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 undue financial burden on small NPOs and could actually be detrimental to social welfare. In this paper, 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 show that the optimal target set by the donor is non-increasing in the probability of a negative outcome shock and non-decreasing in the donor's opportunity cost of funding. Further, our analysis shows that setting a high target can lead to lower actual benefit being delivered under PfR because the NPO curtails funds spent on the project to avoid financial risk. We also show that the donor's expected utility is higher under the traditional funding (TF) approach wherein funding is provided upfront to the NPO when the cost of financing the project using investors' funds is very high and/or when the probability of a negative outcome shock lies within a band. Our model and analysis provide insights to donors and NPOs on how to make optimal decisions under different funding approaches and when PfR is likely to yield higher expected utility.

Keywords: non-profit operations, sequential game, donor funding, payment for results