Tighter Times

Harvard is not immune to the vicissitudes of the economy. During the fiscal year ended June 30, 2002, the University's operations produced a financial surplus of $70.4 million. That is a comfortable cushion, particularly when compared to Dartmouth and Stanford, which are slashing budgets, freezing hiring, and deferring construction, and Duke, which is talking about such steps even as it concludes a $2-billion capital campaign. But despite a very large increase in funds released from the endowment for spending, expenses rose nearly twice as fast as revenues, so Harvard's surplus was nearly $100 million less than that recorded in the prior fiscal year. The underlying causes, and the current fiscal context for Harvard's plans, are discussed in the annual Financial Report to the Board of Overseers of Harvard College, published in December and available on-line.

In the most recent fiscal year, revenue rose $129 million (5.8 percent), to $2.36 billion. Endowment income distributed for operations increased $134 million (22 percent), to $749 million—32 percent of total revenue. Support for sponsored research, the next-largest revenue line, also grew, rising 3 percent, to $518.8 million, led by the continuing surge in federal grants for biomedical science.

Student income, the funds provided by tuition and fees, increased less than 1 percent, to $509.5 million. That result reflects modestly higher tuition, offset by the 13 percent increase in scholarships; and an actual decline in revenue from continuing- and executive-education programs, particularly at the schools of business and government—attributable to the weak economy and reduced travel after 9/11. Gifts for current use decreased by $28 million, to $132.2 million. That 17 percent decline (echoed by an even sharper decline in capital gifts for the endowment) no doubt reflects the economy and investment market, as well as the unusually high volume of large gifts received in fiscal year 2001.

But as total revenue increased more slowly than in the recent past (revenue rose 10.2 percent in fiscal year 2001), Harvard's expenses grew more rapidly. Following 8.5 percent growth in fiscal year 2001, expenses rose 10.8 percent, to $2.29 billion, in the succeeding 12 months (see chart below).

Higher expenses reflect both Harvard's academic commitments and external factors. Compensation costs—half of total expenses—rose 11 percent, to $1.13 billion. Within that total, salaries and wages rose 10 percent, reflecting pay increases; faculty appointments and growth in administrative, technical, and research staff—driven by academic plans and rising sponsored-research funding; and the phasing in of higher compensation for lower-paid service workers following the recommendations of the committee on employment and contracting policies. Benefits costs escalated more sharply, rising 17 percent to $202 million. Higher healthcare costs and changes in pension plans both contributed.

The costs of University facilities ("space and occupancy" in the financial statements) also rose notably, as Harvard invested to accommodate its expanding staff and spent on future needs. Recent acquisitions—the Harvard Institutes of Medicine building, Watertown Arsenal, property in Allston—plus added rental space to accommodate the medical and law schools, and new facilities coming on line—Bauer Center, Hawes Hall—combined to increase such costs 19 percent, to $205.3 million.

Together, Harvard's fiscal year 2002 revenues and expenses yielded the $70.4 million surplus, down from $164.9 million in the prior year. The unrestricted surplus all but vanished, coming in at $1.3 million, while the restricted surplus was $69.2 million, compared to $113 million in fiscal year 2001. The latter funds, reflecting endowment distributions that will be used for future projects and programs, in effect accumulate as a reserve within each faculty. The Faculty of Arts and Sciences (FAS), for example, maintained $94.8 million of such unexpended income as of June 30, 2002. In fact, each faculty had more funds "on account" in this sense than a year earlier—the expected result of large endowment distributions for current and future use.

Putting the results in context in an introductory letter—a new feature with this year's Financial Report—President Lawrence H. Summers wrote, "Despite the extraordinary circumstances of the past year, I can certify that Harvard University remains in sound financial health."

Emphasizing the importance of being "responsible stewards of the resources at our disposal," he made note of efforts to "look anew at some of Harvard's financial procedures." He also observed that Provost Steven E. Hyman has created a new process to engage each faculty in "strengthening their budgeting and academic planning processes." Finally, Summers alluded to use of "an outside management consulting firm" to review administrative functions "to ensure we are maximizing the resources available to support our mission." (McKinsey & Company has reviewed human resources, financial management and budgeting, development, and procurement and reported on possible operating and strategic improvements in each area.)

Close readers of the report will note other innovations this year. First, new accounting standards require that gross assets and liabilities associated with investment strategies—and not just the net difference between the two—appear on the University's financial statement; that has the apparent result of inflating Harvard's assets and liabilities by nearly $20 billion each—a difference washed out when the individual items are totaled. Of greater interest may be the new narrative on "risk management" included in the report on Harvard Management Company's operations—an account of market, credit, liquidity, and operational risk assumed in running the University's investment portfolio. "In light of the current accounting environment," said Victoria M. Johnson, director of finance and accounting, "there's a desire to give complete disclosure and information to the users of our financial statements." Accordingly, it seemed particularly valuable to create this new section.

Within the small print, readers can make out other interesting tidbits. One is an apparent surge in degree students enrolled at Harvard, to more than 19,500 from a recent average of 18,600. Some of this growth reflects differences in the business school's academic calendar, but some is real, particularly in the Graduate School of Arts and Sciences. The report reveals that Harvard took advantage of low interest rates to refinance some of its long-term debt, and has continued to take on new debt ($1.84 billion was outstanding last June 30) to finance construction and property acquisitions. And a supplemental endowment distribution assessed on the schools to pay for Allston costs (see "Addressing Allston," July-August 2001, page 66) kicked in, with initial funding of $85.2 million in fiscal year 2002.


Given the immediate situation, said Ann E. Berman, acting vice president for finance, Harvard's schools are "very conscious of the need to moderate expense growth tremendously." The outcome in fiscal year 2002, she said, reflects that "growth in spending often lags growth in revenue because of the thought process and consensus-building that goes into what we should be doing." That is, the resources provided by the higher endowment distributions and research grants of recent years naturally produced surpluses, which then are deployed into new faculty appointments, expanded facilities, and so on—a very gradual process Berman knows first-hand from her former perch as the fiscal director for FAS.

Now that distributions from the endowment will rise only a percent or two for the foreseeable future, Berman said, "We'd like to be able to live within our means without going through a period of painful cutbacks" like those being endured at other research universities. "The community's quite aware of the general economic climate."

The provost's new budget process figures significantly in helping Harvard to adapt to more straitened circumstances without "pain," Berman said. The process, she explained, in effect asks each school, "Does your use of resources match your mission and your aspirations, and does it match the University's aspirations?"

Satisfying those aspirations will be challenging. New facilities have to be staffed, lit, heated, and maintained, and more are coming on line. Construction is now under way on the FAS Center for Government and International Studies (see page 57) and on a huge underground parking garage, atop which extensive new laboratories are envisioned in a North Precinct extension of the science facilities. The medical school's new research building, the largest capital project in Harvard history, is nearing completion. The University's information technology staff recently moved into new quarters. Apart from those tangible investments and their associated operating costs, more conservative assumptions about future investment returns and likely inflation in medical costs imply higher continuing expenses for pension and healthcare benefits, according to finance and accounting director Johnson.

Nevertheless, President Summers looked ahead with optimism in his opening letter, outlining priorities in undergraduate education; scientific research and teaching; graduate-student financial aid (the report mentions a recent study of financial challenges facing students and alumni, and promises a "pilot program to help incoming students in 2004 and beyond" through scholarships, debt relief, and a loan program); and developing Allston. Pursuing these opportunities, he acknowledged, will require both "the commitment of substantial new resources" and "prudent fiscal management."        

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