Question

Briefly describe the concept of "moral hazard" as it relates to corporations in the presence of government bailouts.

Who realizes the benefits and who bears the cost of moral hazard?

How can the costs of moral hazard be reduced through effective corporate governance?

Answer 1

Moral hazard means when a entity who does not bear the full costs of the risk ,has an incentive to increase its exposure to risk.its like information asymmetry where risk taking parties know about the intention then the party paying consequences of risk.

We can take example of principle agent problem in which if agents know more than principle then agent has an incentive .

In case of insurance of a car ,a person who has done his car insurance will take less efforts to lock the car because he knows that if his car will be lost by theft he can get claim with company.hence here insurance company bears the cost and the person who is having car insurance is benefited.

Cost of moral hazard will be reduced bt taking effective governance.means both the parties have full information about the product company employees and stakeholders have true information about the companies actual position.Managers and investors also share true information about company.so that risk will be reduced.