Monday, July 28, 2014

Crowdfunding: Are Crowds Wise or Idiots?

The new crowdfunding exemption in section 4(a)(6) of the Securities Act will, once the SEC adopts the rules required to implement it, allow ordinary investors to invest in unregistered securities offerings. Will those unsophisticated investors go down in flames or will they be able to make rational investment choices?

Some proponents of crowdfunding argue that crowdfunding benefits from the so-called “wisdom of the crowd": that the collective, consensus choice that results from crowdfunding is better than what any individual could do alone, and often as good as expert choices. A recent study seems to support that view.

Two business professors—Ethan R. Mollick at the Wharton School and Ramana Nanda at Harvard—looked at crowdfunding campaigns for theater projects. They submitted those projects to people with expertise in evaluating theater funding applications and compared the expert evaluations to the actual crowdfunding results.

Mollick and Nanda found a strong positive correlation between the projects funded by the crowd and those rated highly by the experts. In other words, crowds were more likely to fund the campaigns the experts preferred. In addition, projects funded by the crowd that were not rated highly by the experts did just as well as the projects chosen by the experts.

Of course, theater projects aren’t the same as securities, but this study should certainly be of interest to those following the securities crowdfunding debate. The full study (44 pages) is available here. If you don’t have time to read the full study, a summary is available here.

http://lawprofessors.typepad.com/business_law/2014/07/crowdfunding-and-the-wisdom-of-the-crowd.html

C. Steven Bradford, Corporate Finance, Entrepreneurship, Financial Markets, Securities Regulation | Permalink

Comments

Great post, Steve. Thanks for alerting me to this study. I wish it had come out before I finished my paper on disclosure in the crowdfunding space: "Investor and Market Protection in the Crowdfunding Era: Disclosing to and for the 'Crowd'," available at http://ssrn.com/abstract=2435757, which works off the madness/wisdom of the crowd literature. I intend to do more work in this area and will be sure to read this study in that connection.

Posted by: joanheminway | Jul 28, 2014 7:53:57 AM

My limited experience with crowdfunding is where one of my law school classmates decided to resurrect his family brewery in Milwaukee, Wisconsin. He is a staff attorney to the Chapter 13 bankruptcy trustee in that area. It was a hoot. It was successful and relaunched it on a small scale. This would be characterized as "friends of the brewery" wanting simply to play a part (nominal, based on contributions) in a microbrewery.

Because the cost was so nominal, it was made - more or less - like purchasing lottery tickets. If it takes off, it is something to "share." If it does not, it is a "nominal cost" for the entertainment.

Posted by: Tom N | Jul 29, 2014 6:03:02 PM

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