Need for the third-sector.

Entrepreneurship is known to support the economic development of a nation. Entrepreneurship can be on many dimensions, one of which is social entrepreneurship. The very broad definition of social entrepreneurship as defined by many scholars across different disciplines is the pursuit of an opportunity with a mission to create and sustain social value. The economic theory and proponents of free market believe that the state is allocatively efficient in a utopian world. But in practicality, the state though by nature is allocative may not be always efficient. Markets in practical can be imperfect because of information asymmetry, principal-agent problems, taxation rules and so forth. So, it is not surprising that the state and market can fail and the state and market failures are seen as an opportunity by the third sector. Also, given the geographical vastness, diversity in culture and languages in India, the solutions to the social problems needs to be done on a localized basis, whereas the state and market believe in standardization.

The organizations are of different forms as for-profit, not-for-profits and co-operatives (that are somewhere midway between the other two). The members of for-profit firms who are shareholders of the firm want to maximize their residual claims (because as per the pecking order theory, the shareholders of the firm have the last claim on the resources of the firm on liquidation after debt holders, employees). Their personal assets are also insulated from the firm going kaput by virtue of their limited liability. The horizons for enterprises are mid-term where as the horizon of the state is long term. The supervisory mechanism built on the fixed payoff mechanism keeps the members aligned to the organizations. Non-Profits however differ from for-profits in three main ways as they are non-coercive in participation and profits are not distributed to stakeholders. There are no residual claims on the current income and the residual claims on liquidation are given to another firm with a similar charter or to the state with whom the ultimate responsibility of social welfare exists. Signaling plays a very significant role in the arena of non-profits.

Whereas membership of for-profits is based on the residual claims of capital; the usage (also called patronage) is the determinant of the membership and residual claims in the case of co-operatives. Membership in the case of co-operatives is open to a large extent on account of the fact that one can cease to be a member by not using the services, by not supplying and can then become an active member after break as well. The reason why the co-operatives is said to be in between profits and non-profits is in the way residual claims are handled. The residual claims on the current income are like that of for-profits organizations, where the claims are settled on the basis of patronage. Co-operatives resemble not-for-profits in the way residual claims on liquidation are handled. Co-operatives are largely decentralized unlike the majority of for-profits that have centralized organization structure. Other principles are democratic control, member economic participation, autonomy and concern for the community. The cooperatives can be shaky and vulnerable because of the problems due to the flight of capital by members taking their share of profits and not staying invested for a long period. There are some measures taken by cooperatives to retain the capital, for example by having a higher moratorium on withdrawals of capital and by ploughing back more residues. These approaches have their merits and demerits (risks), but the struggle is what makes them vulnerable because of the vested interests of some of its members.