Scandinavian Working Papers in Economics

Working Paper Series in Economics and Institutions of Innovation,
Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies

No 450: How Wise Are Crowd? A Comparative Study of Crowd and Institutions in Peer-to-Business Online Lending Markets

Ali Mohammadi () and Kourosh Shafi ()
Additional contact information
Ali Mohammadi: Department of Industrial Economics and Management, Royal Institute of Technology (KTH), Centre of Excellence for Science and Innovation Studies (CESIS) and Swedish house of finance.
Kourosh Shafi: Center for Entrepreneurship and Innovation Warrington College of Business, University of Florida.

Abstract: Funding small businesses used to be the exclusive domain of angel investors, venture capitalists, and banks. Crowd have only recently been recognized as an alternative source of financing. Whereas some have attributed great potential to the funding provided by crowd (“crowdfunding”), others have clearly been more skeptical. We join this debate by examining the performance of crowd 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. Exploiting the randomized assignment of originated loans to institutions and the crowd in the online peer-to-business platform of FundingCircle, we find that crowd underperform institutions in screening SMEs, thereby failing to lend at interest rates that adjust for the likelihood of defaulting on a loan. Moreover, the underperformance gap of crowd compared with institutions widens with risky and small loans, suggesting that crowd lack the expertise to assess the risks or the incentive to expend resources to perform due diligence. Overall, our findings highlight when crowd face limitations in screening SMEs.

Keywords: peer-to-peer lending; institutional investors; online loan market; SME; wisdom of the crowd

JEL-codes: D80; G11; G20

53 pages, March 3, 2017

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