The Performance of Crowdfunding Investors: Evidence from Random Assignment of Loans to Crowds and Institutions

47 Pages Posted: 21 Mar 2016 Last revised: 20 Jul 2020

See all articles by Ali Mohammadi

Ali Mohammadi

Copenhagen Business School - Department of Strategy and Innovation; Danish Finance Institute; Royal Institute of Technology (KTH) - Center of Excellence for Science and Innovation Studies

Kourosh Shafi

California State University, East Bay

Date Written: August 15, 2016

Abstract

Funding small businesses used to be the exclusive domain of angel investors, venture capitalists, and banks. Crowds have only recently been recognized as an alternative source of financing. Whereas some have attributed great potential to the funding provided by crowds (crowdfunding), others have clearly been more skeptical. We join this debate by examining crowds’ performance to screen the creditworthiness of small and medium sized enterprises (SMEs) compared with the performance of institutions in the context of online peer-to-business lending markets. By exploiting the randomized assignment of originated loans to institutions and crowds in the online peer-to-business platform of Funding Circle, we report that crowds underperform institutions in screening SMEs and thus, relative to institutions, crowds miss the opportunity to lend at higher interest rates as adjusted by the likelihood of loan defaults. The interest rates set by crowds predict default 22% less accurately than those set by institutions. Moreover, the underperformance gap of crowds compared with institutions widens with risky loans, implying that crowds show limited expertise in their risk assessment. Overall, our findings highlight when crowds face limitations in evaluating SMEs.

Keywords: crowdfunding, peer-to-peer lending, institutional investors, online loan market, wisdom of the crowd

JEL Classification: G23

Suggested Citation

Mohammadi, Ali and Shafi, Kourosh, The Performance of Crowdfunding Investors: Evidence from Random Assignment of Loans to Crowds and Institutions (August 15, 2016). Swedish House of Finance Research Paper No. 17-10, 2017 Emerging Trends in Entrepreneurial Finance Conference, Available at SSRN: https://ssrn.com/abstract=2752085 or http://dx.doi.org/10.2139/ssrn.2752085

Ali Mohammadi

Copenhagen Business School - Department of Strategy and Innovation ( email )

Kilen
Frederiksberg, 2000
Denmark

Danish Finance Institute ( email )

Royal Institute of Technology (KTH) - Center of Excellence for Science and Innovation Studies ( email )

Drottning Kristinas väg 30
Stockholm, SE-100 44
Sweden

Kourosh Shafi (Contact Author)

California State University, East Bay ( email )

25800 Carlos Bee Boulevard
Hayward, CA California 94542
United States

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