Categorical cognition and outcome efficiency in impact investing decisions

• Author: Jasjit Singh,Matthew Lee,Arzi Adbi
• Date: 01 January 2020
• DOI: http://doi.org/10.1002/smj.3096
• Published date: 01 January 2020

RESEARCH ARTICLE

Categorical cognition and outcome efficiency in

impact investing decisions

Matthew Lee

1

| Arzi Adbi

2

| Jasjit Singh

2

1

Department of Management and Organizations, NYU Stern School of Business, New York, New York

2

Department of Strategy, INSEAD, Singapore

Correspondence

Matthew Lee, NYU Stern School of

Business, 44 W 4th Street, New York,

NY 10012.

Email: mlee@stern.nyu.edu

Funding information

INSEAD R&D Committee; INSEAD

Randomized Control Trials Lab; Abu Dhabi

Education Council

Abstract

Research Summary:The emerging practice of “impact

investing”optimizes both financial and social outcomes,

and thus promises to support hybrid organizations that

simultaneously pursue financial and social goals. We

argue, however, that impact investing decisions may be

prone to behavioral factors that limit their outcome effi-

ciency. In a portfolio allocation task designed to reflect the

essential features of an impact investing decision, we find

across a range of scenarios that individuals systematically

fail to choose investment portfolios that achieve financial

and social outcomes efficiently and thereby waste opportu-

nities for value creation. We further show in online and in-

person experiments that outcome inefficiency is related to

“categorical cognition”: suppression of categorical labels

on investment options increases efficiency.

Managerial Summary:The “impact investing”approach

promises to encourage greater financial investments in

hybrid organizations that pursue a combination of financial

and social goals. We experimentally demonstrate a chal-

lenge of this approach: People struggle to identify portfo-

lios of investments that simultaneously optimize across

financial and social outcomes. This is partly due to “cate-

gorical cognition”: a natural tendency to view investments

in terms of known categories rather than the actual out-

comes they produce. Our experiments show that removing

the labels “for-profit company,”“charity,”and “social

enterprise”from investment options—thus making it more

Received: 1 September 2018 Revised: 4 August 2019 Accepted: 7 August 2019 Published on: 28 October 2019

DOI: 10.1002/smj.3096

86 © 2019 John Wiley & Sons, Ltd. Strat. Mgmt. J. 2020;41:86–107.wileyonlinelibrary.com/journal/smj

difficult to think about them categorically—increases

outcome-efficient allocations. We therefore show that real-

izing the full potential of impact investing will require that

investors transcend conventional thinking about business

and charity as separate domains.

KEYWORDS

behavioral economics, categorical cognition, hybrid organizations,

impact investing, social enterprise

1|INTRODUCTION

A growing area of strategy research investigates how market-based organizations might not only cre-

ate private financial value, but also advance broader social welfare goals (Barney, 2018; Dorobantu &

Odziemkowska, 2017; Freeman, Wicks, & Parmar, 2004; Luo & Kaul, 2019). Essential to this work

is the concept of “hybrid”organizations that explicitly pursue both financial and social goals simulta-

neously (Battilana, Besharov, & Mitzinneck, 2017; Fosfuri, Giarratana, & Roca, 2016). Hybrid orga-

nizations, such as social enterprises and impact-driven businesses, transcend conventional

organizational forms that maximize only one of either financial gain (i.e., profit-maximizing busi-

nesses) or social welfare (i.e., social welfare-maximizing charities) and may thereby provide innova-

tive, financially efficient organizational vehicles for solving specific social problems (Kaul &

Luo, 2018).

However, hybrid organizations may struggle to attract investment given conventional capital allo-

cation practices that optimize only either financial returns (via traditional investing) or social welfare

benefits (via charitable giving) (Nilsson & Robinson, 2017). A new practice of “impact investing”

specifically seeks to support hybrid organizations by constructing investment portfolios to jointly

optimize financial and social outcomes (Barber, Morse, & Yasuda, 2018; Hong & Kostovetsky,

2012).

1

In principle, the emergence of impact investing should help hybrid organizations, which

share these joint objectives, to attract greater investment, while also providing incentives for main-

stream companies to pursue social welfare goals (Kim, Wan, Wang, & Yang, 2019).

Early research on impact investing has examined issues such as investor willingness to accept

tradeoffs between social and financial goals (Barber et al., 2018) and the antecedents of new impact

investment funds (Arjaliès & Durand, 2019; Yan, Ferraro, & Almandoz, 2019), but to our knowledge

it has not examined impact investors' actual capital allocation decisions. Yet we believe it is impor-

tant to do so, given research in both contexts of traditional investing (Benartzi & Thaler, 2007) and

charitable giving (Small, Loewenstein, & Slovic, 2007) showing that behavioral limitations often

limit decision-makers from achieving their objectives. Anecdotal evidence suggests that impact

1

As defined by the Global Impact Investing Network (GIIN), “impact investments are investments made in companies,

organizations and funds with the intention to generate social and environmental impact alongside a financial return.”The

Global Sustainable Investment Alliance (2016) estimates the total assets invested as “socially responsible investing”(SRI) at

$22.9 trillion globally. Rather than only avoid negative externalities through the exclusion of certain sectors (e.g., tobacco or

fossil fuels), impact investing actively seeks specific social benefits (e.g., those aligned with the Sustainable Development

Goals on poverty alleviation or healthcare). It thus has a particular focus on enterprises that seek not only financial goals but

also measurable social benefits (Brest & Born, 2013; Global Impact Investing Network, 2017).

LEE ET AL.87