Out of control or right on the money?
Research Paper Title:
“Out of control or right on the money? Funder self-efficacy and crowd bias in equity crowdfunding”
Authors:
Regan Stevenson (Indiana University, Kelley School of Business)
Michael Ciuchta (UMass, Lowell)
Chaim Letwin (Suffolk University)
Jenni Dinger (Indiana University, Kelley School of Business)
Jeffrey Vancouver (Ohio University)
Background:
In 2016, the SEC released new securities legislation that allows entrepreneurs to secure equity capital from crowds of amateur funders via regulated equity crowdfunding portals. The main goal for equity crowdfunders is to select high-quality investments. However, equity crowdfunding is very risky and comes with a high level of uncertainty that makes it difficult to identify high quality ventures. Like in most entrepreneurial settings, having confidence in oneself results in a positive outcome. But is believing in yourself always beneficial when investing in new startup ideas in equity crowdfunding? Professor Regan Stevenson and colleagues explored this question by conducting three research studies. The researchers investigate how inflated self-efficacy affects investment decision-making performance. They also introduce the term “crowd bias,” which they define as an individual’s tendency to follow the opinions of the crowd despite the presence of contrary objective quality indicators.
Methodology:
Sample: Study 1 - business school students at a leading business school in the Midwestern United States, Study 2 - business school students at a Midwestern business school participated in the study in exchange for extra course credit, Study 3 - participants from a large diversified international sample of individuals who were actively engaged in the crowd-based economy using Amazon's Mechanical Turk crowdsourcing platform (MTurk)
Sample Size: Study 1 - 163, Study 2 - 76, Study 3 - 285
Analytical Approach: Study 1 and Study 2 - PROCESS SPSS path analysis macro, Study 3 - Chow tests
Hypotheses:
1a) Funder self-efficacy is negatively related to funder searching effort.
1b) Funder searching effort is positively related to funder decision-making performance.
1c) Funder searching effort mediates the negative relationship between funder self-efficacy and funder decision-making performance.
1d) Funder searching effort mediates the positive relationship between funding knowledge and funder decision-making performance.
2) Unqualified crowd cues moderate the negative indirect relationship between self-efficacy and funder decision-making performance through searching effort, such that the negative indirect effect will be larger when unqualified crowd cues are observable compared to unobservable.
Research Question: (1a) Using a field sample, will funders with high self-efficacy be less likely to select high quality pitches compared to funders with high funding knowledge, and in contrast, (1b) will funders with high self-efficacy be more likely to follow crowd cues compared to funders with high levels of funding knowledge?
Results:
Study 1 - Participants in the self-efficacy group had a negative relationship with funder searching effort, providing support for Hypothesis 1a. In the self-efficacy condition, funder searching effort had a positive effect on funder decision-making performance, providing support for Hypothesis 1b. This study indicates that there was evidence of an indirect effect of self-efficacy on funder decision-making performance through searching effort, providing support for Hypothesis 1c. There was a positive relationship between funding knowledge and searching effort and searching effort and decision-making performance (1d).
Study 2 - Amateur funders in the high self-efficacy condition were less likely to recognize and react to negative pitch cues when positive crowd cues were present, leading the self-efficacy group to invest nearly three times as much in the poor-quality venture based on a mean comparison with the high knowledge group.
Study 3 - The results of the Chow test indicated that funders with relatively high self-efficacy were significantly less likely to fund the high-quality pitch compared to funders with high funding knowledge. In contrast, regarding research question 1b, the results of the Chow test revealed that funders with high self-efficacy were more likely to follow crowd cues relatively to funders with high funding knowledge.
Conclusion:
Contrary to past research, self-efficacy is not always good in entrepreneurial settings. Self-efficacy was negatively related to funder decision-making performance through funder searching effort. Also, high levels of self-efficacy increased crowd bias, which meant that funders overweight the opinions of the crowd and followed the crowd into poor quality funding options. This could result in substantial investment losses for amateur funders. To increase funding knowledge, policy makers could require amateur equity crowdfunders to undertake training programs. Also, investment restrictions that limit the individual funding limit on crowdfunding platforms may be helpful, although the SEC has no intent on enforcing such a restriction.
Research Video: