Adverse Incentives in Crowdfunding
47 Pages Posted: 25 May 2010 Last revised: 21 Oct 2014
Date Written: October 06, 2014
This paper analyses the substantially growing markets for crowdfunding, in which retail investors lend to borrowers without financial intermediaries. Critics suggest these markets allow sophisticated investors to take advantage of unsophisticated investors. The growth and viability of these markets critically depends on the underlying incentives. We provide evidence of perverse incentives in crowdfunding that are not fully recognized by the market. In particular we look at group leader bids in the presence of origination fees and find that these bids are (wrongly) perceived as a signal of good loan quality, resulting in lower interest rates. Yet these loans actually have higher default rates. These adverse incentives are overcome only with sufficient skin in the game and when there are no origination fees. The results provide important implications for crowdfunding, its structure and regulation.
Keywords: Financial Disintermediation, Crowdfunding, Consumer Lending
JEL Classification: G01, G20, G21, G23
Suggested Citation: Suggested Citation