Categorical cognition and outcome efficiency in impact investing decisions

Abstract

Research Summary: The emerging practice of "impact investing" optimizes both financial and social outcomes, and thus promises to support hybrid organizations that simultaneously pursue financial and social goals. We argue, however, that impact investing decisions may be prone to behavioral factors that limit their outcome efficiency. In a portfolio allocation task designed to reflect the essential features of an impact investing decision, we find across a range of scenarios that individuals systematically fail to choose investment portfolios that achieve financial and social outcomes efficiently and thereby waste opportunities for value creation. We further show in online and inperson experiments that outcome inefficiency is related to "categorical cognition": suppression of categorical labels on investment options increases efficiency. Managerial Summary: The "impact investing" approach promises to encourage greater financial investments in hybrid organizations that pursue a combination of financial and social goals. We experimentally demonstrate a challenge of this approach: People struggle to identify portfolios of investments that simultaneously optimize across financial and social outcomes. This is partly due to "categorical cognition": a natural tendency to view investments in terms of known categories rather than the actual outcomes they produce. Our experiments show that removing the labels "for-profit company," "charity," and "social enterprise" from investment options-thus making it more

Impact investing in social sector organisations: a systematic review and research agenda

“…This is due to a behavioural factor, namely, categorical cognitionthe tendency of people to make investment decisions based on known categories rather than actual results they generate. Lee et al (2020) further observe that limiting the effect of categorical cognition by removing the labels (e.g., for-profit company, charity and social enterprise) from investment options leads to more outcome-efficient investment allocations (i.e., optimising both financial and social results). This suggests that to realise the full potential of their investments, impact investors need to focus on investment portfolios based on their potential financial and social outcomes rather than purely on the social organisations' structures and/or legal forms.…”

“…More recent research explores cognitive factors that may limit the outcome efficiency of impact investment decisions. In a laboratory and online experiment, Lee et al (2020) find that individuals systematically fail to identify investment portfolios that optimise both financial and social outcomes. This is due to a behavioural factor, namely, categorical cognitionthe tendency of people to make investment decisions based on known categories rather than actual results they generate.…”

“…Although existing research (e.g., Schr€ otgens and Boenigk, 2017) shows that private investors' age has a significant influence on their willingness to participate in impact investing, we know little about the influence of their other personal characteristics (e.g., educational background, and commercial and social experience) on their impact investment behaviour. Furthermore, existing research identifies categorical cognition as a behavioural factor that limits impact investors' ability to make outcome-efficient decisions (Lee et al, 2020). We need more research to identify what other behavioural/cognitive factors could potentially limit outcome-efficient decision making in impact investing, and what strategies could be taken to effectively address them.…”

Corporate Activism and Corporate Identity

“…Scholars attend to how organizations respond to the multiplicity (Greenwood, Diáz, Li and Lorente, 2010), pluralism (Radoynovska, Ocasio and Laasch, 2020), complexity (Greenwood et al, 2011) and contradictions (Roulet, 2014) of institutional environments, often termed as conflicting institutional logics (Purdy and Gray, 2009;Thornton and Ocasio, 2008), with a recent interest in how the members of hybrid organizations such as social enterprises and microfinance organizations navigate through commercial and social welfare logics (Cobb, Wry and Zhao, 2016;Smith and Besharov, 2019). While prior work focuses on how internal stakeholders manage the tensions of hybridity, we join an emerging line of studies to examine how external stakeholders evaluate hybrid organizational identities (Gehman and Grimes, 2017;Lee, Adbi and Singh, 2020;Tracey, Phillips and Jarvis, 2011;Wry, Lounsbury and Jennings, 2014). Specifically, we answer the call to examine diverse forms and different degrees of hybridity (Battilana, Besharov and Mitzinneck, 2017) by focusing on the cross-sector hybrid organizing activities of a non-hybrid organization (Battilana and Lee, 2014).…”

Impact Investing in Digital Business Models

“…Therefore, the digital economy can cope with this due to the level of the investment attractiveness of digital business models [15]. New ideas and their possibilities and advantages offer opportunities for creating sustainable economic systems which will ensure the production of economic and social value that benefits not only investors but also a wide group of stakeholders, including socially excluded people, the poor and those who need help.…”