Understanding Social Impact Bonds and Their Alternatives: An Experimental Investigation

Policy-makers world-wide have proposed a new contract – the “social impact bond” (SIB) – which they claim can allay the underperformance and underfunding afflicting not-for-profit sectors, by tying the private returns of (social) investors to the success of social programs (Bolton 2010; Bolton & Savell 2010; Mulgan et al. 2010a,b; Liebman 2011; Tierney & Fleishman 2011; Von Glahn & Whistler 2011). Given the high hopes governments on various levels in England, Australia, and New York have pinned on this contract format, the considerable amount of money that has recently been poured into this emerging market (e.g., http://www.bigsocietycapital.com/), and the fact that serious are program evaluations cannot be expected any time soon (Disley et al. 2011; see also McKay 2013 and Pratt 2013), we test this new contract by way of experimental methods. We report an investigation of how SIBs perform in a first-best world, where investors are rational and able to obtain hard information about not-for-profits’ performance. To this end, we use a principal-agent multi-tasking framework to compare SIBs to inputs-based (IBs) and performance-based (PBs) contracts, which represent the most commonly used contracts governments and not-for-profits write. IBs contain a piece-rate mechanism, PBs contain a non-binding bonus mechanism, and SIBs contain a mechanism that, due to the presence of an investor, offers full enforceability. Although SIBs can perfectly enforce good behavior, they also require the principal (i.e. government) to relinquish control over the agent’s (i.e. not-for-profit’s) payoff to a self-regarding investor, which prevents the principal and agent from being reciprocal. In spite of these drawbacks, in our experiment SIBs outperformed IBs and PBs. We therefore conclude that, at least in our laboratory test-bed, SIBs can indeed allay underperformance and therefore possibly underfunding of not-for-profits.