DP11222 A Theory of Crowdfunding - a mechanism design approach with demand uncertainty and moral hazard

Author(s):	Roland Strausz
Publication Date:	April 2016
Keyword(s):	aggregate demand uncertainty, Crowdfunding, entrepreneurship, moral hazard, venture capital
JEL(s):	D82, G32, L11, M31
Programme Areas:	Industrial Organization
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=11222

Crowdfunding provides innovation in that it enables entrepreneurs to contract with consumers before investment. Under aggregate demand uncertainty, this improves screening for valuable projects. Entrepreneurial moral hazard threatens this benefit. Studying the subsequent trade-off between screening and moral hazard, the paper characterizes optimal mechanisms. Popular all-or-nothing reward-crowdfunding schemes reflect their salient features. Efficiency is sustainable only if returns exceed investment costs by a margin reflecting the degree of moral hazard. Constrained efficient mechanisms exhibit underinvestment. As a screening tool for valuable projects, crowdfunding promotes social welfare. Crowdfunding complements rather than substitutes traditional entrepreneurial financing.