Does Consumer Protection Enhance Disclosure Credibility in Reward Crowdfunding?

• DOI: http://doi.org/10.1111/1475-679X.12289
• Date: 01 December 2019
• Published date: 01 December 2019
• Author: STEFANO CASCINO,MARIA CORREIA,ANE TAMAYO

DOI: 10.1111/1475-679X.12289

Journal of Accounting Research

Vol. 57 No. 5 December 2019

Printed in U.S.A.

Does Consumer Protection Enhance

Disclosure Credibility in Reward

Crowdfunding?

STEFANO CASCINO ,∗MARIA CORREIA ,∗

AND ANE TAMAYO ∗

Received 3 July 2018; accepted 17 September 2019

ABSTRACT

We study how the interplay of disclosure and regulation shapes capital alloca-

tion in reward crowdfunding. Using data from Kickstarter, the largest online

reward crowdfunding platform, we show that, even in the absence of clear

regulation and enforcement mechanisms, disclosure helps entrepreneurs ac-

cess capital for their projects and bolsters engagement with potential project

backers, consistent with the notion that disclosure mitigates moral hazard.

We further document that, subsequent to a change in Kickstarter’s terms of

use that increases the threat of consumer litigation, the association between

project funding and disclosure becomes stronger. This evidence suggests that

consumer protection regulation enhances the perceived credibility of disclo-

sure. We find the effect of the change in terms of use to be more pronounced

∗London School of Economics

Accepted by Philip Berger. We appreciate the helpful comments and suggestions of

an anonymous referee, Saverio Bozzolan, Ulf Br¨

uggemann, Sudheer Chava, Mark Clat-

worthy, Miklos Farkas, Joachim Gassen, Stanimir Markov, Facundo Mercado, Maximilian

Muhn, Raghu Rau, Mariano Scapin, Henri Servaes, Felix Vetter, and seminar participants

at the 12th Tel Aviv Conference in Accounting, 2018 Cambridge Centre for Alterna-

tive Finance Conference, Aarhus University, ESSEC Business School, King’s College Lon-

don, Humboldt University of Berlin, INSEAD, London School of Economics, University of

Bologna, University of Bolzano, University of Bristol, University of Exeter, and Warwick Busi-

ness School. We thank Daniel Rabetti for providing web-scraping research assistance. An

online appendix to this paper can be downloaded at http://research.chicagobooth.edu/

arc/journal-of-accounting-research/online-supplements.

1247

CUniversity of Chicago on behalf of the Accounting Research Center, 2019

1248 S.CASCINO,M.CORREIA,AND A.TAMAYO

in states with stricter consumer protection regulations. Taken together, our

findings yield important insights on the role of disclosure, as well as on the

potential effects of increased regulation on crowdfunding platforms.

JEL codes: G18; M41; M48; O31; O38

Keywords: crowdfunding; disclosure; consumer protection; regulation;

enforcement

1. Introduction

We study how the interplay of disclosure and regulation shapes capital al-

location in reward crowdfunding. Crowdfunding, essentially a type of mi-

crofinance, has experienced an unprecedented growth over the last few

years, becoming an important driver of economic and financial devel-

opment. 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.1Although 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., en-

trepreneurs) promise future in-kind rewards in exchange for backer con-

tributions. On reward crowdfunding platforms, project backers represent

“hybrid” stakeholders, in between investors and consumers (Belleflamme,

Omrani, and Peitz [2015]).

The hybrid nature of project backers renders their contractual claims dif-

ficult 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.2Reward 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 crowd-

funding led to a regulatory limbo, in which backers were initially left with-

out much recourse.

A regulatory void is particularly troublesome given the adverse selection

and moral hazard problems that characterize these markets. Information

asymmetries between creators and backers regarding creator ability and

project quality (adverse selection), coupled with the inability of backers

to induce creator effort and ensure that pledged funds are not diverted

for personal consumption (moral hazard), are in fact inherent to crowd-

funding (Agrawal, Catalini, and Goldfarb [2014], Belleflamme, Omrani,

and Peitz [2015]). Project creators may rely on disclosure to signal their

1Forbes, TrendsShow Crowdfunding to Surpass VC in 2016, June 9, 2015 (available at: https://

www.forbes.com/sites/chancebarnett/2015/06/09/trends-show-crowdfunding-to-surpass-vc-

in-2016/).

2The Jumpstart Our Business Startups (JOBS) Act, signed into law on April 5, 2012, legal-

izes equity crowdfunding by relaxing several restrictions related to the sale of securities.

DISCLOSURE CREDIBILITY IN REWARD CROWDFUNDING 1249

ability and project quality (e.g., Grossman [1981]). 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 creators, and the one-time na-

ture 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.3For example, when they provide volun-

tary 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.4

In this paper, we examine two main questions. First, does (voluntary) dis-

closure facilitate contracting in reward crowdfunding, or is it mainly per-

ceived as cheap talk? Second, to what extent does an increase in regulatory

oversight enhance the perceived credibility of disclosure?

We shed light on the above questions by exploiting a widely publicized

rule change on Kickstarter, the world’s leading reward crowdfunding plat-

form. On September 19, 2014, Kickstarter announced that it would change

its terms of use to clarify the nature of the contract between backers and cre-

ators.5This change, which was aimed at alleviating moral hazard, essentially

strengthened the contractual position of backers by explicitly requiring cre-

ators to fulfill their obligation to deliver the promised rewards (or refund

pledges) 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 con-

sumers from “unfair and deceptive trade practices” and significantly varies

in stringency across U.S. states. Although 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 cre-

ators 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 emphasized that they were not a “store”

precisely to limit their own legal exposure.6

3Stocken [2000] develops a model in which managers can make unverifiable disclosures to

investors about the payoffs of a project and shows that, in a single-period game, managers do

not make any informative disclosures in equilibrium.

4Project disclosures may,instead, betruthful. Gigler [1994] develops a model in which pro-

prietary costs, and firms’ opposing incentives to disclose positive (negative) information to in-

vestors (competitors) may render disclosures credible. Agrawal, Catalini, and Goldfarb [2014]

highlight other mechanisms that can lead to truthful disclosure in the context of crowdfund-

ing, and specifically the role of crowd due diligence. There are, in fact, typically many more

(and more varied) individuals reviewing a given project than in a traditional financing setting.

5As Kickstarter typically calls its terms of use “rules,” we refer to the change in Kickstarter’s

terms of use announced on September 19, 2014 as “the rule change.”

6Kickstarter, Kickstarter is not a store, September 19, 2012 (available at: https://www.

kickstarter.com/blog/kickstarter-is-not-a-store).