Is Kindness the Magical Spell? The Role of Information and Reciprocity in Revenue-sharing Crowdfunding

Abstract

We consider an entrepreneur funding his project from investors through a revenue-sharing crowdfunding campaign. The early investor (insider) has a social tie with the entrepreneur and is informed about the future revenue of the entrepreneur’s project. The investor who arrives later (outsider) is uninformed about the future revenue of the entrepreneur’s project and makes an investment after observing the insider’s investment. Thus, the insider’s investment decision may signal information regarding the entrepreneur’s future revenue to the outsider. While the outsider’s investment decision is solely financially driven, the insider has reciprocity toward the entrepreneur and considers both her own payoff as well as the entrepreneur’s payoff in making her investment decision. We investigate how reciprocity and information asymmetry play a role in the outcome of the crowdfunding campaign. We find that information asymmetry benefits both investors because the insider may invest less to signal her type, which moderates the competition between investors. In addition, reciprocity can affect the information transmission in the crowdfunding campaign. In particular, if the reciprocity is higher than a threshold, the separating equilibrium may not exist, and the insider cannot signal the future project’s revenue via distorting her investment. Moreover, when the separating equilibrium exists, the investors’ total payoff decreases as the reciprocity increases. This is because the insider invests more as the reciprocity increases, which intensifies the competition and reduces the outsider’s payoff. To respond to the insider’s increase of investment, due to the increase of reciprocity, the outsider invests less when there is no information asymmetry, but will first increase and then decreases his investment when there is information asymmetry. Our results provide guidelines for platforms and entrepreneurs on how to leverage the social network in a crowdfunding campaign.

Keywords: Crowdfunding, Entrepreneurship, Information Asymmetry, Signaling, Social Tie, Reciprocity