The Limits of Crowdfunding with Common Values

• Authors: Sjaak Hurkens and Matthew Ellman.
• BSE Working Paper: 1477 | February 25
• Keywords: information acquisition , information aggregation , wisdom of crowds , asymptotic efficiency , common value
• JEL codes: C72, D82, G23, L15

This paper establishes efficiency bounds on debt, equity, and reward-based crowd- funding in common value settings. We characterize optimal welfare and profit out- comes in the limit as the crowd of funders grows large. An entrepreneur sets a threshold and rate of return on investments in a risky project with constant returns to scale. Funders can inspect the project at a cost before choosing whether to bid to invest. The entrepreneur’s design choices affect inspection, bidding and information aggregation (“crowdblessing”). With costless information acquisition, crowdfunding asymptotically achieves the first-best because informative bidding by a vanishing fraction of the crowd can ensure certain funding of good projects while excluding all bad ones. However, costly inspection precludes efficiency: to incentivize inspection, entrepreneurs lower thresholds so that some bad projects get funded. This inefficiency rises linearly with cost and falls with precision. Above a critical cost, crowdfunding offers no advantage over standard investment contracts.