Abstract
This paper develops a simple theoretical framework for understanding the emergence of new organizational forms, such as socially responsible firms and social enterprises, that embody the private sector’s efforts to resolve problems that typically have been within the purviewof government and traditional public charities. In our model, firms generate financial and social returns to investors with a negative marginal rate of transformation. Differences in the technologies between the for-profit sector and the social sector give rise to comparative advantages and play a key part in the analysis. This allows us to analyze the conditions under which hybrid organizations emerge in place of traditional charities and profitmaximizers. Our framework yields an optimal investment policy, which we call SoFT: the social/financial tradeoff. SoFT typically Pareto-dominates many common social investment principles, such as break-even conditions, social screening or SROI, because it optimally incorporates foregone financial output when considering the cost of producing social output.