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On Information Asymmetry - Essay Example

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On Information Asymmetry

Owners of the corporations called shareholders therefore remain separate from the active management of the organization and managers manage the organization as custodian of the shareholders. However, this creates issue of agency wherein though managers act as the agents of shareholders, they pursue their own interests. (Sau,2003) The actions of managers therefore are assumed to be in direct conflict with the interests of the shareholders. One of the key reasons for this conflict of interest is the availability and access to information. Since managers are actively involved into the management of any firm therefore they possess relatively superior information as compared to outsiders. This however, can also create corporate failures as shareholders may not be fully aware of the actions of the managers. One way through which both financial and non-financial disclosures can be improved is the effective regulations to make things more transparent.( Baek, Kim, & Kim, 2008) Information asymmetry As discussed above, information asymmetry arises when one party to the transaction has superior or more information as compared to other party to the transaction. ...
In adverse selection models, it is assumed that one party lacks the understanding and information about a transaction whereas in moral hazards model, ignorant party lacks the information about the performance of a transaction. (Chen, Berger, & Li, 2006). Moral Hazards and Agency Problems Information asymmetry becomes important within organizational context due to agent-principal relationship between the shareholders and managers of the firm. One of the key reasons as to why moral hazards can arise is based upon the notion that if all the actions of employees are not monitored, there are chances that moral hazards may arise. This peculiar situation therefore outlines that shareholders may inherently be in a disadvantageous position because of their inability to monitor the actions of managers in effective and comprehensive manner. (Heath, and Norman, 2004) Shareholders, as principals, engage managers as their agents to run the organization and control and manage the day to day operations of their organizations. It is critical to understand however that the efficiency and effort with which managers must perform their assigned actions remain within their own control. This aspect however, gives rise to hidden actions on the part of the managers and shareholders, as principals cannot monitor the effectiveness and efficiency of these actions due to information asymmetry. As a result of this, until and unless, managers have other motives, he or she is always putting in low level of effort behind his actions. This also creates the issue of moral hazards. (Dobson, 1993) Moral hazards suggest that the managers, as the agents of the shareholders, may act without due care and ...Show more
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Summary

Part- A Introduction Information Asymmetry deals with the access and knowledge of information for parties to any given transaction. Information asymmetry therefore arises when one party to the transaction has better information than the other. Based on this asymmetry, person having specific information therefore may be at advantage as compared to party which is relatively ignorant of this new information…
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