10. Corporate Finance under Asymmetric Information

Question 1

Asymmetric information

Answer 1

Whenever one party to an economic transaction possesses greater material knowledge than the other party

Question 2

Agency problem

Answer 2

• Conflict of interest between two parts involved in a contract
• Two parts are called the principal and the agent
• Their relationship implies that the principal gives some form of transfer to the agent to perform a task

Question 3

An agency problem might arise under two conditions:

Answer 3

• Private information

- Different objectives

Question 4

Under these conditions (private information & different objectives), there can be two agency problems:

Answer 4

• Adverse Selection

- Moral Hazard

Question 5

Adverse selection

Answer 5

Adverse selection occurs when there’s asymmetric information prior to a deal between a buyer and a seller

Question 6

Moral hazard

Answer 6

Moral hazard occurs when there is asymmetric information between two parties and change in behaviour of one party after a deal is struck