Voices in the Wilderness

A forum for discussion of all things Dartmouth.

Wednesday, March 30, 2005

Money Talks

We thought it an apt time to reprint a letter originally published in the Valley News by Dick Ramsden (link unavailable), a former Brown trustee who is very well versed in the world of college finance. The emphasis is ours, but we reprint the text unedited. The second and third paragraphs are of particular interest, as our eyeballs pratcially melt every time we read them. Enjoy.

The Rest of the Story

During the recent controversy over the future of Dartmouth College’s swimming and diving teams, a much larger question was not addressed. Why is an institution with an endowment exceeding $2 billion, that has raised over $300 million in total gifts over the past three fiscal years ending June 30, 2002, and has one of the most prolific annual funds in higher education, reduced to cutting swimming to save $200,000 a year? This is an attempt to tell “the rest of the story.”

Dartmouth officials state the College’s endowment is down and they must cut the budget. It sounds reasonable, but how has Dartmouth’s endowment fared in recent years? In June 1994 the Dartmouth endowment was $750 million; by June 2000 it reached almost $2.5 billion, more than tripling in six years. Since then it has receded to an estimated $2.1 billion. Over the 5 and 10 years ending June 2002 Dartmouth’s compound annual investment returns have been 13.7 and 14.8 percent. Over the three-, five-, seven- and ten-year periods ending June 2002, Dartmouth’s investment performance ranks in the top ten of 150 leading colleges and universities. Dartmouth’s investment performance has been superb. The problem lies elsewhere - in the extraordinary growth of endowment spending since 1998.

It took 230 years for Dartmouth to reach the milestone in 1998 where endowment provided almost $50 million (actually $48.7 million) to support operations. In the next three years, that figure more than doubled to $106 million and in it went up almost 160 percent to $126 million. To put that in perspective, incremental endowment spending over the four years of $77.4 million is equal to almost $14,000 for each of Dartmouth’s 5,600 undergraduate and graduate students! Where did the money go? From 1998 to 2002, scholarship support rose from $40 million to $51.5 million, but tuition revenues also increased, from $131 to $158 million. Over the same period operating expenditures grew from $330 to $493 million, of which the biggest piece was compensation, which surged from $184 million in 1998 to $280 million in 2002 — a 52 percent increase in four years!

How could this happen? The answer may lie in the rapid turnover of senior positions at Dartmouth in recent years. Since 1997, Dartmouth had had three different chairs of its Board of Trustees (Bosworth, King and Dentzer) two Presidents (Freedman and Wright) four Provosts (Wright, Brinkerhoff, Prager and Scherr) and three chief financial officers (Hutton, Johnson, Keller). With that kind of turnover, the first casualty is institutional knowledge and accountability. But turnover alone doesn’t explain Dartmouth’s financial problems.
Endowed institutions have spending policies to govern how much endowment income is to be used each year. The purpose is to protect the purchasing power of the endowment over time, and to produce regular spending increases, avoiding large
increases in some years and no increases or even decreases in others.

Dartmouth’s policy limits spending to 4.25 percent to 6.5 percent of the endowment’s average market value over the prior twelve quarters. Within that wide band, for many years endowment spending was on automatic pilot increasing approximately 5 percent a year, which kept spending within the prescribed limits. With the endowment growing rapidly in the late 1990s and the administration desirous of spending more of this sudden wealth, in fiscal
1998-1999, Dartmouth made a fateful course change. It abandoned the policy of automatic 5 percent increases, which was sensible, but replaced it with a formula that would prove both excessive and myopic. It was excessive in that it increased the spending rate, first to 5.25 percent and then in July 2000 to 5.5 percent, well above the 4.5-5.0 percent rate of most institutions. On a $2 billion endowment 0.5 to 1.0 percent amounts to $10 to $20 million of extra spending — every year.


Dartmouth also chose a narrow and volatile base on which to apply the 5.5 percent rate — the average market value for the prior twelve quarters. In what in retrospect is seen as the “blow-off period” of the third great bull market of the century, this ensured that endowment spending would ride the bubble and experience explosive growth. When the bubble burst, and lower market values became part of the base, not only would spending growth be halted, it would have to be cut significantly. How significantly? As a rough gauge, at a 5 percent spending rate on $2.1 billion, present spending from endowment should be approximately $105 million; in the current fiscal year, even after cuts, it is estimated at $122 million.

In the piloting of its fiscal affairs since the mid-i 990s, Dartmouth has gone from several years of automatic pilot to four years of flank speed to the need to reverse engines. Such seamanship is not good for a ship or its passengers; it is not recommended for an educational institution either. And it could have been avoided. Over two decades ago a faculty group at Yale devised an elegant endowment spending formula that combined the best of the automatic increase and market value approaches to endowment spending. Numerous institutions, including Dartmouth’s regional neighbors, the Phillips Exeter Academy and the Montshire Museum of Science in Norwich, Vermont, use the Yale formula.

There is one other mystery that has arisen from the swimming team saga and it begs clarification. How does Dartmouth make its budgeting decisions? Who decides that compensation costs should go up 52 percent in four years, and, when the going gets tough, who gets to pick the swimming and diving programs as sacrificial lambs? In a world that seeks financial transparency, Dartmouth’s budget process is opaque and notably different from some of its Ivy League peers.

In the 1970s Princeton, Brown and many other universities established advisory committees that allowed budget procedures to become more open and accountable. Called priorities committees, they are typically chaired by the provost, staffed by the chief financial officer and include faculty, graduate and undergraduate students appointed for two-to three-year terms. At Brown the committee meets frequently from September to December reviewing detailed presentations on all the key revenue and expense
assumptions driving the operating budget. A sophisticated budget model of the university aids this work.

The committee presents its report to the president and trustees in December and it is published in the university’s community newspaper and placed on the university’s website. The analysis and recommendations are available for all to read, from the most senior faculty member to the newest employee. The report is advisory and the ultimate responsibility for approving the budget falls to the president and trustees, who vote on the budget at the winter trustee meeting. As a former Brown trustee, and chief financial officer when this process was established, I am convinced it is one of the most important elements of governance at Brown and a major reason that after many years of operating deficits prior to 1978, Brown has benefited from both an informed community and well balanced budgets since.

Dartmouth is an institution of national importance that is blessed by a generous and loyal family of alumni and friends. To preserve that goodwill, Dartmouth deserves far better and open procedures for endowment spending and annual budgeting than is evident by an examination of the public record over the past few years.

Dick Ramsden, who lives in Lyme, is the parent of two Dartmouth graduates and is a former trustee and chieffinancial officer of Brown University.