Moral Hazard in Equity Deals: The Principal-Agent Problem The separation of ownership and control entails moral hazard, in that the managers (the agents) might act inside their own fascination rather than in the interest of the stockholder-owners (the principals) because the managers have fewer incentive to optimize profits than the stockholder-owners carry out. Tools to assist Solve the Principal-Agent Difficulty
Production of Information: Monitoring Stockholders engage in a particular type of data production, the monitoring from the firm's activities: auditing the firm regularly and checking on what the managing is doing.
Government Regulation to enhance Information Government authorities have laws and regulations to push firms to adhere to standard accounting principles that will make profit verification easier. In addition they pass laws to impose stiff criminal penalties about people who hide and rob profits.
Monetary Intermediation Venture capital firms pool the resources of their partners and use the money to help future entrepreneurs start off new businesses.
Financial debt Contracts This can be a contractual contract by the debtor to spend the lender fixed dollar amounts at routine intervals. We have a reduced need to monitor managers and the agreement is more appealing than the equity contract.
4. Common accounting guidelines make earnings verification less difficult, thereby lowering adverse assortment and moral hazard problems in financial market segments and hence making them operate better. Standard accounting principles help to make it simpler for investors to screen out great firms by bad organizations, thereby minimizing the undesirable selection injury in financial market segments. In addition , they make it more difficult for managers to understate income, thereby reducing the principal-agent (moral hazard) problem.
with complete insurancewithout a seawall400, 000×0. 02=8, 500
with a seawall400, 000×0. 005=2, 000
with partial insurancewithout a seawall300, 000×0. 02=6, 000
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