Human capital contracts are a new and innovative method to finance university and post-graduate education. These equity-like arrangements could provide a solution to education accessibility issues for students in developing countries.
LUGANO, Switzerland – In 2008, four professors from Harvard Business School published a book entitled Entrepreneurship in the Social Sector. They suggest that a business-like approach in the social sector would help to maximize its impact and value. An approach to maximizing impact could be achieved if residents from developing countries who pursue higher education abroad are incentivized to return to their native countries to apply their skills and experiences in tackling development issues. Yet two problems come to mind when examining the ideal situation: access to higher education within developing markets and incentive structures to recruit competitive business graduates into the social sector.
At the Partnering for Global Impact Conference in Lugano, Switzerland, two innovative solutions were presented to conference delegates. Prodigy Finance, a UK-based student finance firm, and Towers Watson, a global risk management and HR consulting firm, both proposed the concept of human capital contracts.
In its most basic form, a human capital contract is a financial product that allows for the provision of funds to an individual through an “equity-like” arrangement. In regards to education, a human capital contract states that a provision of funds for higher education would be granted to an individual on the basis that payments be made upon finishing said education. The payment amount and schedule would be based on the student’s potential future earnings upon completion of her education.
In contrast, a traditional loan for post-secondary education is obtained through a backward looking assessment of credit history and bank interaction. These loans enforce a strict, standardized payment schedule either throughout or after the educational period, regardless of future income. Unlike a traditional loan, a human capital contract provides the student much more financial flexibility. The flexibility derives from unique post-graduate payment terms based on the future earnings potential of a student rather than a standard structure that is applied to all students, irrespective of their career path.
Shifting the focus to the assessment of future earnings potential rather than past credit history is corroborated by a draft report from the World Bank. It suggests that students need to be reframed as assets rather than liabilities if access to higher education is to become a non-issue. The report also outlines the lack of availability of private sector (bank) loans in developing countries, as these “loans are often only given to the most credit-worthy students, such as advanced professional students in medicine, law and business, or to students with parents who can afford the loans.”
Prodigy Finance provides students with a quasi-like human capital contracts on the provision of funds provided by alumni. The company provides the opportunity for alumni of business schools to invest in current students through a bond listed on the Irish Stock Exchange. The bond provides a 5% return to investors, while helping students finance higher education in a more flexible manner.
Currently, 75% of Prodigy Finance’s student base comes from developing nations. “[Prodigy Finance] attracts high potential students from developing markets who don’t have access to traditional funding sources,” states Cameron Stevens, CEO and co-founder of Prodigy Finance. “We’re looking for people with high potential who have already been accepted into a top school, but just don’t have access to traditional financing methods such as bank loans.”
Students who are seeking a human capital contract go through a scorecard evaluation that helps the company determine their future earnings potential. “We take thousands of data points and we look at correlations between entry profiles and exit salaries. There’s some interesting things that correlate, for example, your GMAT score correlates with exit earnings,” explains Stevens.
The human capital contract concept proposed by Towers Watson is similar to that of Prodigy Finance. Still in its development stage, Emma Hunt from Towers Watson explains: “We’re trying to do what these organizations [like Prodigy Finance] do, but on a larger scale, so that we get a diverse enough investable product.” Unlike Prodigy Finance, the initiatives proposed by Hunt and her colleagues aim to provide financing for multiple academic areas. The aim is to get a large enough student base so that each academic area can be classified as a product type.
At first glance, both concepts appear to only address the first issue of accessibility to education. However, both Stevens and Hunt are also considering the issue of incentive structures for entering social sector career paths. Stevens recognizes that future earnings potential for social sector oriented students may be lower than for those who pursue a profession in careers such as finance. He suggests that the idea of post-scholarships might be relevant in providing incentives:
“The model of post-graduation scholarships is way more relevant than the model of getting scholarships on entry. There’s the guy from Ghana who gets a scholarship from business school and goes to work for Goldman Sachs afterwards. Is he deserving of a scholarship? He is, in a sense, because he comes from Ghana. But if we look at the guy from Ghana who graduates and goes back to work in Ghana in social impact, that might be more worth it. What we’re trying to do is create a loan forgiveness program that would be able to reduce the loan, hold interest payments, and reduce interest payments…”
Although the investor pool that funds the bond would receive a lower interest rate (4% rather than 5%) in return for choosing loan forgiveness criteria, the program would essentially help investors direct students into certain areas. With an investor pool that places interest in social impact as well as financial return, the program has the potential to create tremendous impact.
Hunt’s strategy for incentive structures focuses on the development of product categories. “It would be like match making, matching return profiles by discipline to investors,” she explains. Organizations, such as family foundations, that are looking for a method to develop the social sector would be able to choose which “product” category to invest in, and essentially fund the development of human resource talent within that sector.
Although both organizations offer a solution, neither has critically considered the idea of incorporating social impact metrics to measure the social return provided by students entering the social sector in developing markets. “The development of such metrics would largely depend on the investor class that funds the program,” states Stevens. An investor class that equally values the social impact of such a program, relative to the financial return, could push for a metric system that could concretely define the social value of human capital contracts. A definition of value provides the opportunity for human capital contracts to be funded by a large pool of diverse investors who are looking for more than just a financial return. This could increase the pool of funding and consequentially the number of students entering the social sector upon graduation.
Essentially, human capital contracts provide students with an alternative method to access higher education. The innovative idea is quickly catching on as Prodigy Finance is looking to expand to the U.S and Canada. If demonstrated success in Europe can be transferred to North America and other places, then what we could be witnessing is a key shift in financing methods.