How Could We Use a Price-to-Earnings Premium in Higher Ed?

by Michael Itzkowitz

Last month, we introduced a new measure designed to get a better look at the economic value institutions across the United States are providing to their students. The new metric — called a Price-to-Earnings Premium (PEP) — compares the cost that students pay out-of-pocket to attend an institution versus the additional amount of income they eventually could earn by doing so. It assumes that any additional earnings beyond that of a typical high school graduate in their state could then be used to pay down that net cost, providing prospective students and lawmakers with an estimate of how long it will take to recoup that educational investment.

Given the growing uncertainty that students now face when applying to college, it is more important than ever that they understand which institutions can provide them with a good return on investment. Below is a snapshot of the how students, institutions, and policymakers could use the PEP metric to help them make better-informed decisions about where and how to spend their time — and both personal and taxpayer dollars.

Students: Using a PEP to Inform College Choice

Each year, nearly 20 million students attend an institution of higher education, most with the primary purpose of increasing their employability and gaining long-term financial security. While there are also many intangible benefits that students can gain by attending an institution — better informed and engaged citizenship, social networks, and personal development, to name a few — there is a widespread belief that students should at least be able to earn enough to pay down their college costs in a reasonable amount of time after they complete their credential. If a student is considering a handful of options of where they want to go to school, a PEP can help clarify which institutions are more likely to offer a better economic investment.

For example, take two institutions, both located in Boca Raton, Florida: Florida Atlantic University (FAU) and Lynn University. Both of these institutions predominately offer four-year degrees, have similar admissions requirements, and offer similar fields of study. Furthermore, they are only 1.3 miles from each other, making their location a non-factor for prospective students considering both institutions.

While these two institutions may look quite similar on paper, the PEP metric tells us a different story, with students at FAU recouping their educational investment about four times faster than students who attended Lynn.

Here’s how we know. The annual net price to attend FAU is $12,605. Therefore, if a student earns a degree in four years, it will — on average — cost them $50,420 to do so. The typical student who attends FAU earns $43,200 ten years after initial enrollment. Since FAU students’ wage premium is approximately $20,000 beyond a typical high school graduate in Florida ($22,752), it would take them approximately two and a half years to recoup the total net price of $50,420 to earn a four-year degree from that institution. However, the institution right down the road — Lynn University — shows a higher cost and lower earnings premium, meaning it will take students substantially longer — more than eight years of wage premium — to recoup their educational costs.

Being that postsecondary education is one of the largest financial investments that students and their families will make in their lifetimes, a PEP can help them weigh the costs of attending versus the financial returns they can expect down the road.

Institutions: Using a PEP to Boost Overall Performance

Just as students can use a PEP to better inform their college choice, administrators can also use the metric to evaluate the effectiveness of their institution and target resources toward programs that show good outcomes for those who enroll. While an institution-level PEP can provide administrators with a birds-eye view of how they are doing for their students economically compared to similar institutions, a program-level PEP can help identify which fields of study either cost too much, lead to insufficient earnings, or both. The US Department of Education (Department) could produce this information for institutions — building on its recent release of program-level data — or administrators could gather it by collecting employment information from former students.

A good example of how a PEP metric could be used by institutions to increase their return on investment for students stems from the release of Gainful Employment program-level data, which motivated institutions to voluntarily close approximately 300 failing programs, even before any sanctions were enacted. Similarly, a PEP could help institutions identify program offerings that show limited value relative to their cost. By eliminating programs that show students consistently earning too little to pay down their cost of earning that credential, institutions could better ensure that a higher proportion of students can recoup their educational investment shortly after leaving the institution. Not only would this lead to better outcomes for students who enroll, but it would also boost overall institutional performance.

Lawmakers: Using PEP to Inform Consumers and Target Dollars to Institutions that Serve Students Well

Over the last decade, lawmakers have considered better ways to ensure that federally funded institutions and higher education programs deliver value to the students they enroll. Currently, the main federal law in place to try to provide some protection for consumers — known as the Cohort Default Rate — is easily gamed and hardly affects any institutions. The other main rule — known as Gainful Employment — was put in place in 2014 to ensure that career education programs leave their graduates earning enough to pay down their educational debt. Yet, the Gainful Employment rule has since been rescinded and re-upping it is seen by many as a political non-starter. This leaves a gaping hole in measuring return on investment that a PEP could help fill, either through additional measures of transparency or by using it directly to more efficiently target federal dollars toward effective college programs and institutions that deliver good outcomes for their students.

Providing Greater Transparency: There are several steps that policymakers could take to provide students with consistent and usable information about their likely economic return throughout the college search process.

1. Include a PEP metric on the College Scorecard: Right now, the Department provides a website for prospective college students where they can compare costs, graduation rates, and employment outcomes at institutions across the United States. Still, with all this data available, there is no information about how long it takes the typical student to pay down their educational investment after earning their credential. Adding a PEP metric to the College Scorecard could be done by the administration immediately, making it all the easier for students to compare the likely economic return at the institutions they are considering.

2. Require institutions to publish PEP information in their promotional materials: Another way to help prospective students would be to provide them with the same data points throughout multiple phases of the college search process. One way to accomplish this goal would be to require institutions to make outcomes information (including a PEP metric) visible through any promotional materials they send out to students and accessible on their website as it’s often a first stop for students considering where to enroll.

3. Enhance the FAFSA with a PEP metric: In order to become eligible for federal grants and loans, students fill out the Free Application for Federal Student Aid (FAFSA). The Department could update this form so that students can see the PEP for each institution they choose to send their FAFSA, giving students more information earlier in the process about whether a college is too expensive, its potential earnings are too little to warrant its cost, or both.

4. Add a PEP metric to the College Financing Plan: In 2012, the Department introduced the College Financing Plan — formerly known as the Financial Aid Shopping Sheet — which is a standardized consumer tool that participating institutions use to notify students about how much they can expect to pay out-of-pocket to attend a given institution. Adding a simple metric such as a PEP to this form could help students more easily compare institutional outcomes alongside cost. Requiring all institutions to use this standardized award letter — including a PEP metric — would also go a long way toward ensuring that students can easily compare acceptance offers no matter which institution they are interested in.

Targeting Taxpayer Dollars: Beyond providing students with more information during the college search process, lawmakers could also use a PEP measure to better ensure that federal dollars only flow to institutions that are shown to pay off for the students who enroll.

1. Target future COVID-stimulus funding to institutions that show an economic return: Last month, the federal government allocated $14 billion in grants directly to institutions of higher education. While half of the total disbursement was intended to help institutions transition to online learning, the remainder was reserved as emergency grant aid, an allocation that was meant to be distributed to students who may be reliant on federal grants for living expenses. While this immediate funding was necessary to keep colleges afloat during these uncertain times, hundreds of millions may have inadvertently flowed to institutions that have demonstrated no return on investment in the first place. For future funding packages, lawmakers can use a PEP to better target these funds to institutions that have previously demonstrated a good return investment, rather than taking the risky bet that low-performing institutions will somehow improve student outcomes when transitioning their classes online.

2. Limit Access to Federal Student Aid: One possibility to more efficiently target taxpayer dollars would be to only allow access to federal funding (grants and loans) if an institution shows the majority of their students earning more than those who have graduated high school but have never attended college in their state. The federal government provides approximately $1.9 billion annually to schools that currently fall below this threshold, a substantial amount of taxpayer funding that could instead be targeted toward sending students to institutions that show a better return. Policymakers could also provide institutions with some time to improve before imposing any sanctions that would remove their access to federal grants and loans. For example, for the 16% of schools that either show no return on investment (ROI) or where it takes longer than 20 years for the typical student to earn enough to pay down their college costs, policymakers could allow three to five years for institutions to improve these outcomes before any federal actions are taken.

3. Ensure students are getting an instructional bang for their educational buck: Some federally funded institutions show less than adequate outcomes for the students they enroll. Yet, there’s often a different reason for why this happens: some choose to spend the tuition money they receive on a continuous effort to recruit the next batch of students, while others struggle due to a lack of resources. In fact, some institutions that receive the most federal money spend the least on actual student instruction. Lawmakers can use a PEP to identify institutions that show little to no return on their students’ educational investment. Then, if too much tuition money is spent on activities outside of actual student instruction, Congress can then deny access to federal funds, as marketing and TV ads simply won’t improve students’ post-college outcomes.

Conclusion

Practically, an institution should provide its students with the ability to pay down the cost that they paid to earn their credential within a reasonable amount of time. Weighing costs and future earnings in a single measure — as the PEP does — provides a way to evaluate which institutions provide students (and taxpayers) a strong bang for their educational buck. Just as Wall Street investors use a price-to-earnings metric to judge the value of stocks, students should similarly be able to assess their postsecondary options based on their likely return, and institutions should use the PEP to provide better offerings to their students. Likewise, lawmakers should also be able to assess how well institutions serve their students before allowing billions in federal dollars to flow to schools that may provide limited economic returns for those who enroll.

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