A Dynamic Model of the Research University

We study hiring decisions made by competing universities in a simple dynamic framework, focusing on the structure of university finance. Universities with annual state-approved financing underinvest in high-quality faculty, while universities that receive a significant part of their annual income from (less volatile) returns on endowments hire fewer but better faculty and provide long-term contracts. 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 university 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.