Understanding the Function of a Social Business Ecosystem

Abstract

Social entrepreneurs face challenging situations in trying to expand and grow businesses with little investment and limited resources. Interactions and networks between social entrepreneurs, investors, and other stakeholders are indispensable in promoting social entrepreneurship. Together, they come to form a cyclical “social business ecosystem” (SBE), in which social entrepreneurs can finance their projects by paying “share transfer fees.” By using a theoretical/mathematical model in our method, this study examines the fundamental role of share transfer fees in an SBE. In particular, it establishes a moral hazard model that can explain important characteristics of an SBE. As main results, the study identifies conditions under which an SBE can mitigate the moral hazard of social entrepreneurs. The results suggest that SBEs work efficiently for relatively small social projects. This is consistent with actual cases of social business. Within this framework, this study also explores the practical implications of knowledge spillover; social entrepreneurs conduct SBEs more efficiently if they take advantage of knowledge spillover.

1. Introduction

The current COVID-19 pandemic has exposed the vulnerabilities and inequalities of societies worldwide. While it has drawn attention to the interconnectedness and interdependence of human societies across the sectors of health, social, and economic development, the pandemic has also highlighted people’s needs and the possibility of cooperation and solidarity to help scale innovations and solutions, especially for the most vulnerable [1]. Therefore, it is more urgent than ever to keep the core commitment to the 2030 global agenda for the United Nations’ “Sustainable Development Goals” (SDGs) and build more sustainable and inclusive societies that must not aim to simply go back to business-as-usual [1].

“Social businesses” play an increasingly important role in solving the social challenges we face today [2], and many social businesses combine a commercial business with a business-related social mission [3]. However, accessing investment is still difficult for social entrepreneurs. Moreover, those who are willing to start business projects often encounter financial difficulties in obtaining initial funding; therefore, the role of informal investors, including family members, friends, and business angels, who invest in new ventures, is crucial for promoting social entrepreneurship [4,5]. Therefore, social businesses can be promoted by networks between entrepreneurs, investors (especially business angels), and other stakeholders [6]. For the sustainable management of social businesses, the viewpoint of “ecosystem” is quite helpful, as they have to utilize their stakeholder networks to access and construct resources, as well as deploy persuasive tactics to build legitimacy and financial sustainability, in cases where there is a lack of capital and resources [7]; we call a network of actors in social business a “social business ecosystem” (SBE).

Notably, one of the disadvantages of SBEs is their potential vulnerability to the moral hazard of entrepreneurs. Many SBEs have weak monitoring functions, i.e., entrepreneurs are not strongly monitored by investors. Therefore, they potentially have an incentive to put high effort levels into their social projects. In other words, the agency problem is still an important issue for the existing ecosystems. To examine it, this paper establishes a theoretical model of the SBEs. Through this model, we identify conditions under which an SBE can mitigate the moral hazards of social entrepreneurs. This study contributes to a new theoretical understanding of how to operate an SBE. Although there are several theoretical models of microfinance (see, for instance, Stiglitz [8] and Besley and Coate [9]), a theoretical model of an SBE in which social entrepreneurs can finance social business projects does not exist. Section 2 reviews the background of social entrepreneurship and social business; it also discusses possible theoretical mechanisms behind the system, focusing on the role of investment in social business. Section 3 provides our theoretical analysis, which naturally explains one of the core mechanisms of an SBE. Section 4 discusses results and practical implications. Finally, Section 5 concludes.

2. Background

2.1. Definition of Social Entrepreneurship and Social Business

The term “entrepreneurship” refers to a type of determined mindset or approach to take on the challenge of creating a new business or organization. On the other hand, “social entrepreneurship” is used to emphasize the importance of solving social problems. Thus, the concept of social entrepreneurship refers to the efforts to create businesses and organizations that aim to solve various social problems, while also securing profits by applying business and management skills. The fundamental characteristic of social entrepreneurship is its capacity to integrate elements from both private businesses and volunteer organizations [10]. Although numerous definitions exist by the nature of this characteristic [11], Peredo and McLean [12] defined it as the approach in which a person (or persons) aims to create a social value and pursue that goal through a combination of recognizing and exploiting opportunities, employing innovation, and tolerating risk by creating a company.

Let us consider the concept of “social business,” which is closely related with social entrepreneurship. Notably, social business originates from a type of financial service—the microcredit service of Grameen Bank, which aims to help the poor by supporting them in the process of becoming financially independent. According to Yunus [13] and Yunus Center et al. [14], social business is a business model that does not strive to maximize profits but rather serves humanity’s most pressing needs. It aims to solve social problems with products and services at affordable prices or by giving poor and marginalized people ownership in a business. Moreover, a social business does not pay dividends to its investors; it only pays back the original investment amount and reinvests all additional profits into the development of activities to solve various social problems or further growth [13,14].

2.2. Moral Hazard in Social Business Ecosystems

As mentioned above, social entrepreneurs interact with angel investors, venture capitalists, and incubators. In the development of social businesses, they often form what one can call a “social business ecosystem” (SBE) or an “entrepreneurial ecosystem,” where they are situated by influencing the heterogeneity of ecosystem participants, garnering attention to the ecosystem, and increasing its attractiveness to stakeholders; see Roundy [15] for a related argument. Notably, social entrepreneurs can benefit from not only conventional investment but also a diversity of other investment types, such as non-profit investment and impact investment [15,16].

Non-profit investment can also be regarded as “donations”, because investors do not expect a financial return but a social return on their investments [17]. Indeed, non-profit investors often invest in social ventures because of their perceived financial sustainability and innovativeness (see Letts et al. [18] and Van Slyke and Newman [19] for related arguments). Under impact investment, which is a relatively new type of investment, investors expect to receive both financial and social returns [15,20]. For instance, in the case of social impact bonds, private investors fund the capital requirements of social interventions and receive market rates of return only if the intervention achieves some predefined social outcome targets [21,22,23] (Social impact bonds involve a multi-stakeholder arrangement between the government, the service provider, and investors, facilitated by an intermediary organization. In a social impact bond, investors face risks similar to equity investment [23]).

Notably, SBEs have a fundamental moral hazard problem between entrepreneurs and external investors. For instance, entrepreneurs may avoid making the effort for action choices that are unobservable. Moreover, they may take excessive risks after receiving external financing and thus reduce the probability of success for their enterprise [24,25,26,27]. With external financing, the risk of business failure and financial loss is passed onto lenders, despite the fact that it depends on the efforts of entrepreneurs, which are not evaluated by lenders [24,25,26,27]. Thus, the involvement of entrepreneurs’ private and family financial assets reduces their inclination to defraud lenders and has a positive impact on the company’s survival through the limitation of financial barriers [28].

In particular, the moral hazard problem can be severe for SBEs in developing countries, because entrepreneurs experience high levels of obligation to support family dependents. Khayesi et al. [29] and Daspit and Long [30] examine the influences of socio-cultural factors such as network structures dominated by family and kin on an entrepreneur’s resource accumulation. They suggest that entrepreneurs minimize the influences of family by incorporating nonfamily members into the SBE, and entrepreneurs can minimize the cost of raising resources by including more nonfamily members. Therefore, the family and non-family composition of network members and the relationship between entrepreneurs and investors are considered crucial for SBEs. This is partly because of the moral hazard problem in ecosystems. Moreover, many SBEs practically try to mitigate moral hazard in their systems.

2.3. Social Business Investment in Social Business Ecosystems

In addition to the moral hazard problem, social entrepreneurs face challenging situations in trying to expand and grow businesses with little investment and limited resources [7,31]. This is mainly because the investor makes no financial gain, and all profits have to be reinvested in the business itself. Thus, investors hesitate to invest, and scaling up is a bottleneck for social businesses. Indeed, Bocken et al. [32] revealed that many fail to make a significant social impact due to the lack of scalability of their business (see also Miller et al. [33]; Newbert and Hill [34]).

In the social business program used by venture capital and investors in Bangladesh, the “Nobin Udykta” (NU) program, individuals and organizations interested in social business investment do not profit from their investment [35]. Notably, the program is an investment system only for sons and daughters of Grameen bank borrowers who aim to create a business and become entrepreneurs. Its primary aim is to shift from loans to equity.

Each entrepreneur in the NU program starts as a managing partner of a business owned by an investor. The investor collects the invested money for a fixed period of time, according to the contract with the entrepreneur. Additionally, the investor takes a fixed amount of 20% of the invested money as a “share transfer fee.” This 20% fee is regarded as a modest compensation for training, consultancy services, problem-solving services, and accounting services to support entrepreneurs in doing social business. Notably, in the NU program, each entrepreneur is asked to pay the same amount of invested money to buy out the share of the investor, while the market value of the successful business is thought to be much higher. Therefore, paying an additional “share transfer fee” is not considered a heavy burden for entrepreneurs. To grow the entrepreneur’s business into a successful one, the investor plays an important and active role, providing many services to the entrepreneur, as previously mentioned.

In order to examine the moral hazard problem in SBE, we focus on the mechanism of share transfer fees, which are at the core of the NU program. We consider how the existence of share transfer fees affects the moral hazard problem in SBEs. Moreover, we assume that entrepreneurs can collect the necessary money to start their business not only from investors in an SBE but also from banks, as the SBE has a limited amount of money for some social business, although there is an accumulated fund that can be used. After the entrepreneur receives a certain amount of the necessary money for the business from the SBE, he/she must finance the rest of the money from outside of it, which is a natural and plausible assumption if SBEs with share transfer fees are applied to general social problems, not only in developing but also in developed countries.

3. Theoretical Analysis

3.1. Basic Model

This section formulates a simple model with a moral hazard, which explains the mechanism of an SBE. Our model utilizes limit liability constraints, which were substantially developed by Stiglitz and Weiss [36], Innes [37], Parks [38], Kim [39], and Cato and Ishihara [40]. We assume that one social entrepreneur tries to finance their project, which is significant for a certain social problem. Our key assumptions are that the entrepreneur’s effort level is unobservable and that there is limited liability; thus, the moral hazard problem occurs; we also assume risk neutrality of social entrepreneurs. From an existing SBE that helps social entrepreneurs, the latter can finance a certain amount of funds for start-up projects; they borrow the rest from banks. The entrepreneur who succeeds in financing the project chooses their effort level. For simplicity, the choice of effort level is assumed to be binary; there are only high and low effort levels.

We assume that the entrepreneur needs a certain amount of funds, say $K$, in order to start up the social project; this amount corresponds to the size of the project. In the SBE, there is an accumulated fund that can be used to help finance social projects. This system has a limited amount of money and offers $G$ units of funds for each social entrepreneur. Since this “help” from the SBE is not sufficient (i.e., $K<G$), he/she must finance the rest of the money, $K - G$, from outside of the SBE; they typically borrow $K - G$ from banks, which compete with each other.

If the entrepreneur chooses a high effort level, the project succeeds with a probability $p_H$ and yields $Y_H$. If it fails, the project will yield no profit. That is, the entrepreneur obtains 0 with a probability $1 - p_H$. Notably, we assume that the high effort level is relatively costly. The cost of effort is denoted by $e > 0$. On the other hand, if the entrepreneur chooses a low effort level, its cost becomes zero. Instead, the probability of success decreases, $p_L(<p_H)$, together with the resulting return, $Y_L<Y_H$. The return is zero with a probability $1 - p_L$.

We make the following assumption:

$$p_H{Y}_H - e > p_L{Y}_L$$

This assumption implies that the high effort generates a greater total expected benefit than that of the low effort, and thus, choosing a high effort level is socially efficient (or beneficial).

3.2. Benchmark Analysis

For a benchmark, we briefly examine the case without the SBE, which corresponds to the situation where $G$ is zero. In this case, the entrepreneur finances all that he/she needs from a bank. For both cases of effort choice, if the project fails, there is no return and, thus, there is no repayment to the bank. On the other hand, if the project succeeds, the entrepreneur repays the bank, which is given $\left(1 + r\right)K$, where $r$ is the interest rate. Banks uniformly face the opportunity to make an investment, which yields a certain expected return, $\rho$. We assume that banks are competitive; that is, they engage in Bertrand competition. In contrast to banks, SBEs do not use the market interest rates. They ask for a share transfer fee from the entrepreneur if the project is successful.

In sum, the profit when the entrepreneur chooses a high effort level is as follows:

$$p_H\left[Y_H - \left(1 + r\right)K\right)] - e.$$

On the other hand, if the entrepreneur chooses a low effort level, the profit becomes

$$p_L\left[Y_L - \left(1 + r\right)K\right].$$

Consequently, the entrepreneur chooses a high effort level if and only if the following holds:

$$p_H\left[Y_H - \left(1 + r\right)K\right)\left] - e \ge p_L\right[Y_L - \left(1 + r\right)K].$$

By rearranging this inequality, we obtain the following:

$$1 + r\le \frac{ p_H{Y}_H - p_L{Y}_L - e}{K \left(p_H - p_L\right)}$$

Therefore, if the interest rate is sufficiently low, the entrepreneur chooses a high effort level. Let $r^0$ be the interest rate that satisfies the relation above with equality. Notably, $r^0$ corresponds to the highest interest rate that can make the entrepreneur choose a high effort level. That is, if $r\le r^0$, the entrepreneur chooses the high effort level; otherwise, he/she chooses the low effort level.

Now, we consider how the interest rate $r$ is determined. If the bank does not lend its money to the entrepreneur and uses it for the outside option, then the return is $\rho > 1$. Since banks are assumed to be competitive, the following holds:

$$\rho = p_H\left(1 + r\right).$$

Notably, $\left(1 + r\right) = \rho /p_H$ is the lowest possible interest rate in a debt contract with a bank. If it is expected that the entrepreneur will not choose a high effort level, then this level of interest rate is unprofitable for banks. Indeed, in this case, the lowest possible interest rate becomes higher, meaning $\left(1 + r\right) = \rho /p_L$. In sum, if this interest rate is lower than the cut-off level $r^0$, moral hazard does not occur. Otherwise, moral hazard due to limited liability occurs.

3.3. SBE without a Spillover

Now, we consider the case in which the entrepreneur obtains partial financing from the SBE. If the project fails, there is no refund to the SBE, and the bank obtains no repayment. Otherwise, the social entrepreneur pays the share transfer fee back to the SBE and makes a repayment to the bank—to be precise, the repayment is equal to $\left(1 + r\right)\left(K - G\right)$. Here, we assume that the share transfer fee is given as ($1/p_H - 1)$. Notably, this level of share transfer fee is the lowest possible value for the sustainability of the SBE, from a long-term perspective. To see this point, consider the profit when the high effort level is chosen:

$$p_H\left[\left(Y_H - \frac{G}{p_H}\right) - \left(1 + r\right)\left(K - G\right)\right] - e.$$

If the project is successful, the SBE receives $G/p_H$ from the entrepreneur; otherwise, the SBE receives nothing. Thus, the expected revenue for the SBE is exactly equal to $G = p_H\left(G/p_H\right)$. If the share transfer fee, say $s$, is smaller than ($1/p_H - 1)$, the expected revenue for the SBE is $p_H\left(1 + s\right)G$, which is smaller than $G.$ Thus, in the long run, the accumulated value in the SBE must approach zero. In other words, the SBE is not sustainable. Note that if the share transfer fee is larger than ($1/p_H - 1)$, it yields a positive profit from helping social entrepreneurs. This implies that the accumulated wealth in the SBE becomes positively infinite in the long run. Since profit is a primary objective of SBEs, the sustainability level is a natural benchmark for considering its function.

When the entrepreneur chooses the low effort level, the profit becomes as follows:

$$p_L\left[\left(Y_L - \frac{G}{p_H}\right) - \left(1 + r\right)\left(K - G\right)\right].$$

Notably, independent of effort levels, the entrepreneur’s profit increases in $G$ if and only if $1/p_H<1 + r$. As shown in the previous section, the interest rate is always larger than $1/p_H$. Thus, the SBE is always beneficial for the profit of the social business.

However, this does not imply that the SBE enhances the incentive to exert high effort. We consider the following incentive condition:

$$p_H\left[\left(Y_H - \frac{G}{p_H}\right) - \left(1 + r\right)\left(K - G\right)\right] - e \ge p_L\left[\left(Y_L - \frac{G}{p_H}\right) - \left(1 + r\right)\left(K - G\right)\right].$$

By rearranging the inequality above, we can obtain the following, which yields the boundary of the interest rate for making the entrepreneur choose the high effort level:

$$1 + r\le \frac{ p_H\left(p_H{Y}_H - p_L{Y}_L\right) - G\left(p_H - p_L\right) - p_{H}e}{\left(K - G\right)p_H \left(p_H - p_L\right)}.$$

Let $r^1$ be the interest rate satisfying this relationship with equality. This is the cut-off interest rate in the presence of the SBC. That is, if the interest rate is lower than $r^1$, the entrepreneur chooses a high effort level; otherwise, moral hazard occurs. Notably, the cut-off is affected by the presence of the SBC. Thus, we can examine the impact of the SBC on moral hazard in social entrepreneurship by comparing $r^1$ with $r^0$. It is easy to show that $r^1 > r^0$ if and only if:

$$p_H{Y}_H - \left(1 - \frac{p_L}{p_H}\right)K - e > p_L{Y}_L.$$

(1)

Note that if $r^1 > r > r^0$, the entrepreneur chooses a high effort level in the presence of an SBE, but he/she does not in its absence. That is, if $r^1 > r^0$ holds, it can be said that an SBE effectively functions, in that it enhances the social business by financing and providing an incentive to choose a high effort level. On the other hand, if $r^1<r^0$ holds, the SBE may reduce the incentive to choose a high effort level. In other words, the SBE worsens the moral hazard through the entrepreneur. Indeed, if $\rho /p_H - 1$, which is the interest rate under competitive banks, it is lower than $r^1$ but higher than $r^0$, meaning that the entrepreneur will make an effort in the absence of an SBE, but he/she will shirk if they receive help from the SBE. This is a possible negative effect of the moral hazard issue under the SBE. Specifically, we say that the SBE can trigger the moral hazard issue if and only if $r^1<r^0$ holds.

Here, we consider the economic implications of Condition (1). The key is the gap between $p_H{Y}_H - e$ and $p_L{Y}_L$. We assume that $p_H{Y}_H - e > p_L{Y}_L$. This corresponds to effort efficiency. That is, the gap represents “the value of effort made by the entrepreneur.” On the other hand, $\left(1 - p_L/p_H\right)K$ is always positive; in a sense, this term can be interpreted as the negative effect of the SBE. If the value of effort made by the entrepreneur is larger than the negative effect, the entrepreneur chooses a high effort level, and thus, the moral hazard problem never occurs. However, if the value of effort of the entrepreneur is not larger than the negative effect, the SBE can worsen the entrepreneur’s incentive to work on social businesses. Notably, the negative effect is positively associated with the project size, $K$.

The following statement summarizes the point argued above.

Proposition 1.

Assume that an SBE sets the lowest possible share transfer fee for its sustainability. Then, the SBE cannot trigger the moral hazard problem when (i) the value of effort by the entrepreneur is small and (ii) the project size,$K$, is large.

Proposition 1 identifies the conditions under which the SBE fails, in the sense that it may enhance the moral hazard problem. The fundamental assumption of this result is that the SBE sets the lowest possible share transfer fee for its sustainability. The SBE may not commit to the lowest possible value, and it may ask for a higher share transfer fee from the entrepreneur. Now, we examine whether this moral hazard problem may be mitigated when the SBE deviates from the lowest possible value. Assume that the share transfer fee is set to $s > 0$. In other words, the entrepreneur returns $sG$ when he/she succeeds in the project. The incentive condition is as follows:

$$p_H\left[\left(Y_H - sG\right) - \left(1 + r\right)\left(K - G\right)\right] - e \ge p_L\left[\left(Y_L - sG\right) - \left(1 + r\right)\left(K - G\right)\right]$$

By solving this condition, we can obtain the interest rate $r^2$ under which this condition holds with equality. It is easy to show that $r^2 > r^0$ if and only if

$$p_H{Y}_H - s\left(p_H - p_L\right)K - e > p_L{Y}_L$$

This shows that if $s$ increases, it becomes more difficult for the condition to be met. Therefore, an increase in $s$ cannot mitigate the moral hazard in the SBE. This has an interesting policy implication for the sustainability of SBEs. If an SBE imposes a higher share transfer fee than the bank’s interest rate, the SBE becomes more sustainable. However, it also implies that the probability of default may become larger than before, as the entrepreneur is more likely to choose a lower effort level. This has a negative impact on sustainability. For the SBE, a low share transfer fee is a natural choice from the viewpoint of its sustainability.

Our results on cut-off interest rates are shown in

Table 1. Cut-off interest rates.

Case	Cut-Off Interest Rate
Benchmark analysis ($G = 0$)	$r^0 = \frac{ p_H{Y}_H - p_L{Y}_L - e}{K \left(p_H - p_L\right)} - 1$
Standard case of SBE without a spillover ($G = 0$ and $s = 1/p_H - 1$)	$r^1 = \frac{ p_H\left(p_H{Y}_H - p_L{Y}_L\right) - G\left(p_H - p_L\right) - p_{H}e}{\left(K - G\right)p_H \left(p_H - p_L\right)} - 1$
General case ($G = 0$ and $s > 0$)	$r^2 = \frac{ \left(p_H{Y}_H - p_L{Y}_L\right) - G\left(p_H - p_L\right)s - e}{\left(K - G\right)\left(p_H - p_L\right)} - 1$

.

3.4. SBE with a Spillover

In addition to the share transfer fee, SBEs may have other possible advantageous aspects. For example, an SBE may directly help projects to make them more successful. This may restrict opportunistic behaviors in business; if there is a certain intervention from an SBE, the entrepreneur is partially monitored by the SBE, and thus, the entrepreneurs can be strongly encouraged (or essentially forced) to choose the high effort level. This SBE mechanism can be called the “commitment effect”. That is, the fundamental problem of inefficiency is that the effort level is not enforceable, because it is unobservable for lenders. Even if entrepreneurs prefer to show their private information on effort levels to make an explicit contract (on effort level), which leads to a more efficient outcome, there is no incentive to reveal the information after making the contract. This moral hazard problem becomes serious, since there is no commitment device to reveal this information. One possible interpretation of the SBE is that it offers such a commitment device for social entrepreneurs. This is one possible advantage of an SBE (The commitment effect or monitoring function is not a unique feature of SBEs. A similar mechanism can be found in a relationship banking or the “main-bank system” (or Keiretsu) in the 70s–80s).

Another possible advantage, which is more important, is a positive spillover from other entrepreneurs. Indeed, many SBEs offer opportunities for learning skills in project management. More precisely, entrepreneurs learn about business operations, how to create a demand for their products and services, minimizing costs, carrying out marketing efforts, and other business basics, step by step, at workshops organized by their social partners [31]. In this subsection, we formulate this positive spillover of the SBE as an increase in the probability of success. If the entrepreneur partly finances from the SBE, the probability of success under the high effort level becomes ${p^{\prime }}_H$, which is higher than $p_H$, that is, ${p^{\prime }}_H > p_H$. We assume that the SBE does not change the probability of success when the low effort level is chosen, which is natural, because the SBE usually does not offer know-how to entrepreneurs shirking their work. However, our result is valid even when we assume that financing from the SBE does change the probability of success at a low effort level.

A notable effect of this spillover or skill learning is a possible change in the interest rate. First, this will have a direct effect on the lowest possible share transfer fee for sustainability. Since the project is successful with a higher probability, the SBE can be sustainable with a lower share transfer fee. Specifically, the SBE can impose $1/{p^{\prime }}_H$ instead of $1/p_H$. Second, as argued above, the interest rate from a competitive borrowing market is determined by $\left(1 + r\right) = \rho /p_H$ if there is no spillover or skill learning. However, if there are some positive effects from the SBE, then the expected probability of the realization of repayment will become ${p^{\prime }}_H( > p_H)$. The interest rate is $\left(1 + r\right) = \rho /p{\prime }_H$, which is lower than that without positive effects. This implies that each positive effect has an additional external effect on the borrowing market; the entrepreneur can make a debt with a lower interest rate. This will have another positive effect on incentive conditions. That is, with a lower interest rate, the entrepreneur has a stronger incentive to make efforts, as shown in the previous subsections. This shows that spillover or skill learning is an important device for making an SBE more effective.

4. Discussion

4.1. Reconsidering a Relationship to Microfinance

As emphasized earlier, the SBE, which is at the core of the NU program, has been developed as a “next-generation” approach to microfinance. Since the 1990s, many theoretical contributions have identified the fundamental mechanisms of microfinance [8,9]. Existing studies have shown that peer monitoring can mitigate inefficiency due to moral hazards and adverse selection between lenders and borrowers. Typically, the limit liability constraint is relaxed if a peer is asked to take responsibility (at least partially) for the project. That is, joint responsibility among peers is the key mechanism in the “first-generation” approach of social business.

On the other hand, the SBE or second-generation approach does not include strong incentives based on peer pressure; peers do not take joint responsibility in an SBE. Instead of joint liability, interactions can be helpful for social entrepreneurs; however, their monetary incentives are not directly linked to responsibility-based schemes. People in SBEs can voluntarily help others, and this help is a source of knowledge and know-how spillover. In a sense, the next-generation approach is more strongly dependent on the altruistic concerns of social entrepreneurs. In our model, there is no explicit peer mechanism. Interestingly, however, our results show that even if there is no strong peer pressure, the SBE can work effectively, in the sense that share transfer fees, which are lower than the market interest rate, can mitigate the moral hazard (as long as the size of the project is not large).

Notably, it is reasonable to mention weak and strong ties, drawing from the literature on social relationships, to understand the relationship between microfinance and SBEs. Strong ties are based on close relationships; members with strong ties have frequent interactions and can monitor each other. On the other hand, weak ties hold without such close relationships. Granovetter [41] emphasizes that weak ties can be very powerful for obtaining jobs, for various reasons. One of them is that people in strong ties share their information, meaning it is not easy to obtain new information from the members, while meeting a person with weak ties can yield new information, which is valuable. Indeed, in a sense, microfinance is a system based on strong ties. It is very efficient for monitoring people; however, it tends not to yield productive ideas for social projects. In other words, a system based on strong ties has weaker spillover effects. By contrast, the SBE or NU system is based on weak ties, which can yield various pieces of new information. In other words, it can be expected that an SBE can yield strong spillover effects.

4.2. Project Size

Our results suggest that the SBE works efficiently for relatively small social projects, which is consistent with the actual situation and previous research on social entrepreneurship, including social business. For instance, Sunley and Pinch [7] stated that while most social entrepreneurs do not need large capital because it can also become a burden for repayment, many of them prefer slow growth and grow at the same rate as conventional businesses. Moreover, Phillips [42] insisted that social entrepreneurs have cautious attitudes toward growth and expansion, since they tend to fear losing their control and social ethos.

Regarding social businesses, Ahmed et al. [31] introduced 28 successful micro-type social business entrepreneurs, after conducting a four-year ethnographic study in Bangladesh. Although the types of businesses varied, including dairy farms, cloth tailoring, electrical servicing, cow fatting, handbag production, jewelry business, shoe business, and handicrafts, around 80% of the businesses had no more than five employees, and the maximum number of employees was 25 in handcrafting social business. Therefore, the tendency in social businesses is to avoid starting a large-scale project at the very beginning, and many entrepreneurs approach investors, including informal investors, for seed money after exhausting their finances. In the 28 cases in Ahmed et al. [31], the average amounts of capital from entrepreneurs and investors were 2310.9 USD (min: 290 USD, max: 7062 USD, median: 1838 USD) and 3229.5 USD (min: 625 USD, max: 10,000 USD, median: 2500 USD), respectively. The average ratio of the amount of capital from an investor to the total amount was 59.2%.

Growth is the fundamental goal for any business, and social businesses make no exception. Although social entrepreneurs have to pay back investment money as share transfer fees in SBEs, once they do so, the business will become a profit-making venture. Therefore, after such a venture achieves growth, they may hire more human resources and increase their product quality, assortment, revenue, and profit to a certain extent.

4.3. Effective Utilization of Limited Resources System

As mentioned in Section 2.2, social entrepreneurs often face very challenging situations, trying to expand and grow businesses with little investment and limited resources. Notably, Di Domenico et al. [43] insisted that social entrepreneurs must grow with limited resources in areas where private markets function poorly and then proposed the concept of “social bricolage” as their distinctive feature. Notably, the concept is based on the notion of “bricolage,” which was adopted as a metaphor by anthropologist Levi Strauss to encapsulate processes of cultural hybridization [44].

According to Di Domenico et al. [43], an important factor of social bricolage is the refusal to be constrained by resource limitations; in the process of social bricolage, the lack of resources pushes social entrepreneurs to use all available means to acquire unused or underused resources that could be leveraged differently to create social value. However, Sunley and Pinch [7] mentioned that this characteristic of social entrepreneurs is sometimes problematic and may restrict the growth and expansion of businesses and projects. Given that the desire to survive the lack of financial and other resources is deeply ingrained in social entrepreneurs, it is necessary to develop other types of strategies and resourcing, supported by intermediaries who can provide knowledge about appropriate funding and business know-how [7].

The SBE discussed in this paper can play the above-mentioned intermediary role by providing not only a certain amount of money, G, but also an opportunity for social entrepreneurs in the system to learn project management skills. Moreover, the existence of such an SBE expands the network of social entrepreneurs. In many actual situations without an SBE, few social entrepreneurs had any help from (social) business angels capable of offering financing and knowledge on matters such as conventional entrepreneurship.

The SBE may be a system of “social bricolage” that makes up for the shortcomings of individuals’ social bricolage. Although investments in SBEs cannot expect a financial return, they can yield strong investment spillover effects. Therefore, social entrepreneurs participating in SBEs can find it easier to start their businesses or projects. In this way, the existence of the SBE as a system helps the growth and expansion of social businesses in local society.

5. Concluding Remarks

5.1. Possible Extensions

In this study, we clarified the advantages of SBEs by extending a simple model of moral hazard. We show the possibility that an SBE with share transfer fees, which is employed in the NU program, can partially suppress the difficulty of moral hazard. Indeed, social entrepreneurs are encouraged to put more effort into the SBE if the sizes of their social projects are not large.

However, there are still some issues. In this study, we focused only on the two key mechanisms of SBEs: (i) their non-profit-maximizing nature and (ii) spillover effects. That is, in our model, the SBE as a lender does not impose an interest rate that maximizes its profit. Instead of interest rate, a share transfer fee is given to make the system sustainable. In this respect, the SBE is based on a non-egotistical concern. Moreover, the spillover effects, which complement the working of the SBE, are dependent on other-regarding concerns, such as altruism or intrinsic social motivations; see Cato [45] for other related concerns in a model of multi-agent moral hazard. These are two important features that make the SBE distinguishable from the typical business (On the other hand, in our model, the social entrepreneurs are assumed to be profit-maximizers when they choose their effort levels. In this sense, this model shows that even if social entrepreneurs have self-interests, the SBE can be socially beneficial, in that it improves efficiency. In sum, our model naturally includes various altruistic and selfish motivations). However, there can be various other mechanisms of a non-egotistical nature in social business systems. The examination of such mechanisms is important to understanding the nature of social businesses.

Another issue is the extension of the model with adverse selection. Notably, we focused on the moral hazard problem as a source of inefficiency. However, it is also important to consider adverse selection, since there are various types of social entrepreneurs, and the “type” information is typically unobservable on the side of the SBEs. Therefore, it is natural to introduce some selection/screening mechanisms in these systems. Since there are no peers considered in the model in a strict sense, it is essential for the SBE to establish such screening systems. Indeed, in the case of the NU program, there is a reasonable screening system. That is, if a person’s parent has a relationship with the Grameen bank, he/she can access the NU program, which can serve as a very strong screening system. However, since it can be quite restrictive, it may be reasonable to explore other possible types of screening (especially for SBEs that cannot use the NU program approach). Examining such a direction remains a topic for future research.

5.2. Limitations

There are two limitations of this study. First, although this study clarifies the significance of knowledge spillover, it does not show how knowledge spillover occurs in SBE. Indeed, it is important to examine how the know-how or human capital of some entrepreneurs is transmitted to new entrepreneurs in SBE. To examine this, it will be necessary to include the earlier stage for learning knowledge in our model, although this will make the model more complex. Second, this paper focuses on a theoretical mechanism, mainly based on anecdotes and cases. To establish our results, we assume that individuals/entrepreneurs are rational. However, in reality, individuals are not always rational. This is a limitation of this study, because the relevance of the rationality assumption is dependent on social environments or contexts. One possible resolution for strengthening our study is to conduct experiments and examine how individuals behave in SBE environments.