Budget Uncertainty and Faculty Contracts: A Dynamic

We study hiring decisions made by competing universities in a dynamic framework, focusing on the structure of university finance. Universities with annual state-approved financing under-invest in high-quality faculty, while universities that receive a significant part of their annual income from returns on endowments hire fewer but better faculty and provide long-term con-tracts. If university financing is linked to the number of students, there is additional pressure to hire low-quality short-term staff. An increase in the university’s budget might force the univer-sity to switch its priorities from ‘research ’ to ‘teaching ’ in equilibrium. We employ our model to discuss the necessity for state-financed endowments, and investigate the political economics of competition between universities, path-dependence in the development of the university system, and higher-education reform in emerging market economies. ∗The authors are grateful to Sergei Guriev and Aleh Tsyvinski for many helpful comments