Moral Hazard And The Principal-Agent Factor Analysis

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Moral Hazard and the Principal-Agent Problem Defined:

Moral Hazard can be easily defined as an individual or business will be more likely to take risks because the negative consequences of the risky behavior will be felt by another individual or business (Hill). For example an individual who gets their automobile insured might start speeding or other reckless driving behavior. That same person might let their insurance lapse and will continue to start driving safe once again. However, the insurance companies have already figured people will engage risky behavior if they fell like there would be no cost associated with the risk which is why the insurance companies provide incentives such as not replacing the full value of the car if anything
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Knowing what makes up executive pay is an important aspect in making the connection between compensation and incentives to the principal-agent problem. Executives might be more interested in pursuing their own well-being such as the executives of Enron. Frydman and Jenter suggest that if the executive’s interests are not aligned with the interests of the firm then that can be extremely devastating to a company (page 7). An executive might make a decision that will better benefit the CEO rather than the …show more content…
“implemented a new rule that executive officers must hold triple their base salary in company stock” (Worstall). Apple’s new policy goes along with the company’s requirement for the CEO to hold 10 times the base salary in company stock and nonemployee directors to hold 5 times their base salary in company stock. Having this change aligns the incentives of the executives with the best interest of the firm.

The reason for this change was because Apple’s stock prices were not doing so well at that time, the company had a growing cash pile, and competition is getting more and more fierce (Jessica E. Lessin and Joann S. Lublin). Another reason why Apple made the changes is because the company wants its executives to think more like owners and not just “hired help.” Owners of a company are more inclined to make decisions that would better benefit the company and not just the executive (Rob

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