Signaling and Fraud when Crowdfunding Campaigns Compete for Pledges

Robin Christmann (Leibniz FH, University of Applied Sciences)
Mark Broere (Leibniz FH)

Abstract

Crowdfunding as a part of micro-finance has received considerable attention from the public and among researchers, both due to its novel form of collecting funds and the emergence of fraud and misconduct to the disadvantage of lay backers. We develop an adverse selection model of reward-based crowdfunding that introduces Bertrand-style competition between campaign owners. We find that the traditional result in the literature about successful separation of high-type and low-type creators does no longer hold when accessible information about quality becomes less reliable and the market for the high-quality product grows. Under certain conditions, we also observe an instability in competition where campaign owners randomize between withdrawing to a certain market niche and price competition. All this gives rise to fraud in equilibrium. In this perspective, crowdfunding scams resemble a bet on market demand and are often able to evade liability. We then discuss specific remedies and provide insights for platform policy and regulation.

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