What makes behavior on crowdfunding platforms and the like different from that of a typical information cascade, Cong and Xiao find, is that on platforms with an all-or-nothing threshold, cascades happen in one direction only—in the choice to support the project. Consequently, financing novel projects and aggregating information can be efficient, they argue, challenging existing theories on information cascades.
An all-or-nothing system changes decision-making because people consider how their choices affect those who choose after them. In Cong and Xiao’s theoretical model, people who believe in a crowdfunding project always choose to support it because they know the final funding determination will reflect the wisdom of later decision-makers, minimizing their downside risk. If enough additional willing backers decide to fund a project, an information cascade may result, resolving the issue in the project’s favor.
Information cascades and all-or-nothing features also manifest themselves in VC rounds in which an entrepreneur approaches venture capitalists one by one, sequentially. But on crowdfunding platforms, the large investor base improves the efficiency of the process. And the theoretical insights should apply to other situations that also involve large numbers of people or “economic agents” making sequential decisions that have an economic effect. That happens in voting, for example—in national elections, early results announced in one state affect ongoing voting in another, and the election results in turn affect the economy. It also happens in fashion, when people wearing their new purchases in turn influence what others buy.
“Information production becomes more efficient, especially with a large crowd of agents, leading to more successes of good projects and weeding out some bad projects, and generally harnessing better the wisdom of the crowd,” the researchers write.
