Student Pledge, Then Student Regret (2017 May)

by Barry A. Liebling

A student, Sophia (which means wisdom), needs money to go to college and is presented with two alternatives. She is familiar with the first possibility – taking out a loan. When she finishes college she will owe the principal plus the agreed upon interest. If she takes a long time to pay off the loan the interest will mount up, and she will incur what could be a huge debt. Alternatively, Sophia might pay off the loan quickly, and finish early. In either case she will be able to calculate exactly what she has to pay to eliminate her obligation.

The second possibility for Sophia is entering into an Income Share Agreement (ISA). While the idea is not new, it is only recently catching on and is being endorsed by the National Association of Scholars. As of this writing Purdue University has an active ISA program, and efforts are underway to have private, for-profit entities enter the ISA arena.

With an ISA instead of borrowing money Sophia finds an investor who is counting on her to succeed in her career. She obtains cash for school and pledges that for a period of ten years her investor will get a set percentage of her income (as little as 3% or as much as 10% depending on the agreement). The contract with the investor puts a limit on how much she will pay in total – generally no more than 2.5 times the cash she was given.

Before diving into the consequences of an ISA, consider why Sophia needs outside money to get her degree in the first place. Higher education was not always so expensive.

The cost of obtaining a college degree has been increasing at an alarming rate for more than fifty years. In the not-so-distant past it was common for students to take on part-time jobs and “work their way through college.” Look at movies and television shows produced in the 1950s and 1960s to see how students who were not affluent managed to graduate and join the workforce without incurring significant debt.

The escalation of college costs is largely attributable to the flood of student loans that were made available through the “enlightened generosity” of government agencies. A vicious cycle was started that continues to this day. Students borrow money for school. Colleges adjust their prices upward to capture the money. Students need more money, and the “well-meaning” government increases the size and volume of their loans. This is a signal to the colleges that they can extract even more from students, and the process begins again. Here is an interesting question. What entity benefits more from student loans – the students themselves or the colleges that take their money?

Of course, students who leave school with large debts are not happy about it. At best, paying off their sizable loans is an unpleasant task. Apparently, a huge number of former students are unable or unwilling to pay back their loans, and the default rate is significant.

This brings us back to Sophia. She knows that she does not want to take on significant debt, and she is wondering if the ISA is a better alternative. What are the likely consequences of pledging a proportion of her income to an investor for ten years?

Recall that Sophia is wise, and if she enters into the agreement she will look out for her own interests.

The clock starts ticking as soon as Sophia has her degree, and the time is up in ten years. Sophia knows that if her income is modest – or even non-existent – for the first few years she does not have to pay anything to the ISA. So this would be a perfect time to take a break, travel, get involved in additional educational activities beyond the degree. The longer she waits to jump into the workforce whole-heartedly, the less she will owe. Of course, this does not mean that Sophia will not work at all. It does mean she has incentives to minimize her official income during the early years. And the investor is certainly aware of this loophole in the agreement. The entity that provided the money will have reasons to investigate Sophia, and see what she is doing. Sophia’s cannot expect privacy once she participates in the pledge.

Suppose Sophia plays it straight and takes on a job that pays very well. The ISA automatically pits the interests of the student against that of the investor. At some point she will realize that she has paid the investor more money than she would have if she had taken out a conventional loan. This is where regret kicks in big time. Sophia will think, “I should have simply taken out a loan, then I would be finished.” It is likely that Sophia will then seek legal advice to see how she can get out of the agreement. After all, she will sulk that the investor has reaped “enough money” from her already. If she extricates herself from the ISA early, the investor will be angry. If she fails to extinguish the agreement, she will be resentful. No happy campers here.

Now think about the last two years of the ten year agreement. Sophia is doing well in her career and knows that her obligation will end soon. Is there some way to make a deal with her employer to defer part of her income until after the ISA expires. You can be sure the brightest recipients of the college money will do their best to arrange this.

There are other possibilities. Perhaps Sophia has only modest financial success during the ten year period. She pays less than she would have had she borrowed the money conventionally. The investor will conclude the ISA was a financial failure. The tuition money given to Sophia would have returned more if it had been directed elsewhere.

Is there a way to modify the ISA scheme so that the interests of Sophia and the investor are aligned? Yes, the investor could take a highly active role in Sophia’s career. The entity giving Sophia college money could be her mentor after she finishes school and decide for her where she will work. The investor could aggressively coach Sophia on how to do well in her job, pull strings to assure that she has advantages, tell her when to ask for a raise, and when to quit and go to another employer. In essence the investor could become Sophia’s agent – similar to how agents work for famous actors and singers. The problem with this method is that it goes far beyond the original spirit of the ISA. It is highly intrusive to the ISA recipient, and it requires the investor to spend a lot of time and money supervising and directing former students.

So what types of investors will be likely to fund ISA arrangements as described by the National Association of Scholars? It does not seem like a good financial deal, so ISA sponsors will likely be non-profits (such as Purdue University) and government agencies. And if students enroll in an ISA program that disappoints them, they will know where to direct their resentment.

*** See other entries at in “Monthly Columns.” ***

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