Crowdfunding, essentially a type of microfinance, has experienced an unprecedented growth over the last few years, becoming an important driver of economic and financial development. Recently, the World Bank has estimated that crowdfunding could reach U.S. $90 billion by 2020, surpassing venture capital and angel capital as a means of financing. While much of this growth has been spurred by lending-based crowdfunding, an interesting phenomenon has been the strong emergence of reward crowdfunding, in which project creators (i.e., entrepreneurs) promise future in-kind rewards in exchange for backer contributions. In reward crowdfunding platforms, project backers represent “hybrid” stakeholders, in between investors and consumers.

The hybrid nature of project backers renders their contractual claims difficult to regulate and enforce in case of contract breach by creators. Reward crowdfunding does not involve the offering of securities and therefore does not fall under the U.S. securities laws or the jurisdiction of the Securities and Exchange Commission (SEC). As such, SEC rules specifically designed for equity crowdfunding do not apply. Reward crowdfunding platforms also disclaim any liability, stating that they act as mere intermediaries. As it is often the case for evolving technologies, the emergence of reward crowdfunding led to a regulatory limbo, in which backers were initially left without much recourse.

A regulatory void is particularly troublesome given the adverse selection and moral hazard problems that characterise these markets. Information asymmetries between creators and backers regarding creator ability and project quality (adverse selection), coupled with backers’ inability to induce creator effort and ensure that pledged funds are not diverted for personal consumption (moral hazard), are in fact inherent to crowdfunding. Project creators may rely on disclosure to signal their ability and project quality. However, the lack of clear regulation and oversight in the early years of reward crowdfunding, the absence of a trustworthy and independent third-party (e.g., an auditor) that certifies the information disclosed by the creator, and the one-time nature of most of these transactions (many creators access these markets only once) may render disclosure not credible. In these markets, in fact, creators can easily engage in “cheap talk.” For example, when they provide voluntary disclosures about the project and themselves with the aim of enticing backers into pledging funds, they can “oversell” the project or, in extreme circumstances, communicate false information in bad faith.

In our recent paper, we examine two main questions. First, does (voluntary) disclosure facilitate contracting in reward crowdfunding, or is it mainly perceived as cheap talk? Second, to what extent does an increase in regulatory oversight enhance the perceived credibility of disclosure?

We shed light on these questions by exploiting a quasi-experiment provided by a notorious rule change in Kickstarter, the world leading reward crowdfunding platform. On September 19, 2014, it was announced that Kickstarter would change its terms of use to clarify the nature of the contract between backers and creators. This change, which was aimed at alleviating moral hazard, essentially strengthened the contractual position of backers by explicitly requiring creators to fulfil their obligation to deliver the promised rewards (or refund pledged amounts) and by clearly spelling out the possibility of legal action against creators. The main mechanism through which such legal action may take place is consumer protection regulation, which is aimed at protecting consumers from “unfair and deceptive trade practices” and significantly varies in stringency across U.S. states. While consumer protection regulation was already in place to protect “traditional” consumers, the September 2014 rule change brought the possibility of legal action to the attention of creators and backers, thereby shifting substantial contractual risk from backers to creators. This effectively altered the perception of consumer protection law applicability in the context of Kickstarter given that in 2012, i.e., prior to the rule change, Kickstarter had emphasised that “they are not a store” precisely to limit their own legal exposure.

In our empirical analyses, we first examine the association between disclosure and project funding to gauge the extent of disclosure credibility on the platform. We find that disclosure (measured as either the length of the project’s campaign pitch or the length of the project’s risks and challenges section) exhibits a positive and robust association with pledged amounts and the probability of a project being funded, which suggests that backers take disclosures by creators into account when deciding to make a pledge.

Next, we turn to the change in Kickstarter’s terms of use announced on September 19, 2014. The cross-sectional variation in consumer protection stringency across states allows us to use a generalised difference-in-differences (DiD) research design to gauge the differential effect of this change on perceived disclosure credibility. Our DiD identification strategy effectively compares disclosure credibility (i.e., the association between project success and disclosure) before and after the rule change by looking at differential responses across states, depending on the varying degrees of stringency in their pre-existing consumer protection laws. Our identifying assumption is that, prior to the rule change, there was limited awareness that state consumer protection laws would apply to Kickstarter creators and backers, despite state consumer protection laws being already in place. We find that, following the rule change, the association between disclosure and both the likelihood that a project is funded and the amount of funds pledged to the project becomes stronger, which we interpret as an increase in the perceived credibility of disclosure. This increase is more pronounced in states with stricter consumer protection regulation. We conduct a battery of sensitivity tests to rule out potential alternative explanations, including a county-level analysis in which we restrict our sample to contiguous counties in different states, a test for differences in pre-treatment trends and a test that relies on shorter windows surrounding the event date.

We also examine alternative measures of project success, such as the number of (new and returning) backers and the level of backer engagement measured as the number of comments on a project’s website. The evidence from these tests is also consistent with disclosure playing a stronger role in facilitating contracting between backers and creators in states with stricter consumer protection regulation following the rule change.

Further, we conduct cross-sectional analyses to explore heterogeneity in treatment effects and find that the increase in the perceived credibility of disclosure varies with the magnitude of rewards, as well as across states with court busyness and with degree of confidence in courts. Specifically, the effect of the rule change on the project success-disclosure relation is stronger when litigation risk is likely to be higher, such as when project rewards are larger, when courts have a lower caseload and when confidence in courts is higher.



Stefano Cascino is an assistant professor of accounting at LSE. He received in PhD in accounting from the University of Naples Federico II. His primary research interests include international disclosure regulation, corporate governance and credit markets. His research appears in leading journals and has generated the interests of practitioners and standard setters. He is a member of the editorial board of Accounting and Business Research. He has received funding and research grants from the Institute of Chartered Accountants of Scotland (ICAS) and the European Financial Reporting Advisory Group (EFRAG). For his dedication to teaching, he received in 2012 the LSE Teaching Excellence Award, and the LSE Education Excellence Award in 2016, 2017, and 2018.

Maria Correia is an associate professor of accounting at LSE. She received her PhD in accounting from Stanford University. Before joining the LSE she was an assistant professor of accounting at the London Business School. Her research interests are in the area of default prediction and credit markets, and enforcement and securities litigation. She is the recipient of the Best Paper Award at the 2011 Review of Accounting Studies Conference and her papers are published in leading journals. She is a member of the editorial board of Review of Accounting Studies and European Accounting Review, and an associate editor of Accounting and Business Research.

Ane Tamayo is a professor of accounting at LSE. She received her PhD in finance from Rochester University. Before joining the LSE she was an assistant professor of accounting at the London Business School. Her research interests include the impact of accounting information on capital markets, the role of financial intermediaries, and corporate social responsibility. Her research appears in leading journals. She is an editor of Journal of Business Finance & Accounting, and an associate editor of European Accounting Review. She is the recipient of a European Corporate Governance Institute (ECGI) prize for research into social capital, trust and firm performance during the financial crisis.