Signaling to the Crowd: Private Quality Information and Rewards-Based Crowdfunding

40 Pages Posted: 19 Dec 2016 Last revised: 26 Mar 2019

See all articles by Soudipta Chakraborty

Soudipta Chakraborty

Duke University, Fuqua School of Business, Students

Robert Swinney

Duke University - Fuqua School of Business

Date Written: March 2019

Abstract

Crowdfunding is a new and popular way of funding innovative products. Despite numerous advantages, there are challenges to this model, chief among them credibly signaling information about product quality to a pool of small, uninformed investors. We explore how an entrepreneur might accomplish this and overcome a key obstacle to crowdfunding. Specifically, we analyze a game theoretic model of signaling between an entrepreneur and campaign backers in which the entrepreneur designs a fixed funding rewards-based crowdfunding campaign for an inno- vative product. Product quality is known to the entrepreneur but unknown to some backers, and we analyze how the entrepreneur can signal quality to backers via the design of the crowd- funding campaign, including the price of the reward and the funding target. We find that the entrepreneur should signal high quality by setting a high target that is distorted above the full information optimal level. While a separating equilibrium always exists, a pooling equilibrium can only occur under very specific circumstances. We show that the high target affects the quality choice of entrepreneurs and may deter high quality, innovative projects. In addition, we discuss how the entrepreneur should modify the signaling strategy when a high target potentially deters backers from pledging due to the cost of participating in a failed campaign.

Keywords: rewards-based crowdfunding, fixed funding, asymmetric information, signaling

JEL Classification: D81, D82, M11, M13, M31

Suggested Citation

Chakraborty, Soudipta and Swinney, Robert, Signaling to the Crowd: Private Quality Information and Rewards-Based Crowdfunding (March 2019). Available at SSRN: https://ssrn.com/abstract=2885457 or http://dx.doi.org/10.2139/ssrn.2885457

Soudipta Chakraborty

Duke University, Fuqua School of Business, Students ( email )

Durham, NC
United States

HOME PAGE: http://people.duke.edu/~sc390/

Robert Swinney (Contact Author)

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States

HOME PAGE: http://people.duke.edu/~rps23/

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