=Paper=
{{Paper
|id=Vol-2173/paper6
|storemode=property
|title=Navigating Uncertainty in Equity Crowdfunding
|pdfUrl=https://ceur-ws.org/Vol-2173/paper6.pdf
|volume=Vol-2173
|authors=Flemming Binderup Gammelgaard,Claus Bossen
|dblpUrl=https://dblp.org/rec/conf/hcomp/GammelgaardB18
}}
==Navigating Uncertainty in Equity Crowdfunding==
https://ceur-ws.org/Vol-2173/paper6.pdf
Navigating Uncertainty in Equity Crowdfunding
Flemming Binderup Gammelgaard, Claus Bossen
Aarhus University
publications18@aaai.org
Abstract investment decision-making, and 2) based on this overview
This conceptual paper focuses on how equity crowdfunding and classification, we develop the first comprehensive
investors navigate uncertainty in their decision-making. We model of how investors make decisions under uncertainty
demonstrate shortcomings of prior research focusing on the (both to be included in the full paper).
attributes that are assessed in micro-investment decision-
making without considering the heuristic processes by which
these attributes are appraised. To overcome these shortcom-
ings, we propose the development of a comprehensive model
Crowdfunding
of micro-investment decision-making, the first of its kind to Crowdfunding is a subset of crowdsourcing defined as the
our knowledge.
act of outsourcing a task to an undefined network of people
in the form of an open call that is broadcast online (Afuah
Introduction and Tucci 2012; Howe 2006; Jeppesen and Lakhani 2010).
Like crowdsourcing, crowdfunding too involves an open
Equity crowdfunding is an online mechanism for attracting call, in this case for financial contributions from mostly non-
financial contributions from large numbers of individual in- accredited investors participating in offerings online outside
vestors through public offerings of unlisted shares (Ahlers traditional financial institutions (Belleflamme, Lambert, and
et al. 2015; Cholakova and Clarysse 2015; Ley and Weaven Schwienbacher 2014; Lambert and Schwienbacher 2010;
2011). Contributions are typically micro-investments in Schwienbacher and Larralde 2010). Thus, crowdfunding
early-stage entrepreneurial ventures operating in rapidly can be defined as a mechanism for securing small contribu-
changing and highly uncertain environments. Consequently, tions from a large number of individuals through social net-
equity crowdfunding is uniquely suited for studying micro- working sites outside the main financial system (Ley and
investment decision-making under the conditions of uncer- Weaven 2011).
tainty surrounding early-stage entrepreneurial ventures. The In recent years, crowdfunding has become an increasingly
purpose of the current study is therefore to determine how viable alternative to conventional sources of early-stage
micro-investors make decisions under uncertainty in equity capital. The most recent global crowdfunding industry re-
crowdfunding. port estimated crowdfunding volume in 2015 at $34.4 bil-
To investigate how micro-investors navigate uncertainty lion globally, up from $16.2 billion in 2014 and $6.1 billion
in their decision-making, we review the emerging equity in 2013 (Massolution 2015). The industry showed continued
crowdfunding literature. Due to limited research on equity growth in 2016 to a market volume of $35.2 billion in the
crowdfunding, we furthermore turn to the entrepreneurial fi- Americas alone with more than 218,000 businesses across
nance literature for theory on investment decision-making, the Americas raising funds from online alternative finance
and to the decision-making literature for insights into deci- channels in 2016 (Ziegler et al. 2017).
sion-making under uncertainty.
To the best of our knowledge, no prior study has system-
atically analyzed crowdfunding within the theoretical Research on Crowdfunding
framework of decision-making under uncertainty. We con-
In addition to its significant practical applications, crowd-
sequently make two contributions to the crowdfunding liter-
funding is an emerging research area, which has gained mo-
ature: 1) we provide the to date most comprehensive over-
mentum with an increasing number of publications over the
view and classification of the constituent elements of micro-
Copyright © 2018 for this paper by its authors. Copying permitted for pri-
vate and academic purposes.
past decade. This literature is mostly empirical, and over- Figure 1).Yet, they stop short of analyzing the role that qual-
whelmingly focused on identifying determinants of funding ity signals play in investment decision-making, and ulti-
success to further our understanding of the factors that sup- mately conclude that "further analysis would be needed to
port successful funding outcomes (see e.g. Koch 2016; Kup- understand ... individual investors' decision-making pro-
puswamy and Bayus 2013; Schwienbacher 2017). However, cesses" (ibid., p. 975).
most crowdfunding studies have failed to go beyond identi- Finally, in his highly cited paper on the dynamics of
fying the drivers of funding success toward a theoretically crowdfunding, Mollick (2014) finds that potential investors
grounded understanding of their role in investment decision- respond to quality signals in all forms of crowdfunding, be-
making. As a result, the influencing factors of investment fore coming to the conclusion that “projects that signal a
decision-making tend to be reduced to determinants of fund- higher quality level are more likely to be funded” (p. 2).
ing success, and the construct of success determinants con- However, as signaling is less well defined in crowdfunding
sequently serves as the lowest common denominator of the than in “traditional new venture settings”, Mollick recom-
literature. mends further research into "the decision-making process in
The current study seeks to remedy these shortcomings by crowdfunding to gain insight into the ... signaling process."
developing the first comprehensive model of micro-invest- (ibid., p. 14).
ment decision-making under uncertainty. Based on our re- Thus, these studies all focus on quality signals as deter-
view of the crowdfunding literature, we argue that as the minants of funding success, while acknowledging that little
quality of entrepreneurial ventures is unobservable under is known about the significant role that quality signals play
uncertainty, micro-investors must base their investment de- in investment decision-making. Furthermore, the list of
cisions on observable quality signals assumed to co-vary quality signals discovered in the literature is arguably so
with the underlying, but unobservable quality of investment long and categories so unstable as to provide confusing and
opportunities (Ahlers et al. 2015; Agrawal, Catalini, and often contradictory evidence concerning their role in the de-
Goldfarb 2014; Belleflamme and Lambert 2014; Burtch cision-making process. Consequently, our key contribution
2013; Mollick 2014). in the following is to demonstrate how micro-investors use
Consequently, investment decisions rely on a range of heuristics to appraise quality signals, and make decisions
quality signals, which can be observed, and which are there- under uncertainty. We thereby account not only for the fac-
fore the success factors identified in the literature. However, tors that inform the decision process, but also for the process
while previous studies have provided important groundwork by which these factors are appraised.
on factors influencing the performance of crowdfunding
projects, they have stopped short of conceptualizing these in
terms of the decision-making process to which they contrib- Crowdfunding Heuristics
ute (Kang et al. 2016). To the best of our knowledge, our According to the heuristics and biases program, heuristics
study is therefore the first to analyze how quality signals can be defined as a cognitive process in which a highly ac-
trigger a kind of cognitive shortcut in the decision-making cessible attribute is substituted for a less accessible attribute
process by substituting for the underlying, but unobservable of a judgment object to reduce the complexity of a particular
quality of the investment opportunity, and thereby reducing judgement (Kahneman 2003). Consequently, a judgement is
uncertainty for potential investors. mediated by a heuristic when an individual assesses a prop-
erty of a judgment object by substituting another property of
that object (Kahneman and Frederick 2002). This heuristic
Quality Signals
process of attribute substitution controls decision-making
As outlined in the previous section, quality signals are typi- when the following three conditions are satisfied: 1) target
cally conceptualized as funding success factors in the litera- attributes are relatively inaccessible; 2) related substitute at-
ture. In their review of the crowdfunding literature, Belle- tributes are highly accessible; and 3) the substitution of heu-
flamme and Lambert argue that “contributors respond to ristic attributes for target attributes takes place intuitively,
quality signals” in equity crowdfunding, and conclude that and is not overruled by higher-order cognition (ibid.).
equity crowdfunding is most successful when entrepreneurs In equity crowdfunding, all three conditions are typically
reduce uncertainty for potential investors by signaling qual- satisfied as information asymmetry and uncertainty make
ity (p. 4). This line of argument is based partly on the study investment target attributes inaccessible, forcing micro-in-
by Ahlers and his co-authors (2015), who demonstrate em- vestors to rely instead on highly accessible quality signals.
pirically that quality signals may "strongly impact the prob- Consequently, the various quality signals discovered in the
ability of funding success", and consequently classify qual- research can be characterized as heuristic attributes substi-
ity signals as “determinants of funding success” (p. 955 and tuting for the underlying, but unobservable target attributes
under information asymmetry and uncertainty.
As micro-investors cannot possibly take all possible qual- stage entrepreneurial ventures (Ahlers et al. 2015; Huang
ity signals into consideration, they furthermore use specific and Pearce 2015).
decision-making heuristics to ignore some of the infor- We therefore posit that it would not be possible for micro-
mation, and come to a decision (see e.g. Gigerenzer 2008, investors to make decisions under conditions of uncertainty
Table 2 for an overview of 10 different heuristics). Deci- if they did not use heuristics, as they cannot possibly employ
sion-making heuristics are strategies of bounded rationality a fully compensatory decision-making model to balance out
that ignore information to make more accurate judgments large numbers of attributes under these conditions. Instead,
than strategies that use more information and computation, they use non-compensatory decision-making heuristics to
for instance under uncertainty (Gigerenzer and Gaissmaier reduce the number of investment opportunities, and identify
2011). These heuristics determine where to search for cues their investment targets by focusing on quality signals rele-
(search rules), when to stop searching without computing an vant to their decision criteria, which in turn are derived from
optimal stopping point (stopping rules), and how to make a their objectives and motivations. As such, the focus on heu-
decision after search is stopped (decision rules) (Gigerenzer ristic attribution amounts to a first step towards modeling
and Gaissmaier 2011; Goldstein and Gigerenzer 2002). observable phenomena and their relationships. In our forth-
In the crowdfunding setting, quality signals serve as cues, coming full paper, we will therefore present the first com-
whereas the relevance of specific cues and their cue values prehensive model of micro-investment decision-making,
depends on investor decision criteria and their choice of de- which will include not only quality signals and heuristics,
cision-making heuristics. Several heuristics would appear but also investor decision criteria, motivations and objec-
be relevant in the crowdfunding context, including social tives.
heuristics such as imitate-the-majority, which investors ar- The implications are manifold as failing to fully under-
guably use when basing their investment decisions on the stand the process of decision-making at the core of crowd-
quality signal provided by capital accumulated in the course funding, and focusing on quality signals, as crowdfunding
of a crowdfunding campaign (Agrawal, Catalini, and Gold- success factors will likely cause all kinds of problems for
farb 2015). researchers and practitioners within the field. Unless the role
Ultimately, heuristics thus enable micro-investors to base of quality signals as heuristic attributes is understood, using
their decisions on quality signals substituting for unobserv- these quality signals to ensure crowdfunding success is
able attributes of potential investment targets, and to prevent bound to be hit and miss. Not only is the list of quality sig-
paralysis by analysis given the huge number of investment nals discovered in the literature long, but also the list is con-
opportunities and even greater number of quality signals as- tinuously growing, as there is no natural limit to how quality
sociated with these opportunities. Without heuristics, micro- may be signaled to reduce uncertainty for potential inves-
investors would struggle to process a potentially over- tors. Quality signals should therefore be studied in their own
whelming amount of information, while simultaneously be- right as low-level constructs, but more important is the func-
ing overwhelmed by information asymmetry and uncer- tion of these constructs in the decision-making process.
tainty. Both from a theoretical and practical perspective, we need
to turn to the process of decision-making rather than the
laundry lists of quality signals produced in the literature to
Discussion understand how quality signals may trigger an investment
While discovering a wide range of signals that inform the decision by matching the decision criteria that micro-inves-
investment decision, crowdfunding research has largely ne- tors derive from their objectives and motivations. Ulti-
glected the process whereby investors make decisions. Con- mately, this will deepen our understanding of how micro-
sequently, this line of research does not observe how quality investors make decisions, shedding important light on how
signals substitute investment target attributes in the deci- they use heuristics to guide their decision-making under un-
sion-making process, or how this heuristic process of attrib- certainty, when all they have to go by are a range of ambig-
ute substitution leads to intuitive, gut feel decisions. uous quality signals thought to co-vary with the underlying,
As the quality of early-stage entrepreneurial ventures is but unobservable quality of potential investment targets.
difficult to gauge due to information asymmetry and uncer- Finally, this approach offers rich opportunities for further
tainty, micro-investors must base their decisions on a range research. The model proposed in this paper is empirically
of quality signals that substitute for the underlying, but un- grounded to the degree that it is based on previous empirical
observable quality of the investment opportunity. As such, studies, but the model itself has yet to be empirically tested
these quality signals are heuristic attributes substituting for in a set-up where the decision-making process is the focus
target attributes that are unobservable due to uncertainty, in- of the research, and where the different factors are therefore
formation asymmetry and the unknowable quality of early- not reduced to determinants of crowdfunding success as the
lowest common denominator of crowdfunding research.
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