Use of social impact bonds to address social problems: Understanding contractual risks and transaction costs

• Author: Sanjay K. Pandey,William F. Winfrey,Joseph J. Cordes,Sheela Pandey
• Published date: 01 June 2018
• Date: 01 June 2018
• DOI: http://doi.org/10.1002/nml.21307

CASE STUDY

Use of social impact bonds to address social

problems: Understanding contractual risks and

transaction costs

Sheela Pandey

1

| Joseph J. Cordes

2

| Sanjay K. Pandey

2

| William F. Winfrey

3

1

School of Business Administration, Pennsylvania

State University Harrisburg, Middletown,

Pennsylvania

2

Trachtenberg School of Public Policy and Public

Administration, The George Washington

University, Washington, District of Columbia

3

Centers for Medicare and Medicaid Intervention,

Baltimore, Maryland

Correspondence

Sheela Pandey, School of Business

Administration, Pennsylvania State University

Harrisburg, 777 West Harrisburg Pike,

Middletown, PA 17057.

Email: spandeywrk@gmail.com

Social impact bonds, a recent innovation in social

finance, are designed to harness capital and knowledge

from private nonprofit, for-profit, and public entities to

address pressing social problems. Although there is great

policy interest in understanding how social impact bonds

can be used to tackle social problems, the emergent

nature of social impact bonds makes it hard to find rele-

vant data and evidence. To overcome this challenge, we

use single-significant-case sampling as our research

design strategy. We conduct an in-depth case study of the

Social Innovation Financing Youth Recidivism Project in

Massachusetts. Our case study is comprised of a qualita-

tive analysis of the multiparty contract and multiyear

quantitative benefit–cost analysis to understand transac-

tion costs. We draw upon contract theory to develop an

analytical framework for the case analysis and highlight

the risks and safeguards for the various parties to the con-

tract, and conduct a formal benefit–cost analysis to map

out transaction costs. We conclude with a discussion of

study implications and future research.

KEYWORDS

benefit–cost analysis, contractual hazards, contractual

safeguards, pay-for-success, social impact bond,

transaction costs

1|INTRODUCTION

Social impact bonds are a recent innovation in social finance that “…integrate philanthropy, venture

capitalism, performance management, and social program finance into an innovative new mix”

Received: 28 June 2017 Revised: 28 January 2018 Accepted: 31 January 2018

DOI: 10.1002/nml.21307

Nonprofit Management and Leadership. 2018;28:511–528.wileyonlinelibrary.com/journal/nml © 2018 Wiley Periodicals, Inc. 511

(Warner, 2013, p. 304). Multiple parties are involved in social impact bond schemes; the parties typ-

ically include nonprofit service providers (Chen & Graddy, 2010), government agencies, private

investors, private and nonprofit foundations, and evaluators. The social impact bond contract out-

lines specifics about the roles, responsibilities, and incentives for each party. But can social impact

bonds, in essence a multiparty contract, produce relevant behaviors and performance from all parties

to the contract? Thus, the research question motivating this paper is twofold—how can social impact

bonds, as multiparty contracts, balance multiparty interests and also achieve social goals; and how

does the need to balance multiparty interests affect the transactions costs, and hence, the real cost of

social interventions?

Given the emergent nature of social impact bonds and the goals of our study, we use single-sig-

nificant-case sampling as our research design strategy (Patton, 2015) and conduct an in-depth case

study that employs: (a) qualitative analysis of the multiparty contract and (b) quantitative benefit–

cost analysis to map out transaction costs. We draw upon contract theory to make assessments about

risks posed by conflicting interests of different parties to the contract. We then discuss some of the

contractual remedies that may be required to address such risks, and present estimates of the transac-

tions costs of implementing these remedies.

In a typical social impact bond (or pay-for-success) arrangement, a public entity enters into a

contract with private sector parties to provide a social intervention (e.g., a program to provide job

training to youthful offenders). The public entity makes payments to the private parties—which

include both for-profit and nonprofit organizations—only if the intervention provides sufficient,

documented cost savings to the public entity (e.g., reduced public costs associated with re-offend-

ing). Our review of the extant literature—academic studies, government and private reports, and

business press—suggests a need for systematic exposition of the benefits, costs, risks, and safe-

guards for various parties to a social impact bond contract. We, therefore, use perspectives from

contract theory and the inherent “...analytical power of the notion of contract”(Brousseau & Gla-

chant, 2002, p. 5) to conduct our case analysis.

Our paper has three key sections. In the first section, we present an analytical framework

grounded in contract theory that is applicable to the social impact bond multiparty context in which

agents from the nonprofit sector, public sector, for-profit sector, and other third parties are involved.

In the second section, we use the analytical framework (identified in the first section) to analyze

case details about The Massachusetts Juvenile Justice Pay for Success Initiative, which is also

known as the Social Innovation Financing Youth Recidivism Project (the “SIF Project”). This SIF

Project—launched in 2014—aims to “…reduce recidivism and improve employment outcomes for

young men at high risk of re-offending in the Boston, Chelsea, and Springfield, Massachusetts

areas”(Third Sector Capital Partners, 2014). The purpose of the case analysis is to systematically

analyze the contract underlying this social impact bond and to highlight the risks and safeguards for

the various parties to the contract. In the third section, we present a formal social benefit–cost analy-

sis based on cost and benefit data that are presented in the SIF contract that illustrate a range of pos-

sible outcomes for the initiative in the aggregate, as well as for its various stakeholders. We

conclude with a discussion of study implications and future research.

2|THEORETICAL FRAMEWORK FOR CASE ANALYSIS OF SOCIAL

IMPACT BOND CONTRACTS

We use a single, significant “high-impact case,”which Patton (2015) defines as “…cases studied and

documented in depth because of the impacts illuminated and the significance of the case to a field,

512 PANDEY ET AL.