Exploiting the Financial Wisdom of the Crowd -- Crowdfunding as a Tool to Aggregate Vague Information
31 Pages Posted: 2 Aug 2014
Date Written: August 1, 2014
Crowdfunding, a novel form of financing, has seen massive growth over the last few years. Under crowdfunding, a firm asks for a large number of small loans from many households. But if some predefined threshold for the aggregate loan volume is missed, the firm cannot draw the loans. We construct a model to argue that this mechanism can be used to aggregate vague information by many households (for example, potential future consumers of the firm's products). Each household can spend an effort to obtain a bit of vague information -- too vague to justify a straight loan. But if the firm sets a high threshold, a household knows that its money will only be drawn if many other households also get positive information. We describe the equilibrium behavior of households and firms. With crowdfunding, from a welfare perspective, firms set both the loan rate and the threshold too low, inducing households to generate too much information. But compared with standard debt, crowdfunding enables more good projects to receive funding.
Keywords: Crowdfunding, Gatekeeper Function of Finance, Wisdom of the Crowds, Entrepreneurial Finance, Information Efficiency, Signaling
JEL Classification: G23, G24, L15
Suggested Citation: Suggested Citation