Lecture 5 Flashcards
do managers’ interests always align with owners?
no
asymmetric information = ?
one party has information that the other party does not
who is the principal/agent between manager and owner or manager and owner?
manager (principal), student (agent)
owner (principal), manager (agent)
how is one determined as the principal or agent?
the agent can impact the principal’s payoffs through their actions
the agent has hidden actions/attributes
how is hiring people different from purchasing goods/services?
humans can have hidden actions e.g., laziness, unproductive output etc.
no guarantee of performance level nor is it controllable
incomplete contract = ?
incomplete contract doesn’t specify the rules regarding every little aspect of the deal
why do workers work hard?
work ethic
feelings of responsibility (morality)
gratitude
fear of being fired
promotion
commission
can traders easily verify quality with incomplete contracts?
no
if they can observe quality, it wouldn’t be verifiable in court
(e.g., employee work ethic can’t be weaponised in court as it can’t be proven)
exogenous enforcement of contract = ?
a contract enforced by the court or another third party
what two things do all contracts involve? (both complete and incomplete contracts)
mutual gain and conflict of interest
mutual gain = ?
both parties profit from the transaction
conflict of interest = ?
either one or both parties are settling to a certain extent
endogenous enforcement of contract = ?
when parties to an exchange adopt strategies to derive favourable payoffs
these strategies involve aspects of the contract that aren’t specified
example of endogenous enforcement of contract?
employee working minimally for maximum pay as it’s not specified how productive they should be
how do principals ensure endogenous enforcement of contract is prevented?
incentivise people to act in a certain way either by providing benefits for certain actions or instilling fear with threats
endogenous = ?
in house, under-the-table
finding loopholes
verifiable information = ?
information that can be used in court of law to enforce a contract
non-verifiable information = ?
information that can not be used in court of law and isn’t enforceable in a contract
what are reasons for contractual incompleteness?
asymmetric information
time
measurability
authority
motivation
principal-agent problem is also known as …?
the agency problem
contingent on = ?
something is dependent on something
moral hazard = ?
when an agent might perform hidden actions that are unenforceable and indicate they’re not holding up their end of the deal
immoral
employer/worker, who’s the principal/agent?
employer is principal
worker is agent
because employer’s payoffs are dependent on worker who may have hidden actions (laziness) or attributes (incompetence)
what goods/services are being exchanged between an employer and an employee?
labour services
