Free-riding

People, especially economists, often mention the danger of free-riding when I talk about Social Policy Bonds. Free-riders would by the bonds hoping to benefit from any increase in the bond price without actually participating in any objective-achieving projects.

However, I think markets would work to limit the benefits from free-riding. To see this, assume that most of a particular issue of bonds were held by would-be free-riders. Then very little, if anything, would be done to help achieve the targeted objective. As the objective became more remote, the value of all the bonds would fall. And as the bonds lost value, they would make a more attractive purchase for people who were prepared actively to help achieve the targeted objective. So free-riders would be tempted to sell, even at a loss, rather than see the value of their bonds continue to fall. Some history of falling bond prices would tend to make free riding on Social Policy Bonds less appealing with future issues. Free-riding then would become a self-cancelling activity. There are other reasons why bondholding would be unattractive to potential free-riders:

Individual free-riders would have no incentive to collude with other free-riders, because the more they did so, the more remote the targeted objective would become, and the further would the value of their bonds fall. This would act so as to limit any free-riding activity to small players.

As with other financial instruments, small players would have to pay higher transaction costs than the bigger institutions — the ones that would be most likely to initiate objective-achieving projects.

Small players also would not have access to the research that would enable big players to value the bonds accurately. Therefore they would be at a disadvantage in the market.

Note also that even if free-riders were to gain from holding Social Policy Bonds, they would do be doing so only because their bonds had risen in value as a result of a targeted objective becoming closer to being achievement. As well, attempted free-riding would have positive effects: it would add liquidity to the bond market.

All this is speculation of course, and I may be wrong. We'll see, if somebody actually issues Social Policy Bonds.