What are some ways your company is dealing with the moral hazard problem and suggest best...

What are some ways your company is dealing with the moral hazard problem and suggest best practices used in the industry to deal with it.

References please.

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Expert Solution

Adverse selection occurs when one party has more information regarding a decision or situation than the other party. Therefore, the uninformed party of the situation may could make an undesirable choice in the selection of goods or services. Moral hazard on the other hand is caused when one party to the transaction takes hidden actions,

actions that it knows the other party cannot observe which once again leads to hidden information (Baye, 2010). To be more specific, moral hazard is deceptive behavior of one party and a disadvantage of the other party. For example, a car salesman selling a lemon, or a health insurance agent selling more insurance or insurance that an individual doesn’t need just to make a profit. There are too many transactions or business deals done daily in this manner. Southwest Airlines deals with moral hazards by paying their employees the compensation that they deserve. As stated previously, they believe in taking care of their employees which in turn, motivates them to take care of their passengers and customers. Per Airways Magazine, Southwest Airlines pilots are the highest paid in the U. S. Airline Industry (V. Bhaskara). Solutions to eliminating moral hazards is to eliminate the information asymmetry, offer incentives to want to perform a above the average job as well as steer the employees to want to perform the desired behavior based on SWA’s policies rather than undesirable behavior. Another solution is to implement policies that are specific to moral hazards and make sure to monitor regularly.

Identify a principal agent problem in your company and evaluate the tools it uses to align incentives and improve profitability: To identify principal-agent problems, SWA should focus on a few important questions.

1.Is anyone making bad decisions and who are they?

2.Are the employees’ incentive program relevant to them in making good decisions?

3.For example, is the performance evaluation versus the award system relevant?

4.Are the employees informed enough to mack good decision?

Rahul Sunny answered 2 months ago

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