Second Tier B-Schools - Higher ROI than Ivy League Schools?

According to a recent study, the highest rates of return were found for the second-tier public business schools. The rate of return for Michigan State (Broad) was 42.72 percent. For Illinois (Urbana-Champaign), it was 42.33 percent, and for Iowa (Tippy), it was 39.7 percent.  Contrast this with the rate of return for Harvard Business School, which was only 19.7 percent. The University of Chicago (Booth School of Business) was in the last place with only a 13.4 percent rate of return.

How the Study was conducted?

The new study estimated the rate of return for the top 30 MBA programs and 15 second-tier MBA programs in the United States by comparing the cost of degree acquisition with the incremental post-MBA income over an expected work life of 40 years. Tuition and fees and two years of foregone income were used as the cost of the investment. The incremental salary was calculated and used as the investment’s cash inflows.

Reasons for high ROI for Second Tier Public Business Schools

According to the study, these high returns can be credited to two distinct aspects of their programs.

First, the tuition and fees are generally less than their private counterparts. For instance, Michigan State’s in-state tuition and fees are $29,359 for two years, and only $58,365 for a non-resident. Chicago and Harvard, on the other hand, are $97,165 and $101,660, respectively – for the same two-year period. The median tuition for Business Week’s top 15 programs is $93,568, while the median tuition for the fifteen second-tier schools is $72,184. The higher required investment reduces the rate of return for a common cash flow. But all MBAs are not created alike. Indeed, the median post-MBA income for a Chicago graduate is $105,000 per year, while the Harvard median salary is $121,000. The median post-MBA salary from the top 15 programs is $110,000.

Importance of Pre-MBA Salary in ROI Calculations

The second-tier schools have a median post-MBA income of $90,000, only three of the second-tier schools report post-MBA incomes of above $90,000. Likewise, the students are not homogeneous in terms of background. The schools that are higher-ranked attract students that are leaving jobs that are higher-paying than those taken by their counterparts who attend the second-tier schools. Business Week’s top 15 schools have a median pre-MBA income of $70,000, while the second-tier median is only $45,000 before their MBA.

Since the incremental cash inflow from an investment in an MBA is the differential between the pre- and post-MBA salary, the top ranked programs are victimized by their success. Highly-ranked programs tend to attract students that are more experienced and that have already achieved success in higher-paying positions. The median incremental gain in income (the difference between post MBA salary and pre-MBA salary) was $35,000 for the top-ranked programs, but $40,000 for the schools in the second tier.

Second-tier schools have a rate of return that is consistently higher than that of top-tier schools. The correlation coefficient between the IRR and the percentage change in income (pre-MBA vs post-MBA) is 92 percent.

Higher Post-MBA Salary

The median income for an entering student at the University of Pennsylvania (Wharton) was $80,000, with an expected median IRR of 18.36 percent over that student’s 40-year career. Had this student been persuaded by the higher IRR and enrolled at the University of Michigan, he/she could have expected a median post-MBA salary of only $93,000. However, a candidate accepted by Wharton that instead chose to attend Michigan State would have given up an $80,000 pre-MBA salary to earn only $93,000 two years later. A Michigan State MBA would yield this candidate an IRR of only 12.45 percent if he/she qualifies for in-state tuition and only an 11.44 percent return if he/she must pay non-resident rates. This is considerably less than the 18.36 percent associated with an MBA from Wharton. Thus, it appears that it is quite rational for students leaving higher-paying positions to gravitate toward the programs with the higher post-MBA salaries.

Weaknesses of the Study

First of all, salary data do not include the value of options and bonuses that may occur in the future. These additional sources of income can be very significant and could increase IRR results for top-tier MBA graduates, who are more likely to get jobs that pay higher bonuses.

Secondly, the study did not take into account the quality of the positions achieved nor the job satisfaction of the graduates.  While return on investment is an important factor,  job satisfaction and quality of the job are also important for MBA applicants to consider when making their school choices.

Source:  Estimating the Internal Rate of Return on an MBA: A Comparison of the Return from Top-Ranked &Second-Tier Programs by John B.  White, Ph.D. Professor of Finance, United States Coast Guard Academy; Morgan P. Miles, D.B.A. Professor of Enterprise  Development, University of Tasmania; Roger M. White, University of Pittsburgh.