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Periodically, discussions on the quality of college education centre on the concept of tenure for university professors. In the US academic system, tenure is a contractual right not to have the position terminated without just cause. To put it simply, a tenured professor cannot be fired unless he/she does something illegal.

Such a concept appears untenable in the 21st century. With widespread job insecurity even among the highly educated, it appears archaic that a particular group of employees – university teaching faculty – are given lifetime employment. In the US, tenure is sharply binary – a handful of scholars obtain tenure while the vast majority of academics achieve poorly paid non-tenured posts with little status or security. In the UK and much of the Commonwealth, the majority of academics begin as lecturers with permanent or open-ended contracts. In the case of an initial temporary contract, there is a reasonable likelihood of an extension or conversion to a permanent contract. Over time, there is a gentle progression to more senior grades with regular pay rises, but in the end, contracts continue to retirement.

Proponents of tenure argue that it preserves the quality of university education, since it gives professors academic freedom to pursue path-breaking research ideas and to voice their opinions freely, without being censured by administrators. Opponents argue that tenure is part of an outmoded system that encourages professors to pursue research, usually of questionable quality, over teaching. Some opponents argue that tenure reduces academic freedom because to get tenure, academics must conform to the political or academic mainstream.

From an economic point of view however, tenure can be seen as a simple mechanism for universities to assure themselves of quality research. Universities have two significant problems in hiring faculty: first, they need to hire faculty who will be research-active in the long term – this is called the adverse selection problem. Second, they need to make sure that they offer incentives for the faculty to stay research-active once hired – this is called the moral hazard problem.

Once a professor gains tenure, he/she cannot be fired. So the tenure process would seem to exacerbate the moral hazard problem. If the university can do nothing to punish the professor, a tenured professor can slack off the rest of his/her life without fear. A regular system of performance reviews might appear to be better than tenure here – if a professor starts slacking off, he will be fired on his next review.

However, this system of performance reviews makes the adverse selection process worse – and adverse selection is what will ultimately destroy the university. Consider what makes a university’s reputation – the quality of its research. What did professors at the university discover? What did they create? This is what the great universities are remembered for.

Teaching is measurable. The quality of teachers can be assessed through student evaluations, student sign-ups for elective classes and so on. However, basic research by its nature, is unpredictable. Science has become increasingly specialised, so much so, that a scientist in one field will not be able to understand why a discovery in another field is important, if at all. This means that the best judges of quality are other professors in the same field.

Imagine if a university abolished tenure, replacing it with a performance review every five years and stating that those who contributed least to research would be fired. Under such a scenario the university will not place that much emphasis on teaching because its reputation depends on the ideas that its professors generate. What would be the best strategy for a senior untenured professor in the area? Simple: Interview all the aspiring professors and hire the idiots. In five years, the new untenured professors will all be fired because ex ante they had silly research ideas and the wise senior professor achieves de facto, though not de jure, tenure. That is the adverse selection problem the university faces. To solve it, the university tells its senior professor to hire the smart juniors. The university explains that these bright juniors will bring fame to the department, attract more funds from government and industry and increase the resources available to the faculty. The senior professors are assured that their jobs are safe whatever happens.

But unfortunately, this worsens the moral hazard problem. So how do universities solve that problem? By making the tenure process so difficult that only a handful of professors achieve it. In the US system, over 90 per cent of professors do not make tenure in the schools they start in. Why is this hurdle so high? The answer is because universities hope that the handful of professors who do achieve tenure are so driven that they will work hard even though they do not have to – although the university acknowledges that this is a hope, not a requirement.

The US system also has an additional feature not shared by the UK and other systems. In the US, if a faculty member does make tenure, he/she is automatically promoted and if not, he/she is automatically fired. This is called the up-or-out rule. This rule prevents exploitation of the faculty by the university.

In the UK, which does not have the up-or-out rule, a faculty member might achieve tenure without being promoted. Getting tenure lowers job mobility since another university who wishes to hire the faculty member will have to offer tenure to get the faculty member to move (under the assumption that lifetime employment is a desirable outcome). However, getting tenure without promotion means that the faculty member’s salary stays the same. So the university gets a valuable associate professor (US), reader (UK) – if he/she were not valuable, the university would not have offered lifetime employment to begin with – for the pay of an assistant (US), lecturer (UK)). Without the up-or-out rule, an ambitious junior in the UK has incentives to refuse tenure even if eligible, unless he/she knows that promotion will follow shortly thereafter, a perverse incentive.

The binary nature of tenure in the US is therefore a rational economic solution to the twin problems, adverse selection and moral hazard, universities face. It is also why despite frequent calls to abolish tenure, the tenure system has survived – without it, universities would cease to be centres of research. It is also likely to be a reason why by far the greatest amount of academic research originates in the US.

The author is the Sir Evelyn de Rothschild Professor of Finance, Judge Business School, University of Cambridge and co-editor, Financial Management

Copyright The Financial Times Limited 2017. All rights reserved.

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