How Wise Are Crowd?

A Comparative Study of Crowd and Institutions in Peer-to-Business Online Lending Markets

Ali Mohammadi, Kourosh Shafi

Research output: Contribution to conferencePaperResearchpeer-review

Abstract

Funding small businesses used to be the exclusive domain of angel investors, venture capitalists, and banks. Crowds have only recently been recognized as an alternative source of financing. Whereas some have attributed great potential to the funding provided by crowds (?crowdfunding?), others have clearly been more skeptical. We join this debate by examining the performance of crowds to screen the creditworthiness of small and medium sized enterprises (SMEs) compared with institutions in the context of new online peer-to-business lending markets. We exploit the randomized assignment of originated loans to institutions and crowds in the online peer-to-business platform of FundingCircle, and find that crowds underperform institutions in screening SMEs, thereby failing to lend at interest rates that adjust for the likelihood of defaulting on a loan. The interest rates set by crowds predict default 39% less accurately than institutions. Moreover, the underperformance gap of crowds compared with institutions widens with risky and small loans, suggesting that crowds lack the expertise to assess the risks or the incentive to expend resources to perform due diligence. Overall, our findings highlight when crowds face limitations in screening SMEs.
Original languageEnglish
Publication date2019
Number of pages36
Publication statusPublished - 2019
EventDRUID19 Conference - Copenhagen Business School, Frederiksberg, Denmark
Duration: 19 Jun 201921 Jun 2019
Conference number: 41
https://conference.druid.dk/Druid/?confId=59

Conference

ConferenceDRUID19 Conference
Number41
LocationCopenhagen Business School
CountryDenmark
CityFrederiksberg
Period19/06/201921/06/2019
Internet address

Cite this

Mohammadi, A., & Shafi, K. (2019). How Wise Are Crowd? A Comparative Study of Crowd and Institutions in Peer-to-Business Online Lending Markets. Paper presented at DRUID19 Conference, Frederiksberg, Denmark.
Mohammadi, Ali ; Shafi, Kourosh. / How Wise Are Crowd? A Comparative Study of Crowd and Institutions in Peer-to-Business Online Lending Markets. Paper presented at DRUID19 Conference, Frederiksberg, Denmark.36 p.
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Mohammadi, A & Shafi, K 2019, 'How Wise Are Crowd? A Comparative Study of Crowd and Institutions in Peer-to-Business Online Lending Markets' Paper presented at, Frederiksberg, Denmark, 19/06/2019 - 21/06/2019, .

How Wise Are Crowd? A Comparative Study of Crowd and Institutions in Peer-to-Business Online Lending Markets. / Mohammadi, Ali; Shafi, Kourosh.

2019. Paper presented at DRUID19 Conference, Frederiksberg, Denmark.

Research output: Contribution to conferencePaperResearchpeer-review

TY - CONF

T1 - How Wise Are Crowd?

T2 - A Comparative Study of Crowd and Institutions in Peer-to-Business Online Lending Markets

AU - Mohammadi, Ali

AU - Shafi, Kourosh

PY - 2019

Y1 - 2019

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AB - Funding small businesses used to be the exclusive domain of angel investors, venture capitalists, and banks. Crowds have only recently been recognized as an alternative source of financing. Whereas some have attributed great potential to the funding provided by crowds (?crowdfunding?), others have clearly been more skeptical. We join this debate by examining the performance of crowds to screen the creditworthiness of small and medium sized enterprises (SMEs) compared with institutions in the context of new online peer-to-business lending markets. We exploit the randomized assignment of originated loans to institutions and crowds in the online peer-to-business platform of FundingCircle, and find that crowds underperform institutions in screening SMEs, thereby failing to lend at interest rates that adjust for the likelihood of defaulting on a loan. The interest rates set by crowds predict default 39% less accurately than institutions. Moreover, the underperformance gap of crowds compared with institutions widens with risky and small loans, suggesting that crowds lack the expertise to assess the risks or the incentive to expend resources to perform due diligence. Overall, our findings highlight when crowds face limitations in screening SMEs.

M3 - Paper

ER -

Mohammadi A, Shafi K. How Wise Are Crowd? A Comparative Study of Crowd and Institutions in Peer-to-Business Online Lending Markets. 2019. Paper presented at DRUID19 Conference, Frederiksberg, Denmark.