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Thursday, January 14, 2010

The Lord (Federal Government) Gave, and the Lord (Federal Government) Hath Taken Away

Harvard must be feeling like Job. Its endowment has taken a hit larger than the total actual endowments of of the the sum of all institutions not in the top 100. Now Harvard is the target of an IRS audit which is focused on some of the more profitable activities of this non-profit institution. See http://www.thecrimson.com/article/2010/1/13/harvard-irs-hmc-compensation/

I actually have a problem with this definition. What exactly is a non-profit? I looked to the source of all knowledge, Wikopedia to provide some insight.

"A nonprofit organization (abbreviated NPO, also not-for-profit[1]) is an organization that does not distribute its surplus funds to owners or shareholders, but instead uses them to help pursue its goals.....A primary difference between a nonprofit and a for-profit corporation is that a nonprofit does not issue stock or pay dividends and may not enrich its directors. However, like for-profit corporations, nonprofits may still have employees and can compensate their directors within reasonable bounds."

Harvard has no stockholders, so what is the problem? The problem appears to be that the investment activities which Harvard leveraged into a tidy sum. Being shrewd about investment of endowment monies should be viewed as good stewardship of resources unless it actually crosses the line into something legally suspect.

However Harvard, like its other brother and sister institutions which have benefited from the tax status benefits conferred upon non-profits, long ago made a deal with the state. Now that non-profits such as Harvard look like fat cats by virtually any measure, it should come as no surprise that the cash hungry Feds see an opportunity to tap into a windfall. Large research institutions like Harvard have double exposure in that they receive substantial funds from the Federal government through grants and are exempt from taxes. Although I can only guess as to the exact amounts, add to this the cash flow into the health care businesses which comes from Medicare and Medicaid and I strongly suspect that the lion's share of money which is required to operate this institution comes either directly or indirectly from the Federal government.

This a cautionary tale. Build a business whose income stream is poorly diversified and it is an open invitation to be held hostage. The Harvard model is by no means unique. If the Feds find they can bully Harvard (and I think this is highly likely), it is going to send a chill throughout academia. What to do? What behavior do you need to change? Do you fire your investment advisors if your return is too good? Discard the charade of non-profit status and perhaps operate like the motion picture industry?

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