chap18 - Asymmetric InformationChapter 18 Many economic...

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1 Page 1 1 Asymmetric Information—Chapter 18 Many economic transactions involve considerable uncertainty - Incomplete information on product quality - Employers may not know which workers shirk - Insurers have little information on client probability of illness or accident This uncertainty creates inefficiencies, because trades are based on poor information - Contractual agreements may reduce inefficiencies, but some problems remain Asymmetric information means that one party to a transaction has more information than the other 2 Principal-Agent Problems An agency relationship occurs when a party is employed to make economic decisions for another - The agent is the party that acts - The principal is the party whom the action affects Examples - manager is the agent and owner is the principal - hospital physician is agent and hospital is principal – the physician may take high-risk patients and impose costs on hospital - auto repairman is the agent and auto owner is the principal
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2 Page 2 3 Agents May not Fully Understand or Pursue Goals of the Principal Information is costly, so it is difficult for the principal to monitor the behavior of the agent Two key questions - How does imperfect monitoring affect how agents act? - How can principals construct incentives for agents to pursue the interests of the principal? 4 Managerial Incentives Owner-manager must forgo $1 in benefits for $1 in profits, so he bears the full cost of his decision If manager owns a third of the company, then manager benefits are “cheap” and the manager has an incentive to purchase extra benefits at the expense of profits Incentives to limit managerial abuse - owners may replace or threaten to replace management - takeover bid by outsiders who will replace management Market forces work imperfectly to police managers
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3 Page 3 5 Alternative Firm Objectives Many firm decisions are made by managers who are not the owner of the firm - managers do not receive profits, so they may not maximize profits - manager is not residual claimant like owner Manager may get more power or prestige from maximizing revenue or sales - large or growing market share gives the manager
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This note was uploaded on 12/08/2008 for the course ECON 101 taught by Professor Buddin during the Spring '08 term at UCLA.

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chap18 - Asymmetric InformationChapter 18 Many economic...

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