A Theory of Crowdfunding: A Mechanism Design Approach with Demand Uncertainty and Moral Hazard

Abstract

Crowdfunding provides the innovation that, before the investment, entrepreneurs contract with consumers. Under demand uncertainty, this improves a screening for valuable projects. Entrepreneurial moral hazard threatens this benefit. Focusing on the trade-off between value screening and moral hazard, the paper characterizes optimal mechanisms. Current crowdfunding schemes reflect their salient features. Efficiency is sustainable only if returns exceed investment costs by a margin reflecting the degree of moral hazard. Constrained efficient mechanisms exhibit underinvestment. Crowdfunding blurs the distinction between finance and marketing, but complements rather than substitutes traditional entrepreneurial financing. As a screening tool for valuable projects, crowdfunding unambiguously promotes social welfare.

Learning Through Crowdfunding

“…Hence, the optimal mechanisms they derive do not allow for the possibility that crowdfunding enables …rms to obtain a proof or concept from a small sample, which in turn creates a substantial real option value and mitigates moral hazard. 10 Indeed, in contrast to our …ndings, Strausz (2016) argues that moral hazard creates large ine¢ ciencies and it would be bene…cial to restrict information that the …rm obtains from a crowdfunding campaign. Our paper highlights 9 Cumming, Leboeuf, and Schwienbacher (2014) provide evidence consistent with the idea that All-or-Nothing schemes dominate Keep-it-All schemes.…”

“…The equations in (27) are identical to (4), (6) and (7) respectively. We also denote the cumulative distribution of m…”

Crowdfunding, Efficiency, and Inequality

“…It is well known that efficiency and voluntary participation can generally not both be reached in this case because either some users may be (inefficiently) excluded in equilibrium, or individual contributions are too small (see, e.g., Gailmard and Palfrey, 2005 and the references therein). Efficiency results such as the introductory example in Strausz (2016) thus rely on a discrete distribution of consumer types, whereas our main result holds for continuous type distributions as well.…”

Crowdfunding, Efficiency, and Inequality

“…Asset owners do not understand what those people who do not have wealth think about the world" (Financial Times, 2016). mechanisms (Chang, 2015;Chemla and Tinn, 2016;Ellman and Hurkens, 2015;Schwienbacher, 2015;Strausz, 2016). A pre-order crowdfunding scheme operates like a set of forward transactions that are all made conditional on the aggregate volume of purchases.…”

“…Ellman and Hurkens (2015) study how crowdfunding can be used for market testing. Chang (2015), Chemla and Tinn (2016), and Strausz (2016) focus on the trade off between information gathering aggregation and incentives when the entrepreneur can embezzle the funds. Belleflamme et al (2014) investigate whether an entrepreneur should rather use pre-order or equity-based crowdfunding.…”