Tapping the Financial Wisdom of the Crowd - Crowdfunding as a Tool to Aggregate Vague Information

Crowdfunding, a novel form of financing, has seen massive growth over the last few years. Under crowdfunding, a large number of small households offers small loans to a firm. But if some threshold is missed, the firm cannot draw the loans. We construct a model to argue that this mechanism can be used to aggregate vague information by many households (for example, potential future consumers of the firms product). Each household can spend an effort to produce a bit of vague information too vague to justify a straight loan. But if the firm sets the threshold high, a household knows that his money will be drawn only if many other households also get positive information. We describe the equilibrium behavior of households and firms. A welfare analysis reveals that with crowdfunding, firms set the loan rate too low and the threshold too low, inducing households to generate too much information. In comparison to straight finance, crowdfunding is employed too often.