EC223 Chapter 8: Ch 8
Document Summary
8 an economic analysis of financial structure p. 198. Eight basic facts about financial structure: adverse selection and moral hazard. Tools to solve adverse selection problem (facts 3-8) Tools to solve the moral hazard problem in equity contract (fact 1, 3, and 5) Tools to solve moral hazard in debt contracts (facts 5, 7, and 8) 8 basic facts: stocks are not the most important sources of external financing for businesses (12%) Issuing marketable debt and security is not the primary way in which businesses finance their operations (15% bond and 12% stock) Asymmetric info: adverse selection and moral hazard: asymmetric information: one party has insufficient knowledge about the other party involved in a transaction, agency theory analyses how asymmetric information problems affect economic behavior. Two types of asymmetric information: adverse selection occurs before the transaction, example of used car market. Items: adverse selection increases the chances that a loan might be made to a bad credit risk borrower.
