The recent survey of the compensation packages for public university presidents has caused a stir. If the stir seems greater than usual, it may be because we have witnessed the destructive effects of out-of-control compensation in the financial industry.

With this pain in mind, some wags point to the financial industry as evidence that some university presidents are paid too much. This is a minority view. The dominant approach is to defend or criticize specific compensation packages by comparing them to industry averages, controlling for size and other factors. If the goal is to rationalize compensation to institutional goals, both approaches reason from faulty sources to produce bad outcomes.

A proximate cause of the financial crisis was not how much the bankers were paid. It was the egregious misalignment of their incentive compensation plan. The more bankers damaged the economy, the more money they made. Controlling the exact amount of money would have had a negligible impact on the damage done. On the other hand, setting banker’s compensation plans by consulting industry averages would have been – and is still – irrelevant to the problem.

What can be said about the drivers of compensation for university presidents?

It seems clear that presidents derive some compensation for behavior appropriate to their job, albeit from sloppy metrics. Such is true when they manage expenses responsibly, keep the peace among contentious stakeholders, and serve the communities in which they reside. On the dark side, other very important responsibilities of those who lead taxpayer-supported universities are not represented in their job description. Ignored and therefore unmanaged, these responsibilities are not represented in compensation incentives.

The result is that millions of dollars of public revenue are lost.

Like the bankers, incentives for university presidents are misaligned and, here too, knowing what the other guy earns does nothing to align them.

What million dollar responsibilities are ignored in the job descriptions of university presidents? There are several.

This Executive Briefing focuses on loss of market share to the for-profits and a small group of “for-profit-like” independent colleges and universities.

University presidents are unprepared to manage market share. At best, they temporize because they don’t know what to do and can’t quantify the problem. At times, they behave with all-knowing arrogance, expecting business to come to them while interlopers grab millions in revenue from under their noses.

The losses are even greater in effect than they might seem at first. They hit the bottom line twice with a nasty ripple effect. Interlopers have no interest in taking market share away from the state university’s expensive boutique programs that serve few students and lose money. Their attention is focused on securing high volume, high profit programs which, once stolen, leave Big State U with declining offsetting revenue to support expensive, unprofitable, mission driven programs.

Big State U is hit once with lost revenue, again with higher average program costs which must be offset somehow, raising the specter that any future attempts to offset losses will enter a zone of negative elasticity, and yet again with declining market share and therefore a potential loss of ability to control future program direction and pricing.

To compete effectively and to protect market share, universities must deliver the programs needed in the way the market wants them delivered. Unfortunately, most presidents lack the ability to ensure that their programs are competitive in the marketplace.

One reason presidents cannot make their programs competitive is that they have limited influence and often no control over the behavior of their faculties. University faculties are notorious for advocating the development of programs that interest them without regard to their usefulness to the public. Most state universities are stuffed full of programs for which the market is limited or if there is a strong market, the programs themselves are not positioned to be competitive in academic focus, time, platform, and service conditions.

Another reason presidents cannot make their programs competitive is that they labor under the limitations of 1920’s accounting models. These models do not produce the information necessary to manage market share, revenue, margin, etc. on either a global or a program-by-program basis, the latter being essential to becoming and remaining competitive. Lacking basic tools of management, one is tempted to hold presidents blameless, for a moment. Then one recalls how skillful are these leaders in funding new buildings and sports facilities. The limitations of state universities make for easy pickings by the for-profits. In 15 years they have grown from 1% to over 10% market share by exploiting these weaknesses. In 2009, four large for-profits produced $6.8 billion in revenue. The exact proportion is debatable but many experts would sign off on the idea that around half of this revenue represents market share taken away from public institutions.

Unfortunately, there are no requirements to report the full and true performance of presidents in relation to the total market in which they operate. Were there such requirements, a less attractive picture of competence would emerge. One popular president (charismatic with a good athletics department) lost $7.5 million to the competition in one year! The loss was invisible to most but could be determined by examining the results of two for-profits and one out-of-state community college that deployed a satellite campus, picking up $2 million in business because the state university was too busy to go after it. Would this president’s state legislature rethink his compensation if they knew he allowed millions to slip into the hands of out-of-state interests?

Tragic though it may seem, these losses are a good thing. We only need make them visible to cause state universities to realize that they must make organic changes in how they serve the public.

The solution involves only three steps. All of them are possible for any state university.

• Stop anchoring compensation to industry averages.
• Create an accounting and management information system capable of tracking all performance variables necessary to manage enterprise performance.
• Create compensation incentives that align to agreed-upon performance standards. Public universities operate in an increasingly complex educational environment. The entire environment needs to be part of the evaluation procedure.

Update on January 22, 2010 by Robert W Tucker

The Chronicle of Higher Education today published several views regarding presidential compensation. I contributed one view. Please take a look at their article.