The Promise of Reward Crowdfunding

Abstract

Research Question/Issue. We study reward crowdfunding (RC), the most innovative segment of the crowdfunding market, where, instead of a debt or equity contract, fund providers are promised some good or service in the future in exchange for their contribution to the funding of the investment project under a contract that does not penalize the creator's failure to deliver. The existing economic and legal literature is puzzled by the platform's use of this seemingly inefficient contract where a standard pre‐sale contract would appear to work better. Research Findings/Insights. Counterintuitively, we prove that the no‐penalty contract is the optimal contract between creators of unknown talent and early adopters of their products when creators can benefit from being discovered as talented and from the goodwill generated by delivering on their promise to early adopters. Theoretical/Academic Implications. Our analysis contributes to understanding RC by showing that the no‐penalty RC contract, far from being an inefficiency, is a contractual innovation specifically designed for talent discovery. We also contribute to the literature on relationship contracts, showing that even in a one‐shot game, it is possible to sustain a contract in the desire to build a reputation that will be useful in a future contract with a third party. Practitioner/Policy Implications. Our analysis has important policy implications on how backers should be protected. Standard measures of consumer or investor protection may be counterproductive.