Crowdfunding, asymmetric information and pecking order

Purpose Crowdfunding is a rapidly growing phenomenon in theory and practice. A significant gap exists between theoretical literature and empirical evidence regarding the volumes of crowdfunding and the quality of firms that use crowdfunding. Design/methodology/approach This is one of the first articles that offers a theory of entrepreneurs' choice between debt, equity and crowdfunding (reward-based). It uses a game-theoretic model where information about the expected quality of products developed by entrepreneurs is asymmetric. Findings We argue that in most cases crowdfunding is at the end of pecking order. The payments in the form of pre-orders come before the project investment is made making the entrepreneur's profit independent of actual quality of the product creating a strong ground for cross-subsidies of low-quality entrepreneurs by high-quality entrepreneurs in a pooling equilibrium. Originality/value The paper is consistent with some well-known empirical phenomena on crowdfunding, e.g. relatively small volumes of crowdfunding vs traditional funding, low volumes of reward-based crowdfunding vs debt-based and equity-based crowdfunding and excess entry of low-quality firms to crowdfunding market. We further compare this approach with an approach based on asymmetric information about the cost of production/investment (as in Belleflamme et al. (2014) and some other papers) and argue that even though some predictions maybe close under some general assumptions both approaches lead to qualitatively different results.