What Makes Higher Ed Tick?

Understanding the world of higher education can be confusing. Many people think that because the rest of the world flocks to U. S. colleges and universities it must be a success—especially since incomes rise with college attendance.

Other observers, however, look deeper. They see problems such as rising costs, low graduation rates, questionable learning outcomes, and more. These critics tend to deal with the problems individually, or even with just the symptoms of the problems.

But Robert E. Martin, an emeritus economics professor at Centre College in Kentucky who has studied the economics of higher education, has attempted to wrestle the chaotic world of American higher education into a theoretical framework of underlying causes and incentives.

In a recent Pope Center paper, Martin adapted and applied to higher education the principal-agent model—commonly used to describe how owners of companies (principals) and the managers they hire (agents) have differing interests. Martin defines higher education’s principals to be taxpayers, students, parents, alumni, and donors; the agents are faculty, trustees and administrators. Because the incentives for academia’s principals and agents are not aligned, university administrators always seek to increase revenues instead of cutting costs, as a profit-seeking firm would do. This results in an ever-increasing “cost spiral.”

On June 25, the Pope Center gathered some of the top people in the higher education reform movement—as well as some leaders in the higher education “establishment”—to discuss Martin’s ideas with him. The place was the Cato Institute in Washington, DC. The participants had a varied background, and Martin’s concept—based on economic theory—was foreign to many of them. The paper provoked lively discussion. Some of the key issues were: the principal-agent problem (and whether it is applicable to higher education), shared governance, oversight of education, and the role of institutional reputation.

The Principal-Agent Model

Some participants questioned the whether the principal-agent model is correct for higher education. Lee Fritschler, who now teaches political science at George Mason University, said that he considered the students to be his principals when he was president of Dickinson College. But as their agent, he said he could not always act to please them—they wanted such things as “kegerators in the fraternities” and no foreign language requirements. “I acted like a bad agent when it came to my major principal group.”

“I don’t think the principal-agent theory gives me any guidance (as an administrator),” Fritschler concluded.

Martin countered that he understood that students had “no incentives to make decisions that are more demanding on them,” and in this case he suggested that administrators must act as if they are agents for parents instead (“in loco parentis”).

Roger Ream, president of the Fund for American Studies, said he preferred the term “customers” to categorize donors, rather than “principals.” He said that donors, like customers, are likely to spend their money elsewhere if their initial purchase does not result in satisfaction. This serves as an incentive to administrators to act according to the donors intentions.

But in response Martin questioned whether that is actually the case in higher education. “We don’t really follow through,” he said. “We might start a new program and put money into it, but we don’t come back with a really detailed analysis of ‘did that work?’”

Judith Eaton, president of the Council for Higher Education Accreditation, questioned whether Martin’s depiction of higher education’s spiraling costs and inefficiencies was too negative. Martin agreed that “the quality of higher education is generally quite good,” but he defended his position that it is “not as good as it could be, with huge opportunity costs.”

The model also had its defenders. Neal McCluskey, the associate director of the Center for Educational Freedom at the Cato Institute, said that Martin’s paper is “very good at explaining the inner dynamics of what goes on in a university.” He agreed with George Leef, the Pope Center’s research director, who said that higher education “frittered away” much of its funding in the very manner described by Martin.

But both McCluskey and Leef had a different emphasis than Martin. They suggested that a “third party payer problem” permits the spiral to continue. Third parties (grandparents according Leef and taxpayers according to McCluskey) are far removed from university governance. McCluskey noted that large percentages of students are either attending state-subsidized universities or are receiving some sort of government financial aid: “most people, at least in part, are going to school on somebody else’s dime.”

The third-party problem arises because students are not paying the cost of their own educations, and therefore administrators sometimes do not feel that they have to address student needs. But often third party payers have little knowledge of what is actually happening and no easy way to express their views if they did. “Taxpayers have almost no say over what happens to their money,” McCluskey affirmed.

Michael Rizzo, a lecturer in economics at the University of Rochester whose research has centered on higher education, suggested that the cost spiral is enabled by an often-overlooked fact: the U.S. has become a rich country. In the past, people had to pay 75 percent of their incomes for basic necessities like food clothing and shelter, but in recent years, that figure has dropped to 35 percent. Therefore, people are willing to pay large sums of money for education for their children and grandchildren.

Shared Governance

The difficulties surrounding the definition of principals made some of the participants hesitant to agree with application of the principal-agent model to higher education. In the corporate world, it is obvious that the shareholders—the owners of the company’s stock—are the firm’s owners. In higher education, however, it is much harder to define who the shareholders are.

Martin said this is largely due to academia’s system of “shared governance,” in which trustees, administration, and faculty all play a role. In his paper he wrote that the system of shared governance evolved over time because ownership is so unclear. He suggested that the expectations of the system are that all three groups will be involved in all facets of the university, and that they will monitor each other.

But today, he said, the system has broken down. The three groups have “competing incentives” that frequently operate against the best interests of the university. In time, trustees have come to limit themselves to finances and the faculty has attained dominant control over the curriculum. University administrations have managed to position themselves in between the others, “cutting off the communication that needs to take place between board members and faculty.”

Anne Neal, the president of the American Council of Trustees and Alumni, said she felt that shared governance, as defined by Martin, marginalizes the role of trustees. She said the trustees “should be viewed sometimes as the owners (of a university), with a unique stewardship role that should be focusing on the mission of the university (education).”

Martin had written that the trustees should bear much of the responsibility for reform. But he also said at the meeting that the faculty have critical knowledge about the curriculum and they should be involved in governance, too, even beyond the realm of curriculum.

Robert Glidden, former president of Ohio University, said that he is a big supporter of shared governance, but that it needs further study, particularly in the way it functions differently in different types of universities. He conceded that there are serious problems with the system of shared governance: “in the large institutions, it’s very difficult because the politicos take over, because they’re the ones who spend time on it.”

He acknowledged that higher education has “tremendous inefficiencies of management” arising from the confusion of duties and incentives:

Looking at things from the perspective of a provost or a president and dean, as I have been, we don’t give enough authority to department chairs to make difficult decisions. They’re elected by their peers, so issues like ‘curricular glut’—courses that are taught to a very few students by an expensive senior professor just because that’s what he or she wants to do—we haven’t faced that. To me, that’s a big issue in cost control, but it also has to do with shared governance.

Rizzo cautioned that costs are not really out of control because they are capped by revenues. Then he asked rhetorically “what are revenues capped by?” He said that what limits revenues is whether students continue to attend a school. If they continue to attend at a particular tuition level, then tuition, and therefore costs, are not too high from an economist’s perspective.

Anne Neal said that an analysis of higher education should begin with concerns about its primary mission of spreading knowledge first, before cost-control. This was seconded by Ream, who said that successful non-profits are often able to achieve their goals by focusing “on results instead of good management practices.”

Who Should Oversee Education?

The lack of the profit motive means there are fewer incentives for higher education to become efficient than the private sector, according to Martin. In particular, he identified the failure of higher education to develop outside oversight mechanisms, the way investors in profit-seeking firms have. He suggested there is “an information problem that’s created a lot of these issue.” He especially called for some sort of measurement of the value each university adds to its graduates in terms of human capital, so that third-party and primary party payers could make a “rational choice” about attendance decisions.

Martin wrote that an “outside reform program has to involve private groups, state and local governments, and the federal government.” However, some participants rejected this call for greater government involvement in regulating higher education.

Neal McCluskey said, “It strikes me that there’s an accepted good that comes from regulation, and I’m not sure the history of regulation supports that.” Eaton added that Martin’s paper places “too much faith in government addressing transparency.”

Kevin Carey, the policy director of the Washington, DC-based think tank Education Sector, countered that only the federal government is large enough to enforce transparency. He also said that simply increasing transparency is not enough, but that “some one has to take more of an active role to convince people to use the new information.”


Martin devoted a large section of the paper to the topic of institutional reputation. He regards the pursuit of reputation, to the detriment of education—especially by administrators and trustees—to be one of the academy’s chief sources of “mischief.” This is largely because reputation, as it is currently manifested, can be bought—through winning sports teams, high salaries for celebrity professors, and impressive buildings and research programs, rather than through actual high-quality education.

Alternatively, Brian Mannix, a former administrative official at the Environmental Protection Agency, suggested that reputation is not necessarily a “fundamental part of the problem.” In the absence of an efficiency-promoting profit motive, reputation could perform “some of the function of a balance sheet.” He added that “the focus should be on how reputation markets can be improved.”

Frederick M. Hess, director of education policy studies at the American Enterprise Institute, cautioned that there are different types of reputations. “Reed and Oberlin are not playing the same kind of strategy as Rochester, MIT, and Cal Tech,” he said. He added that the single type of reputation described by Martin—based on top-flight athletics, ground-breaking research, and prestigious alumni and professors—is only true of the top 200 or 300 elite institutions, those “that actually accept less than 50 percent of applicants.”

In contrast, second- and third-tier public schools are more focused on their relationships with the state legislators who vote on higher education appropriations, according to Hess. And their reputation is based not on the number of “peer-reviewed scholarly journal articles,” but on “their ability to be seen as an engine of local economic growth.”

When all was said and done, it was apparent that, despite some detractors, the paper had sparked lively debate from both sides of the political spectrum. Mannix said to Martin, “I think in terms of explanatory power, it has a ways to go. But keep looking—I think you’re going in the right direction.”