A1 Introduction

Question 1

Definition Information Asymmetry

Answer 1

deals with decisions in transactions
one party has more/better information
parties have conflicting interests
=> one party can take advantage

Question 2

Principal-Agent Model: players

Answer 2

• *Principal** is the party who designs terms of contract and offers it (take-it-or-leave-it contract => all bargaining power
• *Agent** is the party who decides whether to accept or decline the contract offered => no bargaining power

Question 3

Two big information problems

Answer 3

• *Moral hazard (hidden action)**: unobservable effort, but observable (&verifiable) outcome. Solution: Convince agent to do what principal wants
• *Adverse selection (hidden information)**: unobservable desirable characteristic. Solution: e.g. collateral

Question 4

Asymmetric information in financial markets can occur between …

Answer 4

• *investors** and entrepreneurs: effort choice of the entrepreneur (Moral Hazard), the true quality of the firm (Adverse selection) -> under-/overinvestment
• *shareholders** and management: Perks (MH), Project choice (AS/MH)
• *supervisors** and banks: investment choices of banks (MH)