The Wisdom of Crowdfunding

Want to raise money to develop your idea for an electronic sandwich press that sears the face of Jesus onto bread? How about finding backers who are as excited as you are to build a giant inflatable sculpture of Lionel Richie's head?

With the arrival of web-based crowdfunding platforms such as Kickstarter, entrepreneurs have discovered a new pool of potential investors — beyond venture capitalists or grant-making bodies — for their projects, be they artistic or social enterprises, technological advances, or bizarre novelties.

Kickstarter alone, since its founding in 2009, has raised more than $1 billion for some 67,000 projects from almost seven million backers. In June 2014, two UK-based restaurant chains were the first to offer retail bonds through crowdfunding, via the site Crowdcube.

In the finance world, all this excitement raises an obvious question: When it comes to assessing investment opportunities, is there wisdom or madness in crowds? On the one hand, the aggregated judgment of many should trump the single opinions of experts. On the other, crowds lack expertise and are vulnerable to cognitive group biases that have led to tulip crazes.

“Despite the growing role of crowds in making decisions once left to experts, little is known about how crowds and experts may differ in their ability to judge projects or even whether crowd decision making is based on any rational criteria at all,” says Ethan Mollick, assistant professor of management at University of Pennsylvania’s Wharton School.

As Mollick points out, most research to date has focused on the role of crowds in systems, such as crowdsourcing and innovation tournaments, that depend on mediation by experts or prediction markets. Crowdfunding, by contrast, does not operate like a market nor does it feature centralized price-setting, expert oversight, or collaboration among crowd members.

To start filling in the gaps, Mollick, with Ramana Nanda of Harvard Business School, conducted the first robust comparison between crowd and expert evaluation of prospective projects that rely on taste and judgment rather than prediction. He reported on the study at the Economics of Entrepreneurship and Innovation conference held in June 2014 at Queen’s School of Business.

Kickstarter Matches Experts in the Arts

Mollick and Nanda opted to focus their study on crowdfunding in the arts, specifically on funding decisions for proposed theatre projects. It was a wise choice. More money flows into the arts through Kickstarter than through the National Endowment for the Arts, a U.S. government agency. 

“Theatre projects have a number of appealing features,” says Mollick. “Evaluating them entails both a subjective artistic component and an understanding of the commercial bottom line and it is possible to develop a somewhat objective sense of the long‐run success of the project. Theatre funding is also a one‐time event and not subject to the forecasting challenges associated with multi‐stage financing.”

For their study, they started by selecting 120 Kickstarter projects attempting to raise at least $10,000. They then assembled a panel of 30 judges with extensive expertise in assessing theatre funding applications. Each judge was asked to evaluate six projects — three that failed to reach their funding goal, two that achieved their goal, and one that raised more than they expected. Finally, the researchers compared the long-term outcomes of projects that were supported by both crowds and experts and those supported only by the crowds.

Mollick and Nanda found “a remarkable degree of congruence” between the funding decisions of crowds and experts. Projects that were funded by the crowds received consistently higher scores from experts, were more likely to be rated as being the best of the six in the set, and were much more likely to have received funding from the professionals. 

Where crowds and experts disagreed, 75 percent of the time it was the crowd that was willing to fund the project. There was a clear pattern in these projects that attracted the crowd but not the judges: there were more reward levels and more videos and photos supporting the pitch. 

“The crowd expands the number, and potentially the type, of projects that have a chance of success”

Interestingly, the projects that were funded by the crowd but not the experts were just as likely to have been successful as those supported by both the crowd and experts. “They are equally likely to have delivered on budget, result in organizations that continue to operate, and although the metrics for success are subjective, we find strong qualitative evidence that many of these shows had both commercial success and received positive critical acclaim in national outlets such as the New York Times,” says Mollick.

Looking at the big picture, Mollick says crowdfunding has the potential to be an engine for innovation. Given that projects that were sponsored only by the crowd had similar final results to those selected by experts, “the crowd expands the number, and potentially the type, of projects that have a chance of success.” And by giving project creators and innovators a direct pipeline to potential customers, crowdfunding can also be a source of market intelligence.

As for the role of expert opinion in funding decisions, Mollick adds a cautionary note. While their study did not examine the outcomes of the projects selected by experts but not by the crowd, he says there may be systematic differences.

“For example, some discussions with experts showed more willingness to fund more artistically challenging work that may not appeal to the crowd. Experts may also be less swayed by the salesmanship of the pitch, as evidenced by the lower importance they appeared to place on the quality of the pitch itself. In a crowd‐based decision regime, there is still a place for expert judges.”

— Alan Morantz