Signaling Quality: How Refund Bonuses Can Overcome Information Asymmetries in Crowdfunding

Crowdfunding can suffer from information asymmetry, leaving some investors disappointed with low-quality projects, whereas other high-quality projects remain unfunded. We show that refund bonuses, which provide investors a payment if a fundraising campaign is unsuccessful, can signal project quality and help overcome the market failure in crowdfunding. Because strong projects have a lower risk of bonus payout, entrepreneurs with strong projects are more likely to offer bonuses. This signals high quality to investors, and due to their updated beliefs, this drives investment toward such projects. An experiment provides supporting empirical evidence for the benefits of this signaling solution to the problems of information asymmetry in crowdfunding.