Payment for Results: Funding Non‐Profit Operations

Abstract

Payment for results (PfR) funding approach, where donors reimburse the non‐profit organization (NPO) based on outcomes, is being increasingly adopted in the non‐profit sector. However, there is also concern expressed by many voluntary organizations that such a funding approach puts an undue financial burden on small NPOs and could actually be detrimental to social welfare. In this study, we build a theoretical framework to analyze PfR funding mechanisms. We use a sequential game to model the interaction between the donor and the NPO, with the donor as the first mover. This model captures how PfR funding is typically implemented in practice using social impact bonds (SIB), wherein social investors provide the upfront funding needed by the NPO to implement the project. The donor provides funding, based on the actual benefit delivered, at the end of the project and the investors are paid back using these funds. We find that higher targets set by the donor do not necessarily translate to higher expected utility or expected benefit delivered under PfR. When comparing the performance of PfR and traditional funding (TF) mechanisms, we find that the donor typically has a higher expected utility under the PfR mechanism when the probability of a negative outcome shock is either high or low, and is better off using the TF approach otherwise. When the donor’s opportunity cost of funding the project is high, the donor is better off using a PfR mechanism when her belief about the NPO having low efficiency is sufficiently high. Interestingly, we find that for a large range of parameter values there is a mismatch between the approach that gives a higher expected utility to the donor and the approach that maximizes the expected social benefit delivered. Our model and analysis suggest that the optimal funding approach, and the optimal target set under PfR, depend on the NPO’s financing cost from social investors and project outcome uncertainty.