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Research on human capital may help revolutionize student lending

Miguel PalaciosGenerations of MBA graduates have mastered pricing models designed to evaluate companies based on their capital assets  things like equipment, land, and raw materials.

But as the world economy shifts to one that increasingly places a premium on brainpower instead of horsepower, there are few, if any, reliable methods for analyzing the financial value of human capital.

In an effort to help bridge that gap, Vanderbilt University’s Financial Markets Research Center in early October brought together researchers who are looking at the value and risk of human capital, and how it affects a firm’s business and financial strategy.

For the event’s organizer, Miguel Palacios, an assistant professor of finance at Vanderbilt’s Owen Graduate School of Management, the pursuit of this new model is more than just an interesting theoretical exercise  it’s personal.

The Colombia native is a cofounder of Miami-based Lumni, a company that has developed investment products to help send promising students to school that otherwise would be shut out of higher education by soaring costs. Operating in four countries, including the U.S., Lumni was cited by BusinessWeek in 2009 as one of America’s most promising social ventures. More recently, The Economist highlighted the company in a piece about innovative new microfinance ventures designed to help students pay for higher education.

With co-founder and fellow Colombian Felipe Vergara, a former McKinsey consultant, Lumni has financed education opportunities for 1,800 students using more than $10 million. The company raises money from investors such as the Inter-American Development Bank, foundations, universities, and wealthy donors. Students commit to paying a fixed percentage of their incomenever more than 15%into a Lumni-created fund typically for five years after graduation. In turn, that fund pays out proceeds to investors.

As The Boston Globe has described it, “These contracts, proponents say, would allow more kids to finish college. They would free graduates from crushing debt. And they could liberate youngsters to pursue socially valuable but low-paying work such as teaching.”

But it’s not just save-the-world types who would benefit. Palacios and others point out that this model would also help fund the next generation of doctors and lawyers as a way to spread investor risk through a broad pool of students.

“The best analogy is insurance,” Palacios told the Globe. “Not everybody crashes. If you pool everybody together, you are in a much better position.”

The analogy may end there, however, for unlike insurance there’s no set of accepted standards for quantitatively measuring risk or reward when it comes to education. How, for example, does the value of human capital change when a person adds a medical degree versus a bachelor’s in philosophy?

“This is the largest asset that most people have,” says Palacios, who estimates that human capital accounts for about 90% of aggregate wealth.

But, Palacios says human capital poses a particular challenge for researchers because while it represents the single largest asset class in the world’s economy, one can’t directly observe its value or dynamics. “We merely observe wages, human capital’s dividends,” Palacios wrote in a 2009 paper. “Thus, we need a framework to determine human capital’s value.”

Researchers continue to look for a breakthrough model in the field, and so far Palacios’ work indicates that human capital is less prone to economic shocks than equities, bringing a new level of empirical rigor to academic colleagues and potential investors alike.


There are other, more practical concerns for the student-investment concept beyond technical valuation, namely how to guard against a student putting off a career because there’s no pressure to repay loans.

To address this, Lumni draws on psychologists to help screen its applicant pools and designs the student contracts in such a way as to deter abuse of the system.

There’s also a risk that potentially high earners  medical school students, for examplewould avoid signing up because they could end up paying out more to Lumni’s investors than they would to a private student loan company. Here, the company offers better terms such as a lower percentage of income to be repaid.

Lumni is not the first company to attempt this invest-in-students model; its conceptual roots stretch back to the 1940s and 1950s when the economist Milton Friedman first proposed the idea.

More recently the companies MyRichUncle, a U.S. student financing company that’s now out of business, and German-based CareerConcept, launched versions of the idea. MyRichUncle began experimenting with these types of student contracts in 2001. Career Concept, however, has seen success since it began offering student investment funds in 2002. It has sent thousands of students to school across more than 20 countries, mostly in Europe, through eight funds totaling 40 million euros.

For now, Lumni is trying to establish itself in the Americas, with a goal of financing one million students over the next 12 years.

Vergara told Business Week, “My vision is to create a revolution in investing in human capital to show it’s possible to receive an education despite low income.”

But companies like Lumni can only execute on that vision if they have the analytical tools being developed by Palacios and others to correctly value the contracts they sign.

Published Nov 12, 2010 in Vanderbilt Business Intelligence
Contact: vbintelligence@owen.vanderbilt.edu
Copyright 2010 Vanderbilt Owen Graduate School of Management