Moral Hazard

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DEFINITION of 'Moral Hazard'

The risk that a party to a transaction has not entered into the contract in good faith, has provided misleading information about its assets, liabilities or credit capacity, or has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles.

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BREAKING DOWN 'Moral Hazard'

Moral hazard can be present any time two parties come into agreement with one another. Each party in a contract may have the opportunity to gain from acting contrary to the principles laid out by the agreement. For example, when a salesperson is paid a flat salary with no commissions for his or her sales, there is a danger that the salesperson may not try very hard to sell the business owner's goods because the wage stays the same regardless of how much or how little the owner benefits from the salesperson's work.

Moral hazard can be somewhat reduced by the placing of responsibilities on both parties of a contract. In the example of the salesperson, the manager may decide to pay a wage comprised of both salary and commissions. With such a wage, the salesperson would have more incentive not only to produce more profits but also to prevent losses for the company.

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    Insurance policies have deductibles for behavioral and financial reasons. Moral Hazards Deductibles mitigate the behavioral ... Read Full Answer >>
  2. How did moral hazard contribute to the financial crisis of 2008?

    The financial crisis of 2008 was the result of a wide range of contributing factors. One significant factor leading up to ... Read Full Answer >>
  3. Why is moral hazard so prevalent in the financial services industry?

    Moral hazard tends to be prevalent in the financial services industry due to the nature of the industry, temptation and greed, ... Read Full Answer >>
  4. How do financial market exhibit asymmetric information?

    Financial markets exhibit asymmetric information in that in a financial transaction, one of the two parties involved will ... Read Full Answer >>
  5. What are the most effective ways to reduce moral hazard?

    There are a number of ways to reduce moral hazard, including the offering of incentives, policies to prevent immoral behavior ... Read Full Answer >>
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  8. What are some examples of moral hazard in the business world?

    Moral hazard is a situation in which one party to an agreement engages in risky behavior or fails to act in good faith because ... Read Full Answer >>
  9. What is the difference between ex-ante moral hazard and ex-post moral hazard?

    Moral hazard refers to the way a party acts in a particular situation if protected against risk. It describes the behavioral ... Read Full Answer >>
  10. What is the difference between moral hazard and morale hazard?

    Morale hazard is an insurance term used to describe an insured person's attitude about his belongings. It arises when the ... Read Full Answer >>
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    Agency theory describes the challenges arising from the different interests of agents and principals. Principals employ agents ... Read Full Answer >>
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    A moral hazard occurs when a party acts differently knowing that he or she is protected from any kind of risk. This is a ... Read Full Answer >>
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