Social Impact Bonds (SIBs): the Implications for Investors

The Obama administration recently introduced a new type of financing; it’s called “Pay for Success” and it’s a game changer for the historical rival between the public and private sector. “Pay for Success” financing consists of the use of a mechanism called Social Impact Bonds or SIBs, for short. An SIB is an agreement between investors, service providers, and the government to undertake a project in order to tackle a social issue. Under the terms of an SIB, investors provide the capital in order for the service providers to deliver a social change. If the outcome of such a social change is delivered, then the government releases a previously agreed on amount of money to repay the investors for taking the initial risk (Costa, 2014). Investors should pursue SIBs because they promote more technocracy in governance by providing the opportunity to foster greater collaboration between the private and public sector.

Why Should SIBs Matter to Investors

The relationship between investors and SIBs needs analysis because the information regarding how SIBs will change governance is minor to non-existent. SIBs have their limitations. If the service provider in an SIB agreement fails to deliver the desired social outcome then the investors do not get paid. In addition, investors receive a smaller payout from an SIB it issues because they typically have a lower interest rate. Nevertheless, the number of SIBs has been growing since 2012 (Costa, 2014). There are currently twenty-four SIBs across the world (Finance for Good, 2014). This paper seeks to present why the private sector should invest in SIBs. There are three reasons why investors should pursue SIBs:first, recent consumer behavior is increasing corporate social responsibility; second, investors have the power to take on a larger role in society; and third, the growth of SIBs demonstrates a shift in governance towards technocracy.

The Increase of Corporate Social Responsibility

The technological advances of the twenty-first century have generated an abundance of knowledge that the public was not previously privy to. For example, in 2007 the company GoodGuide was founded. GoodGuide provides an online platform in order to educate consumers on the health, environmental, and social performance of the products they purchase. This increase of public knowledge is related to the increase of organic, natural, and non-toxic product purchasing (Herman, 2010). For example, in 2014 the Organic Trade Association reported that the sales of organic food and non-food organic products in the United States totaled approximately thirty-nine billion dollars. This amount is up eleven percent, breaking the target set from the previous year (OTA, 2015). The public has also become more informed about products which negatively impact the public (Herman, 2010). For instance, in 2015, Fashion Revolution filmed an experiment on ethical purchasing in Germany. In this experiment, a vending machine, promising a tee-shirt for two euros, was placed in the center of Berlin. Once people selected their size for a tee-shirt the machine played a video depicting the reality of low wages and horrible working conditions that contribute to manufacturing a low-priced garment. Costumers were then asked if they wanted to donate their two euros or purchase the tee-shirt. The purpose of the Fashion Revolution’s experiment was to show that people act ethically when they know the truth (Kim, 2015). This increasing consumer demand for good is changing the market and giving companies an incentive to hold themselves accountable. Recent studies have provided that two in three individual investors agree that “a commitment to do good is positively related to how they choose to invest. This trend is likely to continue and thus, leaves investors with the choice to either meet the demands of the market by increasing their corporate social responsibility (CSR), or to fall into insignificance.

Investors Have the Power

Traditionally, the role of government is to meet the needs of people. This task has become increasingly difficult because the number of resources are decreasing while the number of humans with unmet needs is increasing (Herman, 2010). The greater demand and the dwindling supply have set the price high for governments to respond. In the United States, many government programs are created only after a social problem occurs. For example, in 2014 the Obama Administration created a task force to protect university students from sexual assault; but only after a report found that forty percent of universities had not conducted a related investigation within the past five years (Kingkade, 2015). In comparison to governments, preventive interventions are preferable among non-profit organizations. However, these organizations typically lack the necessary resources to launch national preventive interventions (McKinsey&Company, 2012). Investors are not limited by political hurdles like government is nor are they limited by a lack of funding like many non-profit organizations are. In this capacity, investors have the power to prevent a social issue, such as campus assault, and thus, contribute to the humanity of a society.

A Shift in Governance

Technocracy is a system of governance by which decisions are made on the basis of technical knowledge. In comparison to the public sector, investors pursue a technical knowledge on how to make a return in profits. This is precisely why governments are turning to the private sector with social problems. The private sector has the motivation to invest only in issues that will deliver a financial return. Such an agreement creates a win-win situation because public officials can applaud the social changes they made without taking the risk of wasting or misusing tax revenues. Nevertheless, the incentive for investors to fund SIBs is not entirely monetary (Moser, 2012). Since investors are not politicians but technocrats, they have the freedom to invest in social causes they care about without having their efforts hindered by bureaucratic red tape or party partial politics (BBC, 2013). This implies that the private sector will continue to contribute to solving societal issues. Thus, governance is shifting into an era in which investors have the knowledge. This technical knowledge enables investors to dictate which societal issues government can try to prevent or solve.

SIBs are good news for investors. They present the opportunity for investors to become more knowledgeable about human needs. Such knowledge enables the private sector to use their power to wear two hats; the first being profit and the second being social responsibility. This dual role that SIBs push investors to take has the momentum to change the way government works in the long term. As investors continue to gain more power in solving society’s issues it would appear that the private sector is no longer the foe of the public sector but a friend.

About the Author

Bonnie Bethea is currently a Master in Public Policy (MPP) Candidate at the Willy Brandt School of Public Policy at the University of Erfurt. Bethea’s research,writing, and academic interests include Eastern European politics, regulatory affairs, and Transatlantism.

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* Image: ‘SGS_530_HS223‘ by Salzburg Global Seminar via Flickr, released under Creative Commons 2.0 license.