Working Paper: NBER ID: w24777
Authors: Christian Catalini; Xiang Hui
Abstract: Early crowdfunding platforms were based on a premise of disintermediation from professional investors, and relied on the ‘wisdom of the crowd’ to screen high quality projects. This becomes problematic when equity is involved, as the degree of asymmetric information between entrepreneurs looking for funding and the crowd is higher than in reward-based crowdfunding. As a result, platforms later experimented with incentives for professional investors to curate deals for crowd. We study how the introduction of such incentives influenced the allocation of capital on the leading US platform, finding that the changes led to a sizable 33% increase in capital flows to new regions. Professional investors use their reputation to vouch for high potential startups that would otherwise be misclassified because of information asymmetry. This allows them to arbitrage opportunities across regions and shift capital flows to startups that are 37% more likely to generate above median returns. At the same time, this ‘democratization effect’ relies on the presence of intermediaries with professional networks that bridge these new regions to California. Using a large-scale field experiment with over 26,000 investors we further unpack the frictions to online investment, and show that social networks constitute a key barrier to additional democratization, since they influence how the crowd evaluates intermediaries in the first place.
Keywords: crowdfunding; equity investment; information asymmetry; intermediaries; capital allocation
JEL Codes: G24; L26; O31; O33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| introduction of syndicate leads (L14) | capital flows to nonhub regions (R11) |
| syndicate leads (G24) | investors vouching for startups (G24) |
| investors vouching for startups (G24) | crowd investing in higher-potential startups (O36) |
| startups featured by intermediaries (M13) | likelihood of achieving above-median returns (G17) |
| startups with initially low observable quality signals (L15) | likelihood of achieving above-median returns (G17) |
| presence of intermediaries (L14) | hub region investors diversify investments (G11) |
| presence of intermediaries (L14) | nonhub investors favor home region (F23) |
| social networks of intermediaries (Z13) | access to capital (O16) |