Academic journal article Boston College Law Review

Social Enterprise: Who Needs It?

Academic journal article Boston College Law Review

Social Enterprise: Who Needs It?

Article excerpt


Social enterprise lawmaking is a growth industry. Over the past four years, state statutes authorizing new forms of corporate entities have proliferated.1 The new entities come in several flavors-low-profit limited liability companies, "benefit corporations," and others-all with the common element that they purport to authorize the firm's managers to mix profit with some other socially valuable function.

These developments are puzzling. As I argue here, organizational theory suggests that these "hybrid" forms will typically be dominated either by traditional nonprofit forms, or instead by plain old for-profits. The large transaction costs of mixing complex charitable goals with profit imply that only considerable economies of scope, or perhaps a handful of other unusual combinations of circumstances, can justify the combination.

Of course, not all socially beneficial goals are complex. Firms with simple aims, such as paying living wages or avoiding particular toxic inputs, can more easily contract with their stakeholders or commit to their customers. For these firms, the problem is that one or more owners may decide to sell to someone uninterested in the original dogooder bargain. Existing social enterprise statutes only superficially address that problem.

Against this backdrop, Dana Brakman Reiser and Steven Dean have arrived to propose an alternative.2 Rather than a new form of firm, they suggest that, with a few tweaks to standard debt covenants, entrepreneurs can successfully raise money both to earn profits and do some good. Notably, as they acknowledge, their proposal aims only to protect investors and entrepreneurs from opportunistic sales by their counterparty, and does not do much to bind either side during the ordinary course of the firm's dealings. Their proposal does, however, fill exactly the hole social enterprise currently faces.

Their proposal therefore reinforces my general claim that existing social enterprise statutes add little if any social value.3 In the meantime, proponents are busily attempting to secure various forms of subsidy. Unless the existing statutes evolve, lawmakers and regulators should view these calls for subsidy with deep suspicion.

Part I of this Essay sets out background economic theory on the formation of nonprofits, and adds a new tidbit on the distortionary effects of tax rules on the choice of entities.4 Part II expands on the transaction-costs critique of hybrid entities, arguing that the case for using these forms to produce most standard charitable goods is implausible.5 Part III elaborates on the suggestion that social enterprise may overcome some narrow problems in for-profit firms that want to elimi2 nate some "cold glow" aspects of their production process.6 Part IV considers whether the growing legislative popularity of social enterprise casts doubt on my claim that it is mostly superfluous; I argue that it does not, because existing hybrid entities are spawned instead by a race to the bottom.7 Part V returns to the Brakman Reiser and Dean proposal, showing how, despite its limits, the proposal does help social enterprise to overcome the main problem it currently faces.8

I. The Contract-Failure Theory of the Nonprofit Firm

To understand why many existing hybrid entity proposals are deeply flawed, it is helpful first to understand the problem that social enterprise purports to solve. Why would anyone ever want to found a social enterprise, or to invest in one? Profits, of course, are nice. So is saving the world. But what would make someone want to do both in one organization?

Let's begin with a step backward to "pure" or traditional nonprofits. By definition, a nonprofit is a firm that can't distribute net profits to the people who control or invest in it.9 Why, then, would an entrepreneur with an exciting new idea form one? The short answer, first developed by Henry Hansmann and later elaborated by other economists, is transaction costs and asymmetric information. …

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