Rethinking Crowdfunding Platform Design: Mechanisms to Deter Misconduct and Improve Efficiency
50 Pages Posted: 1 May 2018 Last revised: 16 Aug 2019
Date Written: July 15, 2019
Lacking credible rule enforcement mechanisms to punish misconduct, existing reward-based crowdfunding platforms can leave backers exposed to two risks: entrepreneurs may run away with backers' money (funds misappropriation) and product specifications may be misrepresented (performance opacity). We show that each of these risks can materially impact crowdfunding efficiency, and when jointly present, they interact with each other in ways that can either dampen or, more worryingly, amplify their individual adverse effects. To mitigate these risks, we propose two mechanisms based on deferred payments. The first involves stopping the campaign once the funding goal is reached, and servicing any unmet demand in the aftermarket. The second involves escrowing any funds raised in excess of the goal, as insurance for backers. We show that early stopping dominates escrow and boosts platform revenues. Pairing these deferred-payment designs with (costly) performance verification contingencies can bring additional gains, but doing so can flip their relative performance, with escrow coming out on top. Overall, by accounting for different timing (pre- vs. post-campaign) and enforcement rules (mandatory vs. optional) of the verification contingencies, we analyze a total of ten different designs and show that two of them dominate: the early stopping design, and the escrow design with mandatory ex-post verification. We conclude by providing recommendations for which design works best under different conditions, and exploring the potential of crowdsourced performance checks.
Keywords: Crowdfunding, New Business Models, Online Platforms, Moral Hazard, Entrepreneurship
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