Case: Lavish Pay at Harvard

In 2004, Jack R. Meyer, the head of Harvard University’s $20-billion endowment fund, was under pressure to change the compensation plan for the fund’s top investment managers. The previous year, the top five managers of Harvard Management Company, who were university employees, received a total of $107.5 million. The two most successful managers earned more than $34 million each, while Mr. Meyer’s own paycheck was $6.9 million.51

A few Harvard alumni protested. Seven members of the class of 1969 wrote a letter to the university president calling the bonuses “unwarranted, inappropriate and con- trary to the values of the university.” One signer of the letter explained, “Our collective concern is that we think the amounts of money being paid to these folks are by almost any measure obscene.”52 They added, “Harvard should use its endowment for the benefit of students, not for the benefit of people who manage the endowment.”53 The alumni suggested that the millions of dollars paid to fund managers should be used instead to reduce tuition. Angry threats were made to withhold gifts to the university unless the compensation was reduced. The letter said, “Unless the University limits payments to financial managers to appropriate levels ... we see no reason why alumni should be asked for gifts.”54

The compensation of the endowment fund managers far exceeded the salaries of Harvard faculty members and administrators, including the president, who made around half a million dollars. The 5-percent hike in tuition for Harvard students in 2004 was equal to the $70 million paid to the two highest earners. One critic noted, “The managers of the endowment took home enough money last year to send more than 4,000 students to Harvard for a year.”55

Although Harvard has the largest university endowment, the salaries and bonuses paid to the managers greatly exceeded the compensation paid at any other school. The head of Yale’s third-place endowment was paid slightly over $1 million in 2003.56 However, Yale, like most universities, does not manage its investment fund in-house. When management of an endowment is outsourced, the managers are not university employees, and the fees paid to them, which may be as high as or even higher than those at Harvard, do not need to be reported.

Mr. Meyer and his team of managers have produced consistently superior returns for the Harvard endowment. Over a period of 14 years, he increased the endowment from $4.7 billion to $22.6 billion. Over the previous 10 years, the Harvard fund had an average return of 16.1 per- cent, which is far above the 12.5 percent return of the 25 largest endowments.57 If the fund had produced average returns during this period, the endowment would have been one-half of what it was in 2004, which is a difference of almost $9 billion. One person observed, “With results like that the alumni should be raising dough to put a statue of Jack Meyer in Harvard Yard, not taking potshots at him.”58 Mr. Meyer observed, “The letter [from members of the class of 1969] fails to recognize that there is a direct connection between bonuses and value added to Harvard. If you don’t pay the $17.5 million bonus, you don’t get the approximately $175 million in value added—so their math is a little perverse.”59 Moreover, the school’s large endowment is used in ways that benefit students. Endowment income covers 72 percent of undergraduate financial aid,60 and the university charges no tuition to students from families earning less than $60,000.61 Harvard’s immense endowment also enables the school to increase the faculty in growing areas and to expand its facilities.

In the end, Harvard decided to cap the compensation of fund managers. The result was that Jack Meyer and his team of managers left to start their own investment companies, at which many could earn 10 times their Harvard salary. Harvard Management Company also placed large amounts of endowment assets with these new firms. In so doing, it reduced the percentage of assets managed in-house and incurred the higher fees of outside managers, though they did not have to be reported. The university administration declined to defend its previous pay policy, which produced such stellar returns but drew considerable moral outrage. Business writer Michael Lewis speculates that Harvard’s leaders were afraid to say what they thought. He observes, “We have arrived at a point in the money-management game where the going rate for the people who play it well is indefensible even to the people who understand it. No one wants to be seen thinking it is normal for someone to make US$25-million a year.”

Explain whether or not Harvard made the right choice in placing a limit on how much the fund managers could earn in-house. Con- sider whether the limits placed on compensation at Harvard also apply to the corporate world, and explain any differences that you see between the two situations.