Lehman Brothers, William Shakespeare, and the Damage of Moral Danger

On the other hand, in the case of private information about shares, we speak, more appropriately, of “post-consistency”, because unobservability or unverifiability occurs after the contract is signed. I can be sure that the new employee you’ve hired is a very good person, but after hiring her, he might act as if he’s not.

The entrepreneurial project that I intend to fund is likely to be very promising, but after it was funded, its promoter decided not to put all his efforts into making it a success. I choose to entrust myself to a physician, financial promoter, and attorney, and only after entrusting myself have I discovered that by their concrete actions they are not promoting my interest in health, financial security, and justice to the fullest extent possible. In all these cases, the information may be the same initially but becomes asymmetric during the relationship.

Because we are always in “moral danger”

In all of these cases, information asymmetries and interests that do not always fully align between the parties result in certain forms of deficiencies which we will analyze in detail below. But why, after all, are we all at risk of moral hazard? Nobel laureate Kenneth Arrow explains this well when he says, “By definition, an agent is chosen for his specialized knowledge and the president can never hope to have complete control over his choices.” In other words, in a complex society, we can only delegate specialized tasks to specialists, however, we can verify their work only in a very imperfect way.

The list of examples is quite long: an employer who has to delegate many tasks to his employees without being able to accurately verify their compliance; a patient with a doctor who cannot verify his work in terms of the adequacy of the diagnostic procedure or treatment due to the lack, in most cases, of specialized skills; But also, on the contrary, the doctor is with the patient; In some cases, it is the doctor who cannot verify the patient’s compliance with the appropriate prescriptions. Not to mention the company’s shareholders with its management.

Interests can also vary greatly in the face of the ability, on the part of the owners, to assess the adequacy of the limited company’s policy completely. Then there are the insurances with policyholders, whose behavior cannot be disclosed, financiers with novices, teachers with students, families with teachers, public administration with suppliers, and voters with their political representatives. The risks of moral hazard are pervasive, deep, and often endemic.