New development: The application of incomplete contract theory to documenting Social Impact Bonds

ABSTRACT

Nobel laureate Oliver Hart’s work in developing a theory of incomplete contracting is relevant to explaining the evolution of the pay for success contracts that undergird Social Impact Bonds (SIBs). By its very nature, a pay for success contract that supports a SIB is likely to be functionally incomplete in that it is unable to describe and differentiate in the initial contract all relevant future states of the world in which the contract is to operate. Navigating this incomplete world can be particularly challenging when it comes to government contracting for quality outcomes in social services. Accordingly, Hart’s incomplete contracting framework can help us to think more clearly about how to document a pay for success contract that best supports a SIB transaction.

IMPACT

Deterministic pay for success contracts serve neither the impact goals nor the contracting parties of SIBs well. This article explains how flexibility has been built into many of the contracts that support SIBs in the USA and beyond through the use of contractual governance mechanisms. There is room, however, for improvement in these governance mechanisms –particularly their scope, composition and processes.

KEYWORDS:

• Contractual governance mechanisms
• pay for success contracts
• Social Impact Bonds (SIBs)

Disclosure statement

No potential conflict of interest was reported by the author(s).