I.                   Introduction

Non-profit firms are increasingly using business tools associated with the for-profit sector, such as more detailed business planning and analytics, and performance-based human resource systems (Erus and Weisbrod (2002)).  This movement has come as a result of increasingly tight funds and competition from the for-profit world, both of which force non-profit organizations to operate at increased efficiency.  However, the use of such analytical and finance-focused systems is not trivial in non-profit organizations.  There are many instances where operating efficiently may be at odds with the mission of the organization.

The two major considerations are the difference in motivations between non-profit and for-profit employees and the changing nature of non-profit competition.  These two effects may work in the same or opposite directions.  For instance, we might expect that although the use of performance-based contracts is more likely to crowd out intrinsic motivation in a non-profit organization, these contracts allow the organization to compete more effectively with new, more commercial entrants into the industry. 

My research question is whether non-profit microfinance institutions which use incentive contracts are more likely to successfully compete in an increasingly commercialized microfinance industry.  I make predictions about when incentive contracts are more likely to be effective in non-profit organizations and then test the hypotheses of the model using publicly available MIX Market data, which contains financial and social indicators from a large number of MFIs.   My results are largely supportive of the hypothesis that non-profit microfinance organizations are generally less effective at using pay-for-performance contracts, and for-profit competition serves as a moderator of this effect.

II.                Hypothesis Development

Non-profit firms are more likely to target the low-income population and offer lower and flatter salaries.   

Existing literature shows that non-profit employees are more intrinsically motivated, and this is reflected in lower salaries (Ben Ner et al. (2011)) and less incentive-based pay (Grossberg and Sicilain (2012)).  Non-profit status is an endogenous choice used to provide unprofitable services (Oster (1995)), and thus non-profits are more likely to target the low-income population. 

Firms which target the low income population cannot successfully use pay-for-performance contracts which incentivize growth. 

Because for-profit firms which target the low-income population will already be struggling with identity, the use of pay-for-performance contracts will confuse this identity further.  Similarly, non-profit firms which target the low-income population also cannot successfully use pay-for-performance contracts as employees may see them as counter to the mission. 

Non-profits will see more benefit to using pay-for-performance contracts which incentivize growth when they face more for-profit competition.

When there are more for-profits, then it is more socially acceptable to be a for-profit operating in this space.  In addition, if this is correlated with the market expanding, then more for-profit type employees will enter either type of firm and the deleterious effect of pay-for-performance in non-profits will lessen.