The University of Cambridge has been criticised by the Higher Education Funding Council for England for allowing academics to lead its governing council.
Hefce says that academic members of the council may have vested interests that can stop them acting in the public interest when deciding how to spend government funds.
The warning is made in Hefce's final report on Cambridge's governance, which followed an audit last year. The report refers to the Committee of University Chairmen (CUC) governance code, which requires institutions to be governed by a majority of lay members.
The report says: "With its council dominated by people from within the collegiate university, those members have a potential vested interest in the application of funds and are not demonstrably acting primarily on behalf of the public interest.
"This is in contrast to almost every other higher education institution in the country and ... the bulk of publicly funded bodies in all sectors."
The report accepts that the university's performance has been "excellent" and that this should not be undermined "by change for change's sake".
"But we are also confident that our interests and those of the public would be better served by having strong oversight of public investment to the same extent that other institutions have," it says.
It adds: "Debate and decision-making in a university is informed and refreshed by the ideas that outside individuals bring, especially those with experience and expertise from society, business and the professions."
However, Hefce says the university has provided a "comprehensive response" to its request to explain how its governance arrangements safeguarded public funds and provided external stimulus.
Ross Anderson, professor of security engineering at Cambridge, said Hefce's approach was "completely misguided".
"Cambridge (and Oxford) have thrived as self-governing communities of scholars because we have the right incentives to make (it) successful. External majorities will simply hand almost unfettered power to the vice-chancellor and the administration."
He said this model came from the City and had failed there.
Attempts at the University of Oxford to reform its council with a majority of lay members have so far been rejected by dons.
Meanwhile, the University of Sussex's senate rejected a plan that would have put its elected members in the minority. A discussion paper proposes that the number of elected members of the senate, Sussex's highest decision-making body on academic matters, be reduced by two thirds to bring it in line with other members of the 1994 Group of universities.
A University and College Union representative at Sussex said that an alternative proposal would now be developed, "reflecting the core principle of an elected majority and wide student representation".