Meeting the challenge of impact investing: how can contracting practices secure social impact without sacrificing performance?

Abstract

Impact investors seek financial return and positive economic, social or environmental impact. While certain segments of the impact investing industry see strong returns and high positive impact as conflicting objectives, others argue that strong performance across both objectives can be simultaneously achieved. Despite the importance of this question to the industry, no widely accepted framework exists that enables impact investors to determine whether and how they will be able to invest without a trade-off. This article draws on contract theory and the analysis of incentives in multitask principal–agent relationships in an attempt to fill the void. For impact investors, this article pioneers a theoretical framework for the discussion of strategy, offering a first set of hypotheses that can be elaborated through further theoretical work and tested against actual experience. Within contract theory, this article fits most closely alongside the applied multitask literature concerned with an agent assigned to a financial and an environmental task (Sinclair-Desgagné, B., and H. L. Gabel. 1997. “Environmental Auditing in Management Systems and Public Policy.” Journal of Environmental Economics and Management 33 (3): 331–346; Lothe, S., I. Myrtveit, and T. Trapani. 1999. “Compensation Systems for Improving Environmental Performance.” Business Strategy and the Environment 8 (6): 313–321; Lothe, S., and I. Myrtveit. 2003. “Compensation Systems for Green Strategy Implementation: Parametric and Non-Parametric Approaches.” Business Strategy and the Environment 12 (3): 191–203), while the theory referenced within bridges models from Holmstrom and Milgrom (1991. “Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design.” Journal of Law, Economics, & Organization 7: 24–52), Feltham and Xie (1994. “Performance Measure Congruity and Diversity in Multitask Principal/Agent Relations.” The Accounting Review 69 (3): 429–453) and Budde (2007. “Performance Measure Congruity and the Balanced Scorecard.” Journal of Accounting Research 45 (3): 515–539).