Chapter 9: Transactions Costs, Asymmetric Information, and Structure of Financial
1. Adverse Selection –Asituation where sellers have information that buyers do not about some
aspect of product quality
- Insurance and Investor like low-risk and high return
- It covers making bad decisions because of not having the complete information.
2. Moral Hazard – Risk that people take actions after they have entered into a transaction that
will make the other party worse off
- I did not warn someone about a bad condition of an item before selling it such as car
Moral Hazard in Stock Market
- Organization of large publicly traded firms result in a separation of ownership from control.
- Firms are owned by shareholders but run by top management CEO, CFO, COO, etc
- To reduce this problem, the SEC requires managers to issue financial statements.
Moral Hazard in Bond Market