A friend in need is a friend indeed: Strategic insider investments

Speaker: Yizhou Xiao, The Chinese University of Hong Kong (CUHK)

Abstract
This paper studies the information role of financing from family and friends.  While a large strand of literature considers insider financing as a positive signal of high-quality project, we show that, based on investment decisions and funding performance data from a crowdfunding platform, the insider financing might be a signal of performance manipulation, and hence negatively correlated with quality of projects. We show that entrepreneurs with mediocre early funding performance strategically allocate contributions from family and friends to encourage unsophisticated investors to herd. The manipulation is non-monotonic. Entrepreneurs choose not to manipulate when project performance is bad and are very unlikely to be successful. Taking strategic moves into account, sophisticated investors view financing from family and friends as a negative signal and are less likely to invest. The manipulation exists even when sophisticated investors have significant market power and projects with manipulation deliver poorer funding performance.