• Finance
  • Strategy and Organisation


In recent years, organisations the world-over have been putting their money to work—both for profit and as a force for good. Besides chasing the next big IPO, companies are also seeking innovative ways to make a positive difference through the practice of impact investing. A growing breed of impact investors are infusing capital into projects that have a “measurable” social impact, alongside achieving financial returns. 

The worldwide impact investing market, currently valued at USD1.164 trillion, is rapidly being embraced by more mainstream “do-good” investors, such as fund managers, private foundations, corporates, NGOs and development finance institutions. These players are entering the impact investing ecosystem to unlock the full potential of positive social or environmental causes, without losing sight of the potential financial yield across such projects.

In this context, it is important to understand evidence-based insights from scholars who have been researching the field. Prof Bhagwan Chowdhry, professor of Finance at The Indian School of Business (ISB), along with his co-authors, has explored in-depth the aspect of joint financing by profit-motivated and socially-motivated agents (investors) who have differing missions. According to the researchers, if investors invest in a project that delivers social impact, it may not necessarily yield the expected financial return. Therefore, in such situations, a trade-off is inevitable between the monetary pay-off and the social benefit, causing a conflict of interest between the for-profit owner and the impact investor. 

It has been observed that those who invest philanthropic money are willing to accept lower financial returns as opposed to commercial investors who are unwilling to do so. The researchers believe it’s imperative therefore, to bring the two forces together as the power of philanthropic capital combined with commercial funding holds immense potential to pave the way for more ground-breaking impact investments.

To this end, the researchers developed a model that produces both a monetary payoff and a social benefit, and derived conditions under which there is a trade-off regarding which output to emphasise. The model demonstrates how socially minded investors should be encouraged to seek ownership stakes in socially valuable firms. Further, the study also shows how impact investors’ appropriately designed financial claims can counter-balance project owners’ tendency to focus on profits rather than improving social outcomes. 

The larger objective of the study was to provide a conceptual understanding of how to design securities (social impact guarantees) and create metrics for measuring impact.

Key Features of the Model

The researchers developed a model of joint financing by commercial investors and social impact investors in projects that produced both corporate profits and social good. The model demonstrates that impact investors must hold financial claims in order to incentivise profit-motivated owners to remain committed to social goals. The study found that when a project’s potential social value is substantial, a joint financing model benefits both parties. This not only increases the owner’s expected profit, but also improves the social outcome for impact investors.

The researchers found that when the for-profit owner is unable to commit to social objectives, the impact investor must be provided an appropriately designed financial claim in order to incentivise him to stay committed to the project’s social goals. 

The model allows the impact investor to provide the for-profit owner a subsidy for directing scarce resources and attention to ensure the production of social benefit. Joint financing between the two parties is therefore mutually beneficial as the for-profit owner receives the subsidy, effectively monetising the impact investor’s social preferences, and, in return, the impact investor enjoys increased social output.

The Key Outcomes of the Model

Bringing together the profit-motivated and impact-motivated investors is challenging due to their differing incentives. The question arises as to what type of managers should be tied to impact investing funds. While some believe only those who are socially motivated should run the fund, critics view this as a myopic outlook. Managers who may not champion impact creation, could be incentivised to do so. It is crucial, therefore, to create incentives for managers to enhance the fund’s value. In several cases, managers are offered incentives such as stocks and equity. 

Increasingly, however, impact investors are addressing this challenge by developing unique incentives systems that motivate managers to satisfy the impact imperative and the financial return imperative. According to this study, contingent securities and incentives mechanisms should be carefully designed to satisfy investors and create impact. They should be designed in such a way that commercial investors receive monetary gains and philanthropic investors see real impact happening on the ground.

This paper explores the different conditions under which securities are designed. In some cases, it’s optimal to have a non-profit company, while in other instances, in addition to equity and debt, organisations can also design other securities such as social impact bonds and social impact guarantees that measure impact. The financial returns accruing to commercial investors are based on these outcomes. While the focus of the study is on the design of contingent social contracts in for-profit firms, the intuition in the model is also instructive for understanding the use of such contracts in alternative settings.

The study found that incentive alignment is best achieved when the for-profit owner holds a pay-for social-success contract that provides a larger payment when social goals are achieved. The researchers’ model is consistent with the design of social impact bonds (an example of a pay-for-social-success contract), which are commonly used when profit-motivated investors partner with local governments to fund public sector projects. The model suggests that when investors are generously compensated for achieving social success, it improves the synergy between for-profit investors and socially motivated owners.

The model recommends two types of incentives that will motivate investors to stay committed to social goals:

  • Pay-for-social-success contracts: Incentive alignment is best achieved when the for-profit owner holds a pay-for-social-success contract that provides larger payments when social goals are achieved.

  • Social impact guarantees: For-profit owners in socially valuable firms should issue such securities to impact investors as necessary incentives to deliver on social outcomes. This mechanism will ensure impact investors are compensated with a large financial payment if impact goals are not met, especially when the project’s social value is small.  This incentive is similar to the pay-for-social success feature of social impact bonds.

The researchers found that if financial claims are appropriately designed, it will achieve both social impact and corporate profits. Metrics are needed to measure Environmental, Social and Governance (ESG) but no securities are based on them. Therefore, the metrics need to be made rigorous so that some of the securities’ returns are based on reaching some of those outcomes. This will result in trade-offs between the commercial and social impact of such projects.

Making Incentives Meaningful

The researchers found that with the right design of securities, some impact investments that never got off the ground due to their supposed “unfeasibility”, will now become feasible due to the model’s extended incentive and design structure. This significantly expands the scope of impact investing that will result in more private companies investing in impact projects that were previously undertaken by NGOs and the government. The study also brought to light the limited nature of philanthropic money that makes it impossible to fund an entire impact project through only this source of capital. 

The key takeaway from the study is that philanthropic money should be used judiciously to optimise impact projects. This is possible only when philanthropic capital is combined with commercial money.

As more companies are adopting Environmental, social and governance (ESG) initiatives, there is a dire need for them to optimise returns by managing resources in ways that maximise value for all stakeholders. This is why securities should be designed to encourage profit-motivated investors to invest in projects that deliver social good.

Looking Ahead

The study demonstrates that while there is a trade-off regarding which output to emphasise, social projects have the potential to produce both a monetary payoff and a social benefit. While other scholarship have prescribed pure non-profit status when there is a conflict between profit and social purpose, this study’s model provides an intermediate solution between pure non-profit and pure for-profit status.

As potential investors in the impact investing ecosystem start understanding the trade-off, it will pave the way for designing improved incentives structures that go beyond debt and equity. Further, as the global momentum around impact investing continues to build, there will come a time when CEOs who are not in the impact space will also lead companies that are involved in impact. This is the way of the future.