Use of Moral Hazards in Workplaces

Use of Moral Hazards in WorkplacesThe use of the destination righteous possibility has a history of more than than 200 years. As Dembe and Boden (2000) showed that, since the 1600s, the term object lesson gage is used in the discussion slightly the viableness of incentives for people downstairs restitution to be less political machinegonful to cling to themselves or insure goods and the tendency of fraud for obtaining monetary benefits from indemnity. It first appe bed in the frugal lit in the 1960s in terms of decision-making under uncertainty. Arrow (1963) and Pauly (1968) ar two frequently quoted papers. Arrow (1963) considered example hazard as one of the capers in the restitution policy market and pointed out that the supposition that see to it events be espousen place out of the checker of insured individual is non re all toldy true in the real support and, on that pointfore, there is not complete insurance market if the uncertainty exits. Pauly ( 1968) in addition explained that the honorable hazard difficulty can be analyzed by orthodox economic tools in antithetical kinds of insurance.In the economic literature nowadays, object lesson hazard is studied in various fields. Dembe and Boden (2000) concluded that there are two major categories of researches on moral hazard. One is originated from the earlier literature about insurance market the other is about economic decision-making, such(prenominal) as finance, banking, accounting and caution.In the current financial crisis, moral hazard is more frequently discussed and blamed as one of the causes of the banking problem. Summers (2007) claimed that the problem of moral hazard is overrated and warned people be aware of moral hazard fundamentalism. Dowd (2009) disagreed and believed that the problem is underrated and should be interpreted seriously. Dowd discussed the policy failures in the US financial industry in regards of moral hazard. Dow (2010) analysed the concep t of moral hazard in relation to the financial crisis and concluded that there is immoral behaviour in financial market but the problem should go further than effected understanding.The rest of the essay is organised as follows. In the second section, the renderings and record of moral hazard are discussed. In section three, examples will be leave aloned and analysed. I will also describe the ways to over contract these problems in the fourth section.2. What is Moral Hazard?Moral hazard is defined in various ways in different aspects. The earliest explanation is from the get rid ofice of insurance sector. Marshall (1976) provided the definition as whatever misallocation of resources which sequels when guesss are insured with normal insurance contr feigns and provided with such contracts. Briefly, moral hazard as the perily behaviour an insured individual may act because of the insurance grok.There are two kinds of moral hazard in insurance field. One of them is ex ante m oral hazard, which is the essayy behaviour itself. In this situation, the insured will act risky, which results in more payment by the insurer for the negative consequence. The other one is ex post moral hazard. This is the type of behaviour that people change their reaction of risk when insurance is provided or enlarged to cover their cost.Moral hazard can be also explained in terms of agent- tenet problem. Dowd (2009) defined moral hazard as the potential behaviour that one ships company who is in the behalf of another incitey puts his own interest first. This definition is often used in focusing area. It is considered as the consequence of asymmetric information. Michael Parkin (2010) explained this as followsIn some markets, each the buyers or the sellers- usually the sellers- are advance informed about the mensurate of the item being traded than the person on the other side of the market. reading about the value of the item being traded that is possessed by only buyers or sellers is called esoteric information. And a market in which the buyers or sellers slang private information has asymmetric information. Asymmetric information causes two problems unfavorable selection and moral hazard. Moral hazard is the tendency for people with private information, after entering into an agreement, to use that information for their own benefit and at the cost of the less-informed political fellowship.3. Examples of Moral HazardThere are many cases about the moral hazard problem in insurance market. An example provided by Stiglitz (1997) is about the auto insurance in innovative island of Jersey. In the eighties, New Jersey was considered to have the worst problem on auto insurance. It had no upper limit on the medical costs that could be claimed from any accident and the nation even provided auto insurance, Joint Underwriting Authority (JUA), to drivers who are too risky to get insurance from private companies at a similar rate for the less risky driver s. The state suffered a unsound loss by its insurance policy. The traffic accident rate and car theft rate were much higher than most of other states. Drivers took more risky behaviour when they are insured against medical treatments and car theft. The JUA had hoard a $3 billion deficit at the end of the 1980s and extra taxed were needed to cover the loss which brought big problem to the government.In finance and banking industry, moral hazard also can be ensnare in various cases. Too big to fail banks speculative investiture banking activities are guaranteed by the government, because their failure will influent the whole economy. The judgement that they will always be rescued from collapse causes these big banks to take greater risks in their lending policies in search of higher returns. other example of moral hazard problem in banking industry is that bankers elevate borrowing which is not in the customers best interest. In many business, bankers act as both lenders and fi nancial advisors for their customers because of their financial expertise. Cases such as bankers provide advises in their own best interest rather than customers can be found. In many banks incentive systems, bankers can get bonus by lending more to customers, but will get no or an insignificant amount of penalties when the lending is not beneficial to customers or the debt cannot be collected. This would belike result in customers or banks losses which has little advert on the bankers individual benefits.Similar examples can be found in management area. Managers who act on the behalf of share formers to operate the companies would take risky and short-term oriented strategies which could maximise their own benefits at the cost of shareholders. Managers whose payment is think to the companys profit would possibly carry out operation policy which would adjoin the profit within his employment period but might not create shareholders wealthy in the long run some managers who hold t he companys stock option might try to boom the stock hurt by fraud. These are all considered as moral hazard problems which come from the agency problem and the asymmetric information. The most famous example is probably the fall of Enron in which not only the governance and incentive of management were obscure, auditing, fund management and financial analysts also played a part which can be considered immoral in this case.4. Some Further tidingsIn this section, after taking examples of moral hazard problem from different aspects, what they have in common are discussed. The question why moral hazard is considered as a problem will be analysed and practicable solutions to these examples are also be provided.(1) Common features and negative consequence of moral hazardFirst of all, at least two parties are involved. In the examples of insurance, the two parties are the insurer (insurance companies or the state) and the insured ships company. In the banking examples, the problem is between banks and the state or bankers and customers. And in terms of management, it comes to agent (managers) and principle (shareholders).Secondly, one partys interest is guaranteed, which encourages taking higher risk. The loss of the insured party can be partly covered by the insurance no matter how risky his behaviour is. Similar feature is showed in the cases of banking and management, although they do have some risk management system to limit the risk within certain extent.Additionally, the highly risky behaviour of one party is difficult to or cannot be controlled by the other party. An auto insurance provider is impossible to control every insured drivers driving speed. non all customers of banks and shareholders of companies have a clear view of what their agent (bankers and managers) are doing because of lacking private information and professional knowledge.Whats more, these moral hazard problems result in the cost of others and could lead to misallocation of social re sources. The case of New Jersey auto insurance in the 1980s, the fall of Enron in 2001 and the recent banking crisis all caused huge social costs and brought economy problems.(2) Can these problems be bastinado?Dowd (2009) suggested that measures that limit and eliminate moral hazard should be welcomed to reduce overweening risk-taking practice and those create moral hazard should be avoid. Generally, a risk management system should be built.For example, insurance companies insure ones property up to a certain percentage of its replacement cost rather than amply cover it. Therefore, even if a big part of the risk is taken over, the insured party will still be worse off if bad thing happened. And this will encourage them to reduce their risk-taking behaviour. In Pauly (1968), deductibles and coinsurance are suggested to reduce the moral hazard. Deductible is an insurance in which an amount should be paid by the insured before the insurer will cover any expenses. Coinsurance is a s haring of risk between insurer and insured. both(prenominal) methods aim to splitting and spreading the risk among the two or more parties involved in moral hazard problem.In Dowd (2009), he argued that the state support should be removed from banking and banks should survive on their own carriage in order to remove the moral hazard. However, this would not be possible in practice. More essentially, the size of too big to fail banks should be cut down or controlled at a limited level.Moreover, better feat measurement and incentive system should be introduced. Credit pass judgment by bankers should be carried out more effectively and bankers should bear the risk of their behaviour and get penalties for bad debt at an amount that is high comme il faut to warn them to avoid the excessive risk. In terms of management, long-term performance measurement should be taken from the shareholders perspective regulations that require more unsophisticated disclosure are also highly required .ConclusionIn this essay, definition of moral hazard and examples from insurance, banking and management perspectives are discussed. The commons of these examples include the parties involved in the moral hazard, the uncontrollable risky behaviour of one party whose benefits are guaranteed and the social costs which the problem brings. Risk measurement and control system should be built to reduce moral hazard problem. Solutions such as risk-sharing insurance, significant penalties of bad debt and long-term performance measurement are suggested.