypothesis that universities behave according to the pecking order theory. Colleges and universities first use internally generated revenues before going to the external debt markets to finance operations.