Countering moral hazard in higher education: The role of performance incentives in need-based grants

National financial aid programs for disadvantaged students cover a significant fraction of college students and represent a non-negligible component of the public budget. These programs often have relatively weak academic requirements for renewal, potentially leading to moral hazard and efficiency losses. Using a reform in the Spanish need-based grant program in higher education, this paper tests the causal effect of receiving the same amount of grant under different intensities of academic requirements on student performance, degree completion, and student dropout. I use administrative micro-data on the universe of applicants to the grant in a large university. Exploiting sharp discontinuities in the grant eligibility formula, I find strong positive effects of being eligible for a grant on student performance when combined with demanding academic requirements, while there are no effects on student dropout. Students improve their final exam attendance rate, their average GPA in final exams, and their probability of completing the degree. They also reduce the fraction of subjects that they have to retake. The grant has no effects on student performance, degree completion, and student dropout when academic requirements are comparable to those set out by national need-based student aid programs around the world. These results suggest that academic requirements in the context of higher education financial aid can be an effective tool to help overcome moral hazard concerns and improve aid effectiveness.