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
what strategy does the employer use to derive favourable payoffs?
contingent renewal of employment (risk of firing)
lemon = ?
car that is potentially defective
peach = ?
car that turns out to be better value than what it was bought for
mutual benefit from exchange = ?
willingness to buy from buyer - willingness to sell from seller
sellers who realise the market value is less than the actual value of their product…?
will leave the market
sellers will refuse to sell if buyers aren’t willing to pay…
over half the actual value of the product
lemons problem = ?
buyers are principals and sellers are agents
sellers (agents) have hidden attributes/actions that can impact the buyer’s payoffs
e.g., the car might be rubbish and worth less than what it’s being sold for
adverse selection = ?
a problem for a principal who lacks information on relevant attributes of an agent which leads to the principal offering poorly causing the agent to drop out
which factors could disarm the lemon problem?
quality assurance boards/mechanisms
legislation from third parties as a penalty for poor product/service provision
in the benetton model, who’s the principal/agent out of patrisia/armin (buyer and seller)
buyer is patrisia, she is the principal
agent is armin, as he’s the seller who may have hidden actions/attributes regarding the product (e.g., its quality/value)
what gives rise to the principal agent problem?
conflict of interest
the quality of the product can’t be determined, so buyer doesn’t know the calibre of the product they’re buying
how can a buyer determine the quality of products they’re purchasing?
have a repeated relationship
termination probability
enforcement rent (pay good amount)
the level of quality the agent supplies…
depends on how valuable it is to the agent to continue the relationship with the principal
disutility = ?
causing inconvenience
utility = ?
term used to determine the worth/value of goods/services
ICC = ?
incentive compatibility constraint
