For-profit education companies have been all over the news both in the mainstream and in the financial media. Mainstream media have publicized anecdotal accounts of students saddled with high debt, school certification problems, recruiting violations, and many more examples of bad behavior. The financial world has been talking about hedge fund manager Steve Eisman’s presentation on why he is shorting for-profit education companies.
Here, I want to look deeper into the education sector and examine some of the critics’ arguments. Are the problems they allege true for most or all for-profit companies, or are the problems found in the U.S. educational system as a whole? In many cases I find that the allegations against for-profits have some basis in reality but tend to be overblown or affect the educational system as a whole.
One of the greatest differences between most nonprofit schools and for-profit schools, specifically four-year schools, is for-profits’ open enrollment policies. This means that any student can enroll and attend the school (occasionally subject to passing an ability-to-benefit test). As expected this open enrollment policy leads to student bodies with very different demographic characteristics than at nonprofit schools.
For-profit schools tend to cater to students that have materially different demographic profiles than nonprofit schools.
The following information is taken from a 2009 study by the GAO. Over half of students at for-profit schools are “non traditional.” For-profits have a higher proportion of students who are older than 25, financially independent, and female. They also have a higher percentage of minority students. Of nonprofit schools the ones that share similar demographics characteristics are Historically Black Colleges and Universities (HBCUs).
Cohort Default Rates
According to analysis from Bridgespan Financial, LLC Historically Black Colleges and Universities (HBCUs) had three-year cohort default rates of approximately 19% for FY2007, which was approximately the same as the three-year CDR rates for four-year for-profit schools. Two-year for-profit schools had higher CDR rates, which would be expected as two-year schools of any organizational type have higher CDR rates when compared to four-year schools of the same type.
According to the 2009 GAO study referenced in the section above, the biggest factors correlated with high loan defaults was a borrower having low family income and parents who lack higher education. Another factor effecting defaults was higher age. These factors make intuitive sense as well. Younger college-age borrowers usually have fewer total financial obligations such as mortgages or rent and child care. Younger borrowers can and do get help from parents in paying off loans. Furthermore, the more education the parents have the more likely that they have higher salaries and excess income, enabling them to assist their children in paying off loans.
These demographic differences correlate with the high loan default rates critics cite, not with the type of school attended. That is, students in the same demographic profile that attend nonprofit schools exhibit the same tendency to have higher than average default rates as shown by the loan default data for HBCU schools.
Low graduation rates at for-profit colleges are often cited as one of the many reasons of their ineffectiveness. However, in some instances for-profits provide better outcomes for students.
According to the National Center for Education Statistics via the Journal of American Enterprise Institute,
for-profit two-year career and technical institutions graduate 60% of students within three years. Compare this to public and private not-for-profits, which graduate only 22% and 51% respectively.
When looking at the six year graduation rates for four-year programs, for-profits do not do worse. The graduation rate is 22% compared to 64.6% and 57.2% at private nonprofits and public schools respectively. There is no consolidated nationwide data for greater than six year graduation rates. Considering Apollo (NASDAQ:APOL) is the largest for profit education company and has a wide array of programs it can serve as a good proxy for the industry in this case. Looking at graduation rates over more than six years, Apollo’s rate jumps to 39%. Although that rate is below nonprofits, given the demographic differences, I believe it is respectable.
I have further questions about just how valuable graduation rates are as a metric of the value of a school. Institutions have very few choices to address graduation rates, given that schools are not prisons and students cannot be forced to attend classes until degree completion. It seems schools only choices are to become more selective in admissions or lighten course loads by shortening the time to a degree and lowering the academic rigor of classes. I believe the ideal situation would be one in which students are fully aware of the requirements of a degree program before they choose to enroll. After that it is up to the student, with reasonable support from the institution, to complete the program.
I believe that the falling graduation rates across all types of schools reflect not a problem with the schools themselves but generational issues where young adults are used to having things done for them or handed to them with little work.
A high amount of student debt is another issue frequently discussed in the debate over for-profit education. Average debt is $33,000 at for-profits versus $27,650 at private nonprofits in 2008. It is worth noting that compared to 2004 levels student debt loads at private nonprofit schools increased faster than at for-profits, 29% compared to a 23%. (Source: Project on Student Debt.)
Another oft cited statistic is that the percentage of students attending for-profit schools is relatively small; yet, they make up a large portion of those taking out private loans. While this is true, it never seems to get mentioned that students attending nonprofit private schools follow the same private loan patterns as the disproportionate demographic representation.
Percent of Undergraduates
Percent of Private Loans
The higher debt level at for-profits makes intuitive sense as well. Public school students have the least amount of debt, since taxpayers effectively subsidize a portion of the tuition at those schools. We would also expect private nonprofit students to have less debt because of scholarships funded via endowments and private donations. For-profits receive almost no direct taxpayer funding and do not receive private donations; therefore, students must bear the full cost (or at least the full charge) of the education.
The Gainful Employment Rule or The 8% in 10 Years Rule
The Department of Education has proposed a new rule limiting the amount of debt students can take on. The rule would require students to take on no more debt than can be paid back at 8% of their salary over ten years. This proposal is again cited in the context that for-profit students are the only ones who have high-debt-to-projected-income ratios, and that this is some kind of abuse. If the rule were applied to nonprofit education institutions, entire programs would be shut down.
While the range of programs at nonprofit schools affected would be wide, let’s use law schools as an example. According to the ABA for the 2007-2008 academic year, the average public school law graduate carried $59,324 in debt while the average private school law graduate carried $91,506 in debt.
According to the Bureau of Labor Statistics, the median salary for a lawyer nine months after graduation in 2007 was $68,500. Applying the 8% in 10 years rule means that a graduate can expect to pay back only a maximum of $54,800. This figure does not take into account the interest paid. This figure is below the average amount borrowed for law graduates of public schools and well below private schools.
While there has been much debate in legal circles regarding the appropriateness of current student debt levels, some of the best and brightest individuals in U.S. society still choose to attend law school and incur high debt. The media tend to portray for-profit students who take on high debt as stumbling know nothings who are unwittingly lured in by unscrupulous recruiters. Yet, law students, who represent the cream of the intellectual crop, have been making the same choices regarding debt levels in relation to salary.
Clearly one of two things is at play: (1) society has decided that furthering one’s education is a laudable goal and that incurring debt, even amounts greater than the government proposes to allow, is beneficial in the long run; or (2) the debt problem is endemic to higher education.
Indeed, student debt levels at all types of institutions have been rising. Across the entire demographic spectrum of the country, students are continuing to fund education via debt. Therefore, it is shortsighted to single out for-profits for censure while ignoring the same trends at nonprofit institutions.
High quality employment data for graduates of non-profit and for profit schools is very hard to come by. But I would like to discuss one issue that several articles and presentations have pointed out, that is for-profit schools hiring their own graduates to boost employment rates. Guess what? Other schools do that too. Both Southern Methodist University School of Law and Duke Law School have been in the news recently for manipulating employment rates by essentially hiring their own graduates. In those cases the schools paid employers to hire students.
Total Cost Effectiveness and Profits
Many studies focus on what education costs a student via tuition or how much debt a student takes on and how much of this cost is profit for the schools. Few ever mention the total payments made to a school from all sources to educate a student. Put simply, what is a society giving up to educate one person and what percentage of those payments is a school keeping as profit?
Average Total Revenue Per Student
Average Total Expenditures per Student
For 2006-2007, all figures in 2007 dollars. Data from National Center for Education Statistics
When looking at the big picture, for-profit education, as with any private sector business, handily beats both public and private nonprofits on a per revenue basis. For-profit programs take in the lowest average revenue per student and have profit margins slightly greater than public nonprofits but well below private nonprofits. The largest offenders in cost effectiveness are nonprofit private institutions, which bring in an astounding $61,586 per student, yet keep 46% as “profit.”
While some of the data shows that for-profit schools are worse than nonprofits, it does not seem as bad as some short sellers or some media believe. When reviewing all data, it’s important to keep in mind the demographic differences between school types. The open admissions policy of many schools also means the academic quality and motivation of many students will be much lower than that of traditional schools. After all, one cannot just enroll in Harvard or Yale on a whim. Sure, almost anyone can enroll in a nonprofit community college or a branch campus of a state school, but those types of schools do not show student outcomes that are appreciably better than what the for-profits offer specifically in two-year programs. Many of the problems critics point out are not specific to for-profit education. The problems, if there are any, are endemic to the U.S. educational system as a whole and affect students no matter which type of school they choose to attend.
So is it a good idea to invest in a for-profit education company? It depends. Many for-profit education companies are trading at depressed prices based on fears that stricter regulations will be enacted—specifically limits on debt amounts students can incur and perhaps increased scrutiny of cohort default rates. The attractiveness of investing in for-profit education companies, then, hinges on what you believe the government will do. Will it side with the Steve Eismans of the world, or will it realize that, while imperfect, for-profits provide valuable educational opportunities for underserved demographics.
Disclosure: Author is long COCO