Social Finance: What’s New for Business?
By Dr. Halil Kiymaz, Bank of America Professor of Finance
In 1964, Bob Dylan released an album entitled The Times They Are A-Changin’. A few lyrics of this song state:
Your old road is rapidly agin’
Please get out of the new one if you can’t lend your hand
For the times they are a-changin.’
These prophetic words were a harbinger of what business has experienced over the past half-century. In 1970, economist and Nobel laureate Milton Friedman argued that a company’s sole obligation to society is to make money and increase shareholder returns without breaking the rules. The main driver of a traditional business/finance was to achieve financial value—this view, known as the Friedman doctrine, dominated business for decades. Consequently, conventional investments in the form of debt or equity were set up to deliver a financial return. However, many contemporary businesses view maximizing shareholder value as too limited and contend that shareholder interests extend beyond money (Merrick, 2021). To them, the business of business is no longer just business.
The global financial crisis (GFC) in 2007 led to re-evaluating how people conduct business in many parts of the world and provided new perspectives. Many people in countries worldwide have started developing approaches to direct finance or investment toward more inclusive and sustainable business. A distinctive feature of such approaches is that they emphasize an investment’s social and environmental consequences more than traditional investments. They try to achieve a positive social impact on society, the environment, or sustainable development. Some even have an explicit social motivation alongside or on top of the financial motive. This type of financing is commonly called social finance (Future Learn, 2023). This hybrid form of business seeks to achieve the delicate balance of doing well financially by doing social good. In the aftermath of the GFC, new social investment initiatives and funds have emerged worldwide to achieve a positive social impact.
Social finance is a relatively new development in international banking and finance. It represents a paradigm shift in the financial landscape, where economic prosperity converges with social impact. Consequently, various definitions of social finance abound due to a lack of clarity around its scope and intent. Nonetheless, defining the term is essential. Weber (2012, p. 3) views social finance as “the umbrella term for financial products and services that strive to achieve a positive social, environmental or sustainability impact alongside financial returns.”
Social finance integrates financial tools and principles to generate positive social and environmental outcomes alongside financial returns. Unlike traditional finance, which primarily focuses on maximizing profits, social finance prioritizes a broader spectrum of values, including sustainability, equity, and community development. It encompasses various financial instruments, such as impact investing, social bonds, community development finance, and microfinance, each tailored to address specific social or environmental challenges. Dadush (2015, p. 140) views “social finance as a hybrid in that both social and commercial imperatives drive it. Impact investors and social businesses want to generate financial returns alongside a positive social impact.” It uses commercial-style investment tools, instruments, and strategies to seek blended (i.e., economic, social, and environmental) returns. As Weber (2012, p. 3) notes, “… it contradicts the conventional notion that positive societal impacts of finance are contradictory to financial returns.” Tapper (2014, p. 1) concludes, “Social finance is about reframing how markets identify opportunity and risk and recognize value. It’s about redefining efficient markets and reimagining good business.”
Social finance operates on a set of principles that align with the goals of sustainable development and societal well-being. These include using impact measurements that generate tangible social or environmental benefits such as social return on investment (SROI). Additionally, investments must generate adequate financial returns to ensure long-term viability. Social finance should promote inclusivity by providing access to capital and financial services for underserved populations, such as women entrepreneurs, minority-owned businesses, and rural communities. Finally, social finance brings together diverse stakeholders, including investors, nonprofits, and governments; by leveraging collective expertise and resources, collaborative partnerships amplify the impact of social finance initiatives and drive universal change.
Another way to view social finance is along a continuum between philanthropy and traditional business, as shown in Figure 1. Although some use the terms charity and philanthropy interchangeably, noticeable differences exist. Charity is impulsive, emotional, and often temporary in solving the issue. By contrast, philanthropy focuses on the root cause of social problems and requires a more strategic, long-term approach (Manzano, 2017; Jope, 2023). The “umbrella term” social finance occupies a middle ground between philanthropy, which seeks a social return, and traditional business, which seeks a financial return. It includes various forms of responsibility and impact intervention. That is, social finance can be viewed as an advanced or modern form of what used to be called socially responsible investment. It uses various tools and mechanisms to harness the private sector as a force of good by seeking blended value returns.
Source: Adapted from Weber (2012).
Social enterprises innovate to solve problems, not just for a profit motive. Social finance is lending or investment into such social enterprises. Like the businesses in which they invest, investors in these enterprises may also have a social or environmental mission and objectives. As Savell (2018, p. 5) explains, “Social finance exists to find fresh ways to improve the lives of vulnerable people and communities.”
The social finance industry has experienced accelerated growth and institutional interest. Despite its relative newness, social finance is “fast becoming a mainstream source of funding for goods and services that target poor people across the globe” (Dadush, 2015, p. 139). Not surprisingly, social finance has attracted much attention because of its increasing prominence in the alternative investor ecosystem. However, both proponents and critics have received this attention.
Proponents of social finance see it as a vehicle for transforming the role of business in society and harnessing market forces to meet social challenges better. Critics see it as symptomatic of a problematic over-reliance on markets to tackle every type of problem, even social issues that may be better addressed without expectations of return. The concern is that by injecting the social provisioning system with an ROI mentality, we risk deepening, rather than reducing, the vulnerability of the world’s poor (Dadush, 2015, p. 227).
Another example of the changing views involving a company’s obligation to society occurred in 2019 when the Business Roundtable, a group representing chief executive officers of prominent corporations, declared that it had changed its mind about the “purpose of a corporation.” That purpose is no longer to maximize profits for shareholders but to benefit other “stakeholders,” including employees, customers, and citizens (Posner, 2019).
Social finance is new but is here to stay. Stay tuned for a new book by my co-editors, Kent Baker, University Professor of Finance at American University, and Greg Filbeck, Samuel P. Black III Professor of Finance and Risk Management at Penn State Behrend. The title of our book is Social Finance: Mobilizing Markets for Good. It aims to provide an engaging and comprehensive analysis of this developing and essential topic. It views social finance through a wide lens with various iterations.
