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Predicting College Closure: Improving Upon the Federal Financial Responsibility Composite Score with Financial Ratio Analysis An

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Predicting College Closure: Improving Upon the Federal Financial Responsibility Composite Score with Financial Ratio Analysis An Predicting College Closure: Improving upon the Federal Financial Responsibility Composite Score with Financial Ratio Analysis and Non-Financial Risk Indicators A Capstone Presented to The Faculty of the Curry School of Education University of Virginia In Partial Fulfillment of the Requirements for the Degree Doctor of Education by Steven R. Sherman A.B., Duke University M.B.A., University of Virginia May 2016 Abstract The Department of Education is charged by the Higher Education Act of 1965 with carefully stewarding the federal government's massive investment in higher education. A critical tool toward that effort is the Financial Responsibility Composite Score (FRCS), a metric used to assess the financial health of all higher education institutions and to identify those at risk of closure, but which has been criticized in recent years for its flawed methodology and the resulting high costs of its errors. The purpose of this research was to add to the body of knowledge on financial assessment in higher education by first evaluating the accuracy of the FRCS, and then determining whether an alternate model could better differentiate between colleges at risk of closure and colleges that are financially stable. A preliminary analysis suggests that the FRCS is largely ineffective in either predicting precipitous closure or identifying colleges that are financially stable. This study proposes an alternate model, the Modified Risk Assessment (MRA) Index, that builds upon evolving research by including in its methodology four financial ratios, eight key risk indicators, and a multi-year weighted average formula. Through extensive financial analysis of 25 private, non-profit colleges, the MRA Index demonstrates a potential improvement in predicting college closures. Keywords: higher education finance, college closure, ratio analysis, financial responsibility standards ii For Rachel I wish you could have been there for the sun & the rain & the long, hard hills. For the sound of a thousand conversations scattered along the road. For the people laughing & crying & remembering at the end. But, mainly, I wish you could have been there. --Brian Andreas iii Acknowledgements This research would not have been possible without the herculean efforts of my committee: Dr. Brian Pusser, Dr. Justin Thompson, and Dr. Catherine Brighton. To say that I owe a vast debt of gratitude to the three of you is an overwhelming understatement and does not begin to convey my appreciation of your time, your wisdom, your patience, and your expert guidance. Thank you. Many thanks to the faculty and staff of the Curry School of Education for dedicating your lives to inspiring and investing in others. Thanks, too, to my doctoral colleagues who paved the road to the finish line and kept me company on the journey with your intellectual curiosity and your friendship. I am deeply grateful for having had the opportunity to work with many brilliant and talented colleagues at the University of Virginia. In particular, I offer my genuine and heartfelt thanks to Mr. Gary Nimax, a magnificent supervisor, mentor, champion, and friend. Your leadership and camaraderie have been a great highlight throughout these past many years. To my beloved family and friends who have sustained me with your kindness and support during this chapter of my life: I am grateful for all that you are and all that you have done for me. To my cherished godchildren and nieces and favorite small humans: thank you for infusing my world with happiness and wonderment. And to Dawkins and Rugby: I can never begin to repay you for the gifts of your loyalty and your patience, and for adding more joy to my life than any person deserves. Thank you all. So much. iv Table of Contents Abstract ......................................................................................................................................................... ii Table of Contents .......................................................................................................................................... v List of Figures and Charts ........................................................................................................................... vii Acronyms and Short Forms Relevant to this Research .............................................................................. viii Chapter 1: Introduction ................................................................................................................................. 1 The Financial Responsibility Composite Score ........................................................................................ 2 Problem of Practice ................................................................................................................................... 5 Research Questions ................................................................................................................................... 8 Importance of the Study ............................................................................................................................ 8 Chapter 2: Literature Review ...................................................................................................................... 10 Federal Oversight .................................................................................................................................... 10 The Modern Financial Context for Private, Non-Profit Colleges ........................................................... 12 Financial Ratio Analysis in the U.S. ....................................................................................................... 16 Ratio Analysis in Higher Education........................................................................................................ 17 Seminal Works in Higher Education Ratio Analysis .............................................................................. 20 The Composite Financial Index .............................................................................................................. 23 Summary of the Literature ...................................................................................................................... 25 Chapter 3: Methodology ............................................................................................................................. 26 Research Question #1 ............................................................................................................................. 26 FRCS and Predicting College Closure ................................................................................................ 27 FRCS and Identifying Financially Stable Colleges ............................................................................ 29 Research Question #2: ............................................................................................................................ 30 Developing an Alternate Model .......................................................................................................... 31 Data Collection ................................................................................................................................... 38 Limitations of the Research Design ........................................................................................................ 39 Chapter 4: Findings ..................................................................................................................................... 42 FRCS and Predicting College Closure .................................................................................................... 42 FRCS and Identifying Financially Stable Colleges ................................................................................ 44 Developing an Alternate Model .............................................................................................................. 46 Analysis of Closed Colleges: FRCS versus the MRA Index .............................................................. 48 Analysis of Open Colleges: FRCS versus the MRA Index ................................................................. 53 Chapter 5: Conclusions ............................................................................................................................... 65 Discussion ............................................................................................................................................... 65 Implications............................................................................................................................................. 66 Implications for the Department of Education .................................................................................... 67 Implications for Colleges and Universities ......................................................................................... 69 v Limitations and Recommendations ......................................................................................................... 70 Limitations of the Population Sample ................................................................................................. 70 Limitations of the FRCS Formula ....................................................................................................... 71 Limitations on Achieving Improvements in Practice .......................................................................... 71 Additional Recommendation for Future Research .................................................................................
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