Monday, May 5, 2014

Elite universities are venture capitalists in human capital

In other studies, I model HSPE [highly selective postsecondary education] institutions as venture capitalists in advanced human capital because (i) they invest massively in each student whom they educate and (ii) they earn an equity-like return on their investments (Hoxby, 2012). That is, the HSPE institution itself covers the majority of the cost of a student's undergraduate education using donations from alumni. Even HSPE students who receive no financial aid pay for only some of the full cost of their education.

HSPE alumni donate a share of their perceived returns on the educational investment made in them, and most donations occur decades after graduation. Because HSPE alumni earn returns that exhibit a highly right-skewed distribution (in each class, there are many alumni with solid professional careers but only a few Steve Jobs), it matters that donations are analogous to shares of returns and not to the repayment of a loan (the institution's investment plus some fixed rate of return). ...

Of course, this financing system only works if former students do in fact pay back the institution later in life. ...

Why do HSPE institutions use this method of financing education rather than asking for current payments equal to their current costs? The answer is akin to that for venture capital projects proposed by an entrepreneur. There exist students who can earn market rates of return on advanced human capital investments that are large because they (the investments) require cutting-edge instruction and complex infrastructure. Despite being able to earn good rates of return on such large investments, most such students cannot finance them themselves even if they exhaust their capacity to obtain grants and loans. Thus, they must find an investor--the HSPE institution--expert enough to recognize their aptitude and able to provide them with the specialized resources they need. An additional advantage of the venture capital model (as opposed to institutional loans) is that an HSPE institution shares risk across its portfolio of advanced human capital investments (across all its students).
--Caroline Hoxby, "The Economics of Online Postsecondary Education: MOOCs, Nonselective Education, and Highly Selective Education," on the case for donating to your rich alma mater