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

Crowdfunding provides innovation in enabling entrepreneurs to contract with consumers before investment. Under demand uncertainty, this improves screening for valuable projects. Entrepreneurial moral hazard threatens this benefit. Studying the trade-off between screening and moral hazard, the paper characterizes optimal mechanisms. Popular all-or-nothing reward-crowdfunding schemes reflect their salient features. Efficiency is sustainable only if returns exceed investment costs by a margin reflecting the degree of moral hazard. Constrained efficient mechanisms exhibit underinvestment. As a screening tool for valuable projects, crowdfunding promotes social welfare and complements traditional entrepreneurial financing which focuses on controlling moral hazard. JEL classification codes: D82, G32, L11, M31