Incentives for Social Targets at Microfinance Investment Funds

> Posted by Julie Shea
Large scale commercialization of microfinance institutions (MFIs) has led to an increased focus on profitability and with that a growing fear of “mission drift.” In an industry facing increased demands for both social and financial performance, how can investors in microfinance funds ensure that both of these “bottom lines” are appropriately balanced? One way is to create incentive structures that measure and compensate fund managers and the managers of the microfinance institutions (MFIs) in which they invest in accordance with the stated mission of the fund.
Paul DiLeo of Grassroots Capital Management, in his recently published paper, Re-Positioning Microfinance with Impact Investors: Codes of Conduct and “Social First” MFIs, argues that investors should do a better job of articulating their fund’s priorities. Rather than promoting a single, standard model, DiLeo promotes a framework, developed by the Monitor Institute, that more clearly positions funds along a spectrum from “Social First” to “Financial First”. In adopting this framework, investors are encouraged to provide transparency and to attract likeminded investors that support the mission of the MFI.
It is simple to create incentive and compensation structures around traditional financial metrics because they are easily measured and tracked. But how do social-first investors create incentive systems that ensure social goals are prioritized? The Global Impact Investing Network (GIIN)’s Issue Brief: Impact-Based Incentive Structures examines the incentives that three impact investors have created for fund manager compensation. UBS, for example, uses specific criteria to incentivize managers to a) invest in certain countries, b) follow environmental, social, and governance (ESG) protocol, c) strive for high employment growth in portfolio companies, and d) achieve sector-specific metrics.
Similar issues are also addressed in CFI’s publication “Aligning Stakeholder Interests,” which examines the challenges at the microfinance institution level, especially those emerging from an MFI’s decision to transform to a for-profit financial institution. For example, the MFI’s founding members are often reluctant to cede control to new players for fear that the commitment to the social mission will be lost. Using a more comprehensive framework to define the organization within the framework of “Social First” and “Financial First” would undoubtedly clarify expectations and facilitate the transformation process.
In the case of the transformation of FIE, a Bolivian MFI, founding members maintained majority control in order to preserve their original mission to serve low-income clients. The language and framework of “Social First” would have given FIE management tools to prioritize their social mission and thereby reassure their members.
Each of the above studies reveals a small piece of the double bottom-line story, adding up to the conclusion that investors need to create appropriate incentive and compensation structures to ensure that both social and financial priorities are actually being measured and carried out.
Image credit: “Aligning Interests”, CFI & Calmeadow
Have you read?
What Do We Mean by ‘Aligning Interests’?
Governance: The Buck Has to Stop Somewhere
How Much Profit is ‘Responsible’?