College Sports Programs Are Playing Poor, Here's How to Fix It

A simple accounting trick allows major college sports programs to fake poverty. Killing this practice would allow real reform to take hold.

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Jan 12 2015, 1:45pm

College sports have an honesty problem. I'm not talking about self-serving statements by administrators claiming fans will show up whether teams win or lose because the athletes themselves don't matter. Or claims that those same fans won't show up if athletes are paid. I'm not even referencing National Collegiate Athletic Association Bylaw 2.9, which states that the association exists to ensure that athletes are "protected from exploitation by professional and commercial enterprises," such as the BitCoin St. Petersburg Bowl or ESPN's College GameDay built by the Home Depot.

Read More: UAB's Tangled Web of Numbers Doesn't Add Up

These are all truth-challenged statements, ripe for debunking. However, the dishonesty I'm addressing is both less obvious and more sinister: the widespread use (or misuse) of transfer-price accounting to create an illusion of high expenses and low revenues in big-time college football and basketball, a bookkeeping trick that fools the public into thinking that only about 20 schools make money from sports.

If we're going to have a rational debate--and make rational decisions--about the increasingly up-for-grabs future of the college sports economy, we need a better, more honest method of accounting, the better to understand how money actually moves through the system. Here's why (and how):

Writing It Down Doesn't Make It Real

You're probably wondering: what is transfer-price accounting, anyway? And how does it factor into a college sports economy defined by two trends that seem to contradict each other, specifically:

(a) An ongoing explosion in television broadcast rights money, including ESPN's 12-year, $5.64 billion deal for the new College Football Playoff;

(b) Increasing handwringing over the pricey unsustainability of major sports, from Jim Harbaugh's $40-million-plus University of Michigan coaching contract to the University of Alabama-Birmingham dropping football because it supposedly costs too much.

Depiction of college AD desperately tending to his flock. Image via WikiMedia Commons

In universities and other non-profits, transfer-price accounting is used as a way to manage dozens of autonomous, generally money-losing departments. For instance, a school's communications department is given a certain amount of money to spend, and free reign as to how to spend it. When it wants to use university services--like a secretary, a scholarship, or a classroom--it gets told a price, and it deducts that amount from its budget. That price might reflect the actual cost to the university, but it doesn't have to. It's simply a number assigned by a bureaucrat to manage the department's spending, so if the school wants more communications classes, it might lower the cost (that is, the transfer price) of "renting" classroom space; if it wants less spending on administrative staff, it might raise the listed cost of a secretarial position regardless of the actual salary associated with that position.

This is true whether the department is called "Communications" or "Athletics." If central school accounting says each full scholarship costs $50,000, then to the department head or Athletics Director (AD), it likely feels like a real cost. But to the school as a whole, unless forgoing that scholarship really increases total cash by $50,000, that's not what it actually costs.

Keep that mind.

For schools, this management-by-assigning-a-price system works well if the department in question isn't a moneymaker. However, for those few university departments--like athletics--that generate revenue from outside the university, transfer prices don't just help manage costs. They also can be used to shift profits away from the money-making department and towards the central administration by charging the department more than things actually cost. In other words, phony football expenses can hold football spending in check while also making sure the resulting profits end up benefiting more than just the football team.

In the process, it just happens to make football look less lucrative than it really is, but just because the fake price may have a good purpose, it doesn't make those expenses any less phony. Just as being short and shoving my hand into a great coat doesn't make me Napoleon, you shouldn't assume football hurts a university financially just because the accounting dresses up football profits in cost costumes. In her informative book Saturday Millionaires, sports business writer Kristi Dosh provides an excellent example of this by detailing all of the various ways that Ohio State imposes fictional costs on its athletic department (rather than real, cash-based expenditures), with the seeming goal of moving profit from sports (mostly football) to the general coffers of the school.

Among the expenses the school charges its athletic department are $8.5 million for "overhead," "physical plant assessment," "cost containment" and "university fundraising," and another $1 million for "library renovations." (There's also $15.7 million in scholarship costs, but you can read about the fictionalization of scholarship costs elsewhere.)

Thing is, all of the above white lies--sweet bookkeeping nothings that universities tell their athletic departments for management and profit-repurposing reasons--become real lies, and damaging, once outsiders get a hold of them. Sports reporters, even those who firmly believe in the right of athletes to earn their keep in a free market, start writing that it's a shame so few schools can afford to pay athletes what they are worth. Well-intentioned public policy organizations like the Knight Commission start crusading to lower sports costs, without distinguishing between expenses that are real (like coaching pay) and those that are likely just transfers (like academic spending per athlete).

The beautiful struggle of the noble college football program. Image via WikiMedia Commons

Malleable accounting can help you spin gold into straw if you are determined to look like a money loser; it can act as political cover if, like UAB president Ray Watts, you wave a bloody-shirt consulting report filled with dubious assumptions about football revenues and expenses as a "the numbers are the numbers, folks" excuse for cancelling football. (The same sneaky game played out in 2011 at Nebraska-Omaha.)

Taken to its logical end, transfer-price accounting can even lead pro-athlete columnists and professors to question why more schools don't follow UAB's lead by courageously dumping the money-losing sports acting as anchors on American academia.

The answer, of course, is that most big-time football and men's basketball programs aren't losing money. It only looks that way.

Make the Numbers Tell a Truer Story

If better numbers existed, better policy decisions could be made. Right now, very few people within college sports are motivated to do the hard work needed to show the true economic benefits (or costs) of big-time athletics. If anything, many have the opposite motivation--their goal is to hide the profits as much as possible, the better to claim that there's nothing available for anyone else, be they envious professors or hard-working athletes.

For example, in a recent amicus brief filed in the O'Bannon case, the American Council of Education conflated the profits made from football and basketball with the decision of schools to spend that money on other things in order to claim that schools are all too broke to pay their athletes--all while (ironically) also arguing that if allowed to pay athletes, every school in America would immediately do so, with amateur college sports vanishing from the earth. Combine and conflate numbers, and it's easy to show you aren't making money, no matter how much you actually make.

Is there any way out of this pickle? Some have suggested a Presidential Commission on Intercollegiate Athletics. I worry that a federal reform effort populated by academics and politicians may focus on what they know best--academics and politics--while shortchanging the economic rights of campus athletes and using cooked books as a smokescreen, knowingly or not. When I see people arguing that college sports needs Congress to appoint a "benevolent dictator," I get leery, especially if said argument is coming from the would-be czar. Unless athletes have a substantial voting bloc on any such commission, the odds of them getting a fair shake seem low, and if the profits are all hidden as expenses, those odds seem slimmer still.

Dictators always solve everything. Image via WikiMedia Commons

The college sports economy needs less centralized control. Not more. It needs honest accounting so that a free and fair market can direct money to where the value is generated, not additional government oversight and exemptions from those market mechanisms to direct those profits to whomever has the most pull in Washington, D.C. So rather than pretend that campus athletics aren't a business, I propose embracing them for what they are, and harnessing that most American of motivations--the desire to make money--to a better and more honest end.

How so? Here's a simple three-step plan, which I call the Athletic Director Incentive Alignment System (ADIAS):

Step 1: Split athletic departments into two parts, one for football and basketball, one for everything else.

In essence, this splits profit generation from how those profits are spent, and quickly disentangles the false connection between football profits and field hockey expenses.

If the two departments were split into, say, the Football and Basketball Department (FBD) and the Olympic Sports Department (OSD), the schools themselves (and Congress, if it so chooses) could make better decisions about whether FBDs were being run efficiently enough to generate sufficient profit, or whether the people in charge of the FBDs were wasting money, perhaps by paying themselves too much.

Schools could also honestly evaluate whether they are over- or under-spending on their OSDs, something that current would-be reformers often fail to do when decrying financial losses by our contemporary football/field hockey mashups. Of course some sports lose money, just like student theater and campus newspapers. By contrast, some sports make money and perhaps could make even more. When critics complain about athletic department shortfalls, they're really saying that they think football needs to be run more profitably, or that the OSDs are being run too lavishly--perhaps sending the men's baseball team to Hawaii for training camp is too expensive. Those are very different problems. Treating them as the same is a bad way to reform an industry.

Step 2: Cash accounting only.

Schools should use, and publish, cash-based accounting for their FBDs. No accrual accounting, no cost allocations, and no transfer prices. Unless an activity results in cash flowing out of the university (and not just from one university department to another), the FBD pays nothing for it.

Note: that means paying nothing for scholarships. Why? When the school charges the athletic department for a scholarship, no actual money leaves the university. The price it assigns for managerial purposes is ripe for funny-money bookkeeping.

Currently, when athletic departments give a scholarship, they commonly get charged the full retail price (sometimes of an out-of-state student) regardless of the actual cost to the school of providing one more space at the school. The food and books provided probably costs half of what they charge. The real cost of tuition and dorm space is probably de minimis, unless by giving that space to an athlete, a paying customer is forced out. Except for very selective schools with tight space constraints, most of the expenses listed as part of an athletic scholarship are overstated and sometimes purely fictional transfer prices. Your school's results may vary, but the full retail price is almost certainly not a good estimate of the real costs.

Step 3: Provide honest incentives and use public scrutiny to keep things that way.

Once we have true measures of cash flow generated, schools should base the salary of their FBD directors on how much money they hand to the university in cash flow each year--or better yet, on a five-year average to avoid short-term gaming. To wit: the University of Texas's FBD director could earn base pay of $50,000 per year, plus, five percent of all cash flow above a minimum target.

The target is where schools could build in their estimated costs of providing those non-cash expenses to athletic departments. For example, if the school's dorms are at capacity, giving the football team 85 beds may actually reduce the number of otherwise paying customers the school can charge to rent dorm rooms. If you can show that really happened, you can build that lost revenue (what economists call "opportunity cost") into the target. If the school has to double the number of tutors it has on staff for at-risk freshmen because of the FBD, that incremental cost could (and probably should) be built into the target. Any additional expenditures that otherwise would not be made or any revenue forgone from other paying customers (non-hyphenated students), and that can be justified to an auditor as a real expense and not just an accounting cost fiction, should be baked into the target to ensure those costs get covered before the FBD director starts to earn a bonus.

This is literally the future that college sports traditionalists fear. Image via WikiMedia Commons

The second element of the target would be a profit threshold. That is, the bonus would not kick in until the FBD cash-based profits exceeded both the costs per the audited university bill, and some additional profit goal, likely negotiated between the school and the FBD director. The profit target could and should differ by school-the University of Alabama's FBD should probably have a higher profit target than the University of the Pacific's-and it might even be negative at a school that wants to subsidize football to jump-start a program.

Here's where public scrutiny comes into play: all schools would have their numbers audited by a neutral third-party (possibly another good role for Congress), and all numbers would be made public. It's much harder to claim a scholarship is costing you $50,000 if an auditor starts asking who was displaced and how much they would have paid if they'd have been admitted; harder to fudge the real cost of a meal plan to a school when forensic accountants take the place of weary parents reading through student loan and financial aid statements; harder to lie about your sports budgeting decisions when open information means that even some guy from VICE Sports can write a story picking apart your assumptions to the point where you have to change your story. And then he finds holes in the cover story too.

If Congress wants an easy way to regulate campus athletics, insisting on this level of public scrutiny of college sports accounting will go a long way toward a more truth-based discourse as to whether football makes money and as to whether that football surplus is or isn't well spent. With the truth of any football profits out in the open, legislators and others could then focus on whether football programs are so fragile they need to be exempted from the antitrust laws that govern other profitable businesses.

Better Incentives Mean Less "Need" for Collusion

Schools currently claim that they need to fix the price of college athlete labor at tuition, room, board, and books through "amateurism"; otherwise, they argue, they would irrationally spend themselves into bankruptcy while competing for the top high school talents. With the ADIAS system in place, this boogeyman of "ruinous competition" vanishes back under the bed. Instead of collectively begging Congress for an antitrust exemption, each school would empower its FBD director to choose how much to pay its coaches; how much to charge for tickets; whether to bring in 100 football scholarship athletes or 50; whether to provide stipends, trust-fund deposits, or salaries. In turn, FBD directors would balance the benefits of additional spending against the fact that every time they drop an extra million on a coach, that's $50,000 less in their own paychecks.

Meanwhile, schools would run their Olympic Sports Departments like other campus functions that are useful and valued, but aren't expected to break even. We'd then know how much particular schools value these sports by how much money they devote to them, without confusing the act of sponsoring non-revenue sports with the question of whether enough profit has been wrung out of football or basketball. School's don't ask whether the chemistry department's research grants will cover the costs of a classics department--so why should they force football's television revenue to cover volleyball's scholarship costs?

Separating the departments and running OSD like any other cost center will go a long way towards simplifying the math for colleges and the public alike.

But Will It Work?

Much as H.L. Menken advised that no one ever lost money underestimating the intelligence of the masses, I think it is nearly impossible to overestimate the power of profit-sharing on an administrator's desire to show profits. Right now, if the choice is between handing your school $5 million in profits or $1 million in losses--and the latter lets you hand out raises to everyone in your department (including yourself) without affecting your tenure in any way--it's hard to avoid the temptation to spend every dollar in your budget. Such is the oft-wasteful reality of use-it-or-lose-it budgeting: costs rise to whatever level is allowed.

ADIAS turns this upside down and makes the accounting work to encourage surpluses. Its sunshine-as-disinfectant provisions will mean a lower chance of athletic department transfer-pricing chicanery; its greed-as-good incentives will prod schools to spend money on sports in order to either (a) make even more money that can support academia; or (b) achieve tangible performance and participation ends.

How you want to see college sports reformed depends a great deal on who you want the new system to benefit. If you think the industry should exist to extract profits from football and basketball athletes, boost the profits of football facility construction firms, and enrich coaches and conference commissioners, by all means, keep using the current system. If you instead think the problem with the system is that the money extracted from athletes needs to be redirected to new power brokers, then move oversight (and the overseers) from Indianapolis to Washington D.C., or from the athletic department to the faculty senate.

But if the goal of reform is to empower athletes to get what they are worth, an outcome I would endorse, one giant step would be to bring some honesty and openness to the accounting and then to give the market a chance to work its magic. Free the schools to bid for talent as they see fit, but temper that freedom through the administrators' own healthy desire to earn a good living. You'll end up with a system that does not need to sacrifice athletes' economic rights and avoids the excesses of today's skewed, collusive setup.