The Non-Profit "Endowment Effect"
By A.D. Freudenheim  

7 September 2003

The Economist recently ran a column titled “To have and to hold,” examining (and explaining) the results of some ongoing experiments in economic theory, and looking specifically at the so-called “endowment effect.” “Put simply,” they write, “this means that people place an extra value on things they already own,” the result of which seems to be an innate conservatism in considering trading for or investing in something new at the risk of an item already owned – however small that risk might seem to be.[1] The article refers to one of the experiments testing this effect as follows:

In one of the best-known [experiments], researchers at Cornell University began by giving university students either a coffee mug or a chocolate bar, each with identical market values. First the experimenters confirmed that roughly half the students preferred each good. After the goodies were handed out, they let the students trade: those who had wanted mugs but got chocolate (or vice versa) could swap.

With barely 10% of students opting to trade, the endowment effect seemed established (you would expect 50% to have swapped, given the random allocation of gifts). Even after a short time with things of little value, ownership had overwhelmed the students’ prior tastes.[2]

Pondering this experiment, and the apt term “endowment effect,” perhaps there might be interesting applications of this kind of analysis to the actions of non-profit organizations, from colleges and universities to visual and performing arts organizations – many of which seem to approach their own financial and institutional management from the same conservative standpoint: not wanting to trade their mugs for chocolate bars, or vice-versa. A dollar invested in the markets is typically seen as better than a dollar actually spent – even if that dollar spent might, eventually, bring in two dollars, and not just $1.25. This desire not to spend banked resources leaves non-profits in regular competition for philanthropic contributions from what is a strong and deep, but by no means infinite, pool of funds. Likewise, collecting institutions hold on to their objects – arguing for their intangible, communal value – when some kind of sale or trade might bring more significant, longer-term benefits.

The easiest example might be that of American colleges and universities, which both expect – and receive – deep financial support from their legions of satisfied alumni. Some of these funds likely go to support operations (i.e., are spent immediately), but much of it winds up invested as part of endowment funds – and as a result, many American educational institutions are very, very wealthy, with billions of dollars invested. Yet as these funds grow, poorer students are largely left to fend for themselves in finding ways to fund their educations, from a patchwork quilt of outright financial aid, scholarships, and loans; and these loans, often quite large, need to be repaid upon graduation – a situation that surely affects any degree-earner’s ability to contribute to charity of any kind, let alone to their alma mater.

Statistics on the American education system show how greatly a college degree will improve an individual’s likelihood of financial success over the course of their lifetime, as contrasted with those whose educations end at college. If alumni are an important base of financial support, it would seem to make sense for colleges and universities to “invest” more of their well-banked funds now – by covering most, if not all, of the tuition costs for more of the qualifying students – in the (admittedly hopeful) expectation that these graduates will “repay” this debt with even greater philanthropy later on. In other words, give out a few mugs now, in the expectation that the mug-users will be grateful for the experience, and they might return with many more chocolate bars (or even mugs) in the future.

The arts world could likewise examine their pattern of investing and collecting, and reconsider whether their entrenched models are actually the most logical or the most effective for their long-term sustainability. On the collecting side, for instance, many American art museums follow strict rules about how objects can be deaccessioned (as the field calls it; this sounds better than “sold”) and how the resulting funds can be used (typically, only to buy other objects); these rules are designed in large part to make sure that an institution that finds itself in short-term financial trouble does not sell or collateralize the “assets” it manages in order to ensure its short- or long-term health at the cost of the very collection it is supposed to be preserving. There is a certain logic to this restrictive approach, but also some narrowing of vision about opportunities that might strengthen museums as a whole if the fundamental value of collections – and institutions – was viewed in a different light.

For instance, what if art museums were allowed to sell objects for cash – but only to other art museums that met equal criteria for preserving and presenting those objects to the public? Then a poor museum in an impoverished community might be able to bank significant funds for its future from the sale of even a single object – while responsibly ensuring that the object remained available to scholars and the public (even if not necessarily, though sadly, to the public in the same community). These sales might even be made with extensive loan opportunities built in, to protect the seller and make it possible for the deaccessioning museum to present the work every now and again. Eschewing the art market should not automatically mean refraining from every market opportunity.

Or what if museums viewed collections as assets to be shared, more-or-less equally, among a consortium of institutions, all paying an equal share of the maintenance costs? Museums seem to retreat from ideas like this, presumably because the value of being able to lay claim to a famous object or collection of objects trumps everything. Is this ego-driven approach to collecting – whether over a Rembrandt or a Tyrannosaurus Rex – really in the best interests of the public? The long-term ability to present exhibitions using a wider array of objects, from a collection that grows with the proportional efforts of several institutions and not just one, might enable all of the museums in the consortium to improve their public programs, and perhaps even their fundraising. Moreover, donors who want their objects to be visible to the public rather than tucked away in storage might find such an arrangement attractive, since a consortium of users might make better use of their donations than a single museum with limited wall space. Again, a better “investment” of some mugs now might result in copious chocolate bars later on.

As American wealth has grown – and as private American philanthropy has grown with it – certain basic rules and assumptions about the limits of acceptable behavior have become embedded in the non-profit organizations that receive the majority of this largess. Probably, this is much to their and our collective benefit; non-profits typically have responsibilities greater than trying to double their money through better investments, and changes in policy should not be made in haste or in ways that would jeopardize an institution or its mission, whether it be a museum, university, or a homeless shelter. Moreover, organizations that operate on the edge of financial solvency must take care not to discredit themselves in avoiding financial disaster, which is the ultimate goal of many of these regulations, even when self-imposed.

That said, these charitable organizations do compete for funding, and many of them have managed to acquire significant assets – but with very little serious or concerted reexamination of their operational principles, or how these funds might truly be applied to the betterment of the institutions and their communities. In fact, rhetoric aside, communities are often the last thing thought of by these organizations: witness the fact that multiple arts institutions in the same city will all have separate endowments, and fight each other to win contributions, when a collective, city-wide arts endowment might ensure the survival and success of all institutions and enable each to serve its public more effectively. Or look at wealthy Yale University’s very public fight with its non-academic employees over wages and benefits; the city of New Haven, Yale’s home town, is also home to many of Connecticut’s poorest citizens. But increasing Yale employees’ wages – and thus the financial health and stability of New Haven itself – certainly does not look like a priority for one of America’s finest universities, even though improved wages and benefits would not truly to imperil Yale's future. The Economist article notes that “experienced buyers or sellers in well-established markets get over their psychological ‘flaws’” and often overcome the limitations imposed by the “endowment effect.”[3] Maybe this means there is hope for the managers of non-profit organizations, too. There are lots of management ideas that could be tested, if only people weren’t afraid to break a few mugs or melt a few chocolate bars in the process.

[1] “To have and to hold,” Economics focus, The Economist, 30 August 2003. The article is available to their subscribers on the web at.
[2] Ibid.
[3] Ibid.
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