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 …show more content…
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…
made all boils down to the alignment of incentives for both the executives and the company. In the above research executives who do not have the same incentives as the company that they are working for will be more likely to make decisions based on their own self-interest and not in the interest of the company. In the example of Apple, Inc. the people who have the power to make decisions now have the same incentives as the company. In other words if the decisions that the executives make pushes stock prices higher then executives will do better; on the other hand, if those decisions drive stock prices lower than the executives will not do so
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 …show more content…
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…
made all boils down to the alignment of incentives for both the executives and the company. In the above research executives who do not have the same incentives as the company that they are working for will be more likely to make decisions based on their own self-interest and not in the interest of the company. In the example of Apple, Inc. the people who have the power to make decisions now have the same incentives as the company. In other words if the decisions that the executives make pushes stock prices higher then executives will do better; on the other hand, if those decisions drive stock prices lower than the executives will not do so