Backers: Consumers or Investors? Crowdfunding vs. Traditional Financing as an Optimal Security Design Problem

Abstract

This article is the first one that analyzes the choice between crowdfunding and traditional financing as a security design problem. The value of this research comes from several points: 1) the origin of crowdfunding and its features has not been completely explained; 2) crowdfunding regulation is still in the process of development; 3) existing literature on reward-based crowdfunding usually treats backers as consumers while in practice their objectives are rather multidimensional etc. We analyze a model where the choice of financing is affected by moral hazard problem regarding the choice of production scale, by asymmetric information about firm quality, and by the uncertainty about consumer valuation of the product. We show that a two-stage financing where the first stage has small size and delivers goods to investors while the second stage financing has a fixed monetary payment is an optimal solution for entrepreneurs. This combination corresponds to reward-based crowdfunding followed by a bank financing.

Keywords: crowdfunding, traditional financing, asymmetric information, moral hazard, reward-based crowdfunding, debt, security design

JEL Classification: D82, G32, L11, L26, M13