Moral Hazard
Subject: Economics | Topics:

Moral Hazard the form of post-contractual opportunism that arises because actions that have efficiency consequences are not freely observable and so the person taking them may choose to pursue his or her private interests at others’ expense.

The term originated in the insurance industry, where the tendency of people was observed to change their behavior in a way that led to larger claims against the insurance company (e.g., being lax about taking precautions to avoid or minimize losses.
Examples of Moral Hazard:
1. Doctors in the US protect themselves from malpractice suits by practicing conservative medicine, ordering tests and procedures that may not be in the patient’s best interests and, in any case, are certainly not worth the costs, which are borne by the patient or the insurer, not by the doctor making the decision.
2. Some firms may make shoddy or unsafe products when quality is not easily observed.
3. Security brokers may “churn” their clients’ portfolios, encouraging them to trade more frequently than they really should because each additional trade generates commissions for the brokers.

4. Rented apartments and housing may be less well maintained than owner-occupied ones because the renters do not get the full benefits of their efforts at maintenance.

5. An office employee may spend time during the day studying for an accounting exam, thinking about a new business idea that he or she hopes to pursue, or chatting on the phone with friends when there is work waiting to be done.

6. Senior executives may pursue their own goals of status, high salaries, expensive perks, and job security rather than the stockholders’ interests, and so they may push sales growth over profits, treat themselves to huge staffs and corporate jets, and oppose takeovers that would lead to their dismissal but would increase the value of the firm.

Moral Hazard


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