I understand what Moral Hazard is (people taking risks because they won’t be the ones paying the costs if it goes badly), but I don’t understand what it has to do with Asymmetric/Imperfect Information
In: Economics
Asymmetric info arises in the situation where a company is run by a separate person than the company is owned by. The director has all the information about the potential for future projects, income and expenditure etc.
Now the moral hazard here arises because a director could benefit personally from running a company badly in order to boost short term metrics, and therefore their bonuses. By providing limited imperfect information to shareholders who need to back the decision they can steer the decision to benefit themselves instead of the shareholders.
ROCE (Operating profit/Capital Employed) is a good example here, if a director is targeted by ROCE the director will attempt to avoid investment heavy projects which provide a long term boost in profits, but would increase the capital employed, thereby decreasing the metric they are rewarded by. By providing limited data on the availability of investment options the director can persuade the investors they’ve made a good decision.
Latest Answers