Human Capital Contracts: “Equity‐​like” Instruments for Financing Higher Education

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Human capital contracts are "equity-like"financial instruments used for financing highereducation. These instruments are better suitedthan student loans to attracting the private capitalneeded to finance higher education. Further,since repayment depends on earnings and thusadjusts to the student's capacity to pay, humancapital contracts should be more attractive tostudents than traditional student loans. Finally,by making transparent the relative economicvalue of certain fields of study or the value ofdegrees from competing institutions, humancapital contracts would improve the efficiency ofthe higher education market as a whole.

Under a human capital contract, a studentreceives funding in exchange for a percentage ofhis or her income during a fixed period of time.Human capital contracts are equity-like instrumentsbecause the investor's return will dependon the earnings of the student, not on a predefinedinterest rate. The effects of these arrangementsare, among others, less risk for the student,transfer of risk to a party that can manageit better, increased information regarding theeconomic value of education, and increasedcompetition in the higher education market.

To ensure the development of human capital contractsas a viable alternative for financing higher education,policymakers should assure investors thatsuch contracts are fully enforceable and afford themthe same legal protection that student loans receivetoday. Human capital contracts should be acknowledgedas securities so that investment funds will beallowed to hold them. Finally, human capital contractsshould receive tax treatment similar to thatgiven other means of student financing.

Miguel Palacios

Miguel Palacios is author of a forthcoming book on human capital contracts (Cambridge University Press). He developed his work on this topic as a Batten Fellow at the Batten Institute, Darden Graduate School of Business Administration, University of Virginia.