Payment for Results: Funding Non-Profit Operations

The non-profit sector (NPO) faces two critical challenges in delivering public goods effectively and raising funds for developmental projects. The first challenge arises due to donors being uncertain about the NPO's efficiency to deliver the expected output (information asymmetry), and the second because the actual benefit provided is subject to uncertain exogenous shocks (outcome uncertainty). To partially address these challenges, the sector has seen the growth of the payment for results (PfR) funding approach, where the donor funds the NPO after the project is implemented and the outcome is observed, compared to the traditional funding (TF) approach where the donor contributes ex-ante. While the PfR approach addresses the donor's challenge, the NPO still faces a significant risk of shortfall in funds. In this paper we model the interaction between the donor and a NPO as a Stackelberg game and characterize the conditions under which TF and PfR emerge as the equilibrium outcomes when there is information asymmetry and outcome uncertainty. The donor moves first and decides the donation amount if the NPO were to opt for TF and the NPO responds by choosing TF or PfR. Counter to initial intuition, we find that the donor does not prefer PfR under all conditions. We find that incentivizing the NPO to choose TF increases the donor's expected utility when the negative impact of uncertainty and the donor's willingness to contribute are high. On the other hand, the donor prefers the NPO to use PfR when the impact of outcome uncertainty is relatively small. Using numerical studies, we find that PfR does not always maximize the expected benefit provided. We find that the gap between the maximum possible expected benefit and expected benefit at equilibrium is significant when outcome uncertainty and donor's willingness to contribute are high.