The Organization of Social Enterprises: Transacting Versus Giving

Abstract: Traditional models of organizational choice focus on the distinction between the for-profit and non-profit forms. These models ignore a critical distinction between organizations that transfer subsidies on behalf of donors to beneficiaries, and social enterprises, such as microfinance institutions and fair trade firms, that commit to transacting with different classes of disadvantaged groups. I present a model where entrepreneurs receive subsidies and have a choice between (1) giving to the beneficiaries, and (2) forming a social enterprise that transacts with them, as well as choose to incorporate as a for-profit or a non-profit. I show that social enterprises have financial and reputational incentives to measure their beneficiaries' abilities and tailor subsidies to their particular needs. Their effectiveness in utilizing subsidies explains why such enterprises have been particularly effective in addressing social missions, such as increasing access to capital or improving employment opportunities. Entrepreneurs choose to form social enterprises when the variance in beneficiaries' abilities is higher, and therefore the benefits of measurement are greater. Moreover, when the variance in abilities is very high, entrepreneurs will choose to form a for-profit social enterprise, because when the incentives to measure are sufficiently strong, the non-profit form as a commitment device to use subsidies effectively is redundant. The analysis further considers the effects of different tax policies and reform proposals for regulating social enterprises.