Asymmetric Information

Asymmetric information theory

Consider a start-up firm.If the entrepreneur does well and the company is sucessful , they reap large returns.But shareholders of a firm have less information than the managers about the firm.

Asymmetric information - Different levels of information available to different people in an economic interaction or exchange.

Informed party will always have the tendency to not giving all the information to uninformed party because they may have an incentive to conceal it.This situation occurs on both the example of hidden actions and hidden characteristic.

Hidden Actions : Principal-Agent and Moral Hazard

Agency Theory

The agency theory is a supposition that explains the relationship between principals and agents in business.Agency theory is concerned with resolving problems that exist in agency relationships.

The desire target of principal and agent is different

Different attitudes and risk tolerances of principal and agent toward problems

Moral Hazard

Moral hazard occurs when principal unable monitor the agent’s attitude as the agent tends to not putting in all effort when performing a task.

Various ways to resolve this problem:

Better monitoring

To catch irresponsible behavior of agent

High wages

To motivate the agent to work harder

Delayed payment

As a penalty to prevent agent from shirking their responsibilities