New study on financial management in higher education shows budget flexibility is key to security

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The decades-long decline in U.S. college enrollments this spring saw its biggest two-year decline in more than 50 years. Universities increasingly face tougher competition with less money coming from state budgets, which does not bode well for their financial security. A new study of the Strategic management review (SMJ) finds that universities that thrive in this environment are doing more with less simply by embracing more flexible budgeting. The problem is that many universities face internal and external pressures that impede financial flexibility.

“Universities that reallocate resources more regularly are more likely to run larger budget surpluses,” says Sohvi Heaton, visiting assistant professor at Santa Clara University. “However, this is much more likely to be true in universities where external governance arrangements allow for greater discretion on the part of the executive.”

Heaton teamed up with renowned economist and UC Berkley professor David Teece and data scientist and economist Eugene Agronin to study more than two decades of longitudinal data on the financial performance of US public universities. The study delves into the concept of dynamic capabilities and uses the “expenditure ratio deviation” (DER), or the change in the expenditure ratio across all budget segments from year to year, to measure how easily universities can reallocate funds. They compare the DER to the university’s annual surplus or deficit to determine its effect on financial performance.

“In absolute terms over the period we studied, a typical annual change in DER could have added $10.02 million to the university’s average income,” says Agronin. “The effect is not negligible given that a public university typically spends around $5 million on scholarships.”

The authors then segmented universities into low, medium, or high regulatory levels based on their state board structures, finding 239, 328, and 1,136, respectively. Using a complicated linear regression model of performance of universities in light of DER and governance – while controlling for variables such as funding structure, endowments and university size – they found that weak governance more than doubles the effect flexibility in resource allocation, while high governance weakens it.

“In many of these cases, a budget deficit would turn into a surplus if a university increased the DER by a single standard deviation,” Teece says. “In this context, overly prescriptive governance arrangements have a significant effect on the financial performance of universities by making it difficult to achieve the necessary financial flexibility and associated resource reallocations.”

Several corporate studies have established that flexible resource allocation can improve performance under good leadership, but this study is the first to apply these dynamics to higher education. Academic budgets often sublimate financial performance and market considerations to internal politics – or external politics if subject to heavy government oversight. The authors warn that their results clearly indicate that a change in the traditional university budget model is necessary to survive in the current higher education climate.

“A university must be able not only to do research and teaching, but also to learn how to manage itself well,” says Heaton. “In an age of international competition for resources and talent, ‘organized anarchies’ are no longer an acceptable model for the management of colleges and universities.

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More information:
Sohvi Heaton et al, Dynamic Capabilities and Governance: An Empirical Investigation of the Financial Performance of the Higher Education Sector, Strategic management review (2022). DOI: 10.1002/smj.3444

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