In a recent paper, “Equity Crowdfunding and Governance: Toward an Integrative Model and Research Agenda,” Douglas J. Cumming, Tom Vanacker, and Shaker A. Zahra consider the governance mechanisms in equity crowdfunded offerings. Venture-backed companies generally have an established governance mechanism. Public companies also have elaborate governance frameworks. Usually, companies that rely on equity crowdfunded offerings generally attract smaller holders, who may be unsophisticated (relative to venture or private equity investors) and may not be effective in enforcing governance provisions. Without governance mechanisms, concerns related to the quality of available information and adverse selection increase. Venture investors generally conduct extensive due diligence before investing, negotiate for control rights to protect their investments, and may be involved actively in monitoring the progress of portfolio companies. In crowdfunded offerings, investors generally do not meet company management, and also do not necessarily have any ties to other investors. A premise of crowdfunded offerings was that dispersed investors would access data and that the collective wisdom of the crowd would provide a mechanism for curbing adverse selection. However, there is no evidence that this is actually true. Some equity crowdfunding platforms may play a role in conducting diligence and may, especially if they focus on pooled investments, have reputational concerns that would create incentives for them to monitor investments more closely. The authors note that most crowdfunding regulations do not impose any governance requirements for companies seeking to raise capital this way, which would offer the possibility of addressing the adverse selection problem and avoiding creation of zombie firms or empty shell companies.
