Fraud Tolerance in Optimal Crowdfunding

Matthew Ellman and Sjaak Hurkens

Abstract: Reward-based crowdfunding enables credit-constrained entrepreneurs to raise money to develop and create innovative products. Crowdfunders' low monitoring incentives open the door to fraud. In practice, fraud is surprisingly rare. Strausz (2017) proves that crowdfunding implements the optimal ex post individually rational mechanism design outcome in an environment with entrepreneurial moral hazard and private cost information. However, ex post individual rationality precludes all crowdfunding unless fraud can be prevented with certainty. Actual crowdfunding tolerates some fraud. We show this (i) generates strictly higher profits and welfare, but (ii) cannot implement the optimal ex interim individually rational outcome.

Keywords: Crowdfunding, mechanism design, moral hazard, private information.

Classification Number: C72, D42, D82, D86. L12, L26

Economics Letters 118(1): 6-11 (2019)