Why 5 percent? An analysis of optimal endowment spending rates
Purpose - Some members of Congress in the USA have expressed serious concern that endowment spending rates of major American universities are too low. The purpose of this paper is to derive optimal spending rates and compare them with actual rates to determine if this concern is warranted. Design/methodology/approach - A Cobb-Douglas utility function is used to represent the trade-off between current spending and endowment (which allows more future spending). Maximization of this function subject to relevant constraints yields a formula for the optimal endowment spending rate, which takes the form of a difference equation. The steady-state solution to this difference equation is explored, along with the nature of convergence to the steady-state. Relevant data are obtained from American universities with endowments over $500 million in 2007 to determine the optimal spending rates implied by the theory. These optimal rates are then compared with actual average spending rates. Findings - Actual average spending rates are just below 5 per cent, which is well below the optimal rates of 7-8 per cent implied by the theory. Practical implications - The results provide some support for regulations mandating minimum average spending rates from university endowments over time. Originality/value - This paper is the first to model this problem using a theoretical framework that closely parallels the actual trade-off considered by university investment managers, and it is the first to compare actual and theoretically optimal rates of endowment spending.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Volume (Year): 26 (2009)
Issue (Month): 4 (October)
|Contact details of provider:|| Web page: http://www.emeraldinsight.com|
|Order Information:|| Postal: Emerald Group Publishing, Howard House, Wagon Lane, Bingley, BD16 1WA, UK|
Web: http://emeraldgrouppublishing.com/products/journals/journals.htm?id=sef Email:
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Robert C. Merton, 1991.
"Optimal Investment Strategies for University Endowment Funds,"
NBER Working Papers
3820, National Bureau of Economic Research, Inc.
- Robert C. Merton, 1993. "Optimal Investment Strategies for University Endowment Funds," NBER Chapters, in: Studies of Supply and Demand in Higher Education, pages 211-242 National Bureau of Economic Research, Inc.
When requesting a correction, please mention this item's handle: RePEc:eme:sefpps:v:26:y:2009:i:4:p:216-231. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Virginia Chapman)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.