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Jun 07

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A “New” Method of Financing University Education that isn’t New

FixUC, a student-based organization, claims to have found the solution to rising student debt and education costs. The proposal: instead of paying tuition to attend university, students should pay the university a 5% share of their future income for twenty years after graduation. FixUC’s founder and President, Chris LoCascio, explains the logic underlying the initiative, “Charging students when they don’t have money doesn’t make sense.” Indeed, if only those students with sufficient cash on hand chose to invest in education, we’d live in a much poorer society.

On this point, an analogy with corporate finance is instructive. If Henry Ford had decided not to build car factories because he lacked the cash required upfront, the business (and in fact the entire US economy) would have been much worse off. Indeed, when lucrative investment opportunities present themselves, business leaders choose to finance these investments using (i) debt, (ii) equity, or (iii) some combination of both. Debt is the more familiar financing option and takes the most common form of interest-bearing loans. Equity on the other hand involves selling investors a stake in the profits associated with the investment (e.g. shares of stock that pay dividends).

In the case of university education, many students already fund their investments with debt. What FixUC is proposing, in effect, is the introduction of equity financing. FixUC advocates students selling universities a stake (i.e. a piece of equity) in their future earnings much like public companies sell shares of their future profits in the form of stocks.

From corporate finance, we know that debt and equity have very clear tradeoffs. Debt is inflexible and requires repayment regardless of whether the business is profitable. Student debt is even more stringent—students must pay irrespective of their earnings or employment and they can’t clear student loans via bankruptcy. On the plus side, debt is usually much cheaper than equity for the company. Equity, however, grants the business much greater flexibility—dividends are distributed when the company turns a profit and usually not otherwise. Equity in students’ earnings is similar—students only pay the university “dividends” proportionate with their income.

Businesses and investors would be strongly handicapped if equity wasn’t available as a financing option. So, in some sense, aren’t students and universities handicapped while selling equity isn’t possible?

Perhaps. However, one major problem associated with FixUC’s proposal is that only those students expecting low future income will forfeit a precious portion of equity in future earnings. Future engineers, doctors, lawyers, and business leaders will likely choose the debt route as a way of minimizing financing costs. This leaves only students with expected lower income who will likely produce poor yields for shareholders (i.e. universities according to FixUC’s plan). By the same logic, the universities will likely base their admissions decisions (and thereby equity investments) on the earning potential of applicants. If universities prioritize admission for students in technical fields with the hopes of high returns on equity, softer disciplines in the humanities and social sciences will likely suffer as an unintended consequence.

About the author

Benjamin Bohr

Benjamin is a manager at Fulcrum Financial Inquiry. He specializes in statistics and data analysis for use in high-stakes litigation, business valuations, and other financial matters.

Permanent link to this article: http://betweenthenumbers.net/2012/06/a-new-method-of-financing-university-education-that-isnt-new/

1 comment

  1. Stephanie Lee

    “Student debt is even more stringent—students must pay irrespective of their earnings or employment…”

    Actually, for federal student loans, some students can make lower or no payments based on their earnings and/or employment status.

    Income-Based Repayment: it’s been available since 2009
    The Department of Education describes “income-based repayment” on their website here: http://studentaid.ed.gov/PORTALSWebApp/students/english/IBRPlan.jsp and the excellent FinAid website describes it here: http://www.finaid.org/loans/ibr.phtml

    It’s also possible to have federal loans forgiven with certain types of public service/military service/volunteer work, etc.

    For someone temporarily unemployed, deferment or forbearance are options too.

    I wrote a paper about student loans and student loan asset-backed securities that describes federal and private loans in the US, available online here: http://www.nera.com/extImage/PUB_ARS_Student_Loan_0609.pdf

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