A Theory of Social Impact Bonds

Social impact bonds (SIBs) are a new financing mechanism for public goods. In a SIB, an investor provides capital to a service provider for a social intervention. The investor receives a return from the government based on the outcome of the intervention relative to a predetermined benchmark. We describe the basic structure of an SIB and provide some descriptive statistics for these financial instruments including data on performance when available. We then consider a formal model of SIBs and examine their ability to finance positive net present value projects that traditional debt finance cannot. We find that SIBs expand the set of implementable projects if governments are pessimistic (relative to the investor) about the probability an intervention would succeed or if, due to political risks, the government is particularly averse to states of the world where social projects provide no financial benefits. As various public programs include both these features, we conclude that SIBs should be considered for projects when traditional debt finance has been rejected.