WE RECENTLY examined university business models and the value of them of their endowments. Endowments, which stretch into the billions of dollars for elite institutions, deserve a bit more scrutiny. These cash piles have grown at a fair clip over the last two decades thanks to savvier investments by those that manage these funds. Payouts are an increasingly critical component of university revenue, too. Endowment income supports a wide range of activities from hiring, to facility upgrades and even need-based scholarships. They are generally viewed, not least by donors, as a university's rainy day fund. Scholars at the University of Illinois and Nanyang Technological University, in Singapore, wondered how endowments have been helping universities to cope with recent economic difficulties. Do they smooth the income universities receive during financial shocks as expected, and are they treated just as another form of income for the university?

When the team looked at how endowments had responded to negative financial shocks during the technology bubble of 2001-2, and the financial crisis in 2008-9, the picture was different than they expected: endowments do not behave as rainy day funds at all. In a forthcoming paper for the American Economic Review (earlier version here), the authors propose that what they see in spending is more consistent with a hypothesis the team terms "endowment hoarding". When times are bad, leadership is quick to cut the payouts from the endowment to reduce the size of any decline in the overall size of the fund—even though this tends to be contrary to what such funds are expected to do. When times are good payouts do increase, although there is often a slight lag between a bullish turn and increased flow from the tap.

Why might universities be hoarding endowments? One reason, the authors speculated, may be that university leaders are compensated at least in part on the basis of the size of the endowment. To test this, they looked into the corporate finance literature where it has been shown that the stock price at the time the CEO joined serves as a reference point for the CEO when deciding to make secondary offerings of equity or to repurchase shares. The authors then hypothesised that payouts were more likely to be reduced after a negative financial shock if the current value of the endowment is close to the value when the president took office. In other words: presidents like to show that they have grown the endowment. They are more likely to cut payouts if the size of the university's endowment is not far off what it was when they took office.

Further analysis of the data confirmed this proposition. Indeed the response to negative shocks that they had seen in university endowment data was entirely driven by those universities whose endowment value had not shifted much from when their president took office. (Lesson to faculty and donors: beware new presidents.) It could also be the case that university presidents have an eye on their future careers, where they can boast about how they increased the size of a university's endowment. Co-author Stephen Dimmock, at Nanyang Technological University, notes that "presidents use endowments as status symbols".

The results of this sort of decision-making are not good for universities. A downturn in the endowment equivalent to a 10% reduction of a university's budget leads to a 4.9% reduction in the number of tenure-system faculty during the following year relative to similar universities that did not experience shocks to their endowment funds*.

A shrinking endowment also results in cuts made to support employees such as secretaries, but found no similar effect on the numbers of adjunct faculty or administrators. All this suggests that that endowments are being used to keep administrators jobs safe during economic downturns rather than as means to preserve academic quality of the institution. More broadly, one has to ask what the point of university endowments is if there is such an emphasis on growth—rather than protecting the institutions they were created to benefit. The inability of universities to cut administrative staff when endowments are shrinking is also troubling. Universities might also need to rethink the riskiness of endowment investments; a higher risk profile may boost their size in good times but also increases the chances that the endowment performs worst precisely when the university needs endowment income the most.

It is hard to know what the point of such hoards is, if not to cushion universities against the rainiest of days. As co-author Jeffrey Brown says: "if it was not raining in 2008, then when does it ever rain?".

*This may have been because not all endowments were equally hit by the financial crisis as they were structured differently, or because the endowment was never very big relative to the university's budget to begin with.