Performance-Based Agreements: Incorporating Performance-Based Elements into Standard Loan and Grant Agreements

May, 2010     Mayada El-Zoghbi, Jasmina Glisovic-Mezieres, and Alexia Latortue

All donors and investors use contracts to establish legal relationships with the partners they fund. Typically, these contracts define the permitted use of the funds and include general suspension or termination clauses. Unfortunately, many agreements do not include project-specific performance targets and do not define sanctions for failure to deliver minimum performance against those targets.

This Technical Guide presents the rationale for the use of performance-based agreements (PBAs) and suggests ways to incorporate performance-based targets and incentives into existing loan and grant agreements. The focus of this guide is PBAs for retail financial service providers, but some of the advice can be applied to other nonretail projects as well.

Funding agencies use loan and grant agreements as part of their standard operational procedures when partnering with financial service providers. Typical loan and grant agreements stipulate the permitted use of money loaned or granted, define the type and frequency of reporting required, and include general “boilerplate” provisions about suspension or termination of funding.

Standard loan and grant agreements, however, often fall short on defining expected results and creating positive or negative incentives to achieve those results. Absent such definitions and incentives, the parties tend to focus on disbursement of funds for permitted expenditures, rather than on producing the results that are the very reason for funding the financial service provider in the first place. We consider an agreement to be “performance-based” when (1) it is as clear and specific as possible about the expected results and how they will be measured, and (2) it strengthens incentives for good performance by defining sanctions or benefits that are tied to the achievement of the expected results. When there is regular reporting against the targets of a PBA, the funder and its partner are likely to spot problems more quickly and correct them more effectively, and funders are less likely to add resources for second and third phases of projects that are not delivering the right results.