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

Abstract

Crowdfunding provides the innovation that, already before the investment, entrepreneurs can interact with consumers. It, thereby, reduces demand uncertainty and improves screening. Entrepreneurial moral hazard threatens these benefits. After formally characterizing optimal contracts between consumers and an entrepreneur susceptible to moral hazard, this paper argues that current crowdfunding schemes reflect their salient features. Efficiency is sustainable only if expected returns exceed investment costs by a margin reflecting the degree of moral hazard. Constrained efficient mechanisms exhibit underinvestment. Crowdfunding destroys the classical separation between finance and marketing, but complements rather than substitutes traditional entrepreneurial financing.