moral hazard


Also found in: Dictionary, Thesaurus, Wikipedia.
Related to moral hazard: Adverse selection

Moral hazard

The risk that the existence of a contract will change the behavior of one or both parties to the contract, e.g. an insured firm will take fewer fire precautions.

Moral Hazard

The risk that a party to a transaction or activity is not acting in good faith, or that one party has perverse incentives to act in a manner detrimental to the counter party. Moral hazards may exist for almost anything. For example, a plan for a government to bail out delinquent mortgages has the moral hazard that it will encourage mortgage holders to refrain from making their home payment. Likewise, deregulation has the moral hazard that companies will use it as incentive for short-term, unsustainable profits, rather than proper economic growth.

moral hazard

a situation in which one of the parties to a CONTRACT has an incentive, after the contract is agreed, to act in a manner that brings benefits to themselves at the expense of the other. For example, employees may work less conscientiously than expected by the terms of their CONTRACT OF EMPLOYMENT (i.e. they indulge in ‘shirking’ and time wasting). See PRINCIPAL-AGENT THEORY, AGENCY COST.

moral hazard

a situation in which one of the parties to a CONTRACT has an incentive, after the contract is agreed, to act in a manner that brings benefits to himself at the expense of the other party to the contract. Moral hazard is a consequence of hidden actions in TRANSACTIONS, that is, actions that parties to a transaction may take after they have agreed to execute a transaction. If these actions are unobservable to the other parties to the transaction and if they may harm the interests of these other parties, then these hidden actions may prevent the successful completion of the transaction.

Even the anticipation that such hidden action is possible may prevent the transaction from taking place. For example, if insurance companies offer fire insurance at premiums that reflect a normal likelihood of fire damage, there is a danger that people who are insured against fire accidents will tend to behave less cautiously or even with malicious intent so that fire claims upon insurance companies are excessive.

Moral hazard can also apply to EMPLOYMENT CONTRACTS where employees may work less conscientiously than was expected in their employment contracts (i.e. they engage in ‘shirking’) if work supervision is not extensive (see TEAM PRODUCTION). Moral hazard can apply particularly to employment contracts of senior managers who might not act strictly as agents of the shareholders but pursue their own goals in the absence of sufficient shareholder scrutiny (see PRINCIPAL-AGENT THEORY). See ASYMMETRICAL INFORMATION.

References in periodicals archive ?
Finkelstein distinguishes between two kinds of moral hazard that health insurance can give rise to: ex ante moral hazard and ex post moral hazard.
In My Uncle Samuel's solution to the moral hazard problem, Kirk discusses both the essence of the problem of moral hazard and excessive risk-taking at big banks and financial institutions as well as his simple solution to fix it.
Because of the way the pools were organized, however, they fell prey to conventional moral hazard problems--especially the pools organized for child burial.
Done as outlined above, the forthcoming framework for bank resolution can both reduce moral hazard and enhance systemic stability.
Nonetheless, the risk of moral hazard triggering excessive borrowing and lending could have bigger sovereign implications.
Prevention is discussed mainly in the context of moral hazard.
The only way to deal with moral hazard is to get individuals or institutions to take responsibility for paying their debts or taking their losses.
Virtually all of the behavior that created the subprime lending debacle can be explained by incentive distortions, mostly moral hazard, and none of this behavior was new or irrational.
Thus, measuring the moral hazard can be very difficult.
Thus far we have focused on adverse selection, but consideration of moral hazard raises several interesting issues.
We are, however, concerned that the department created a moral hazard by allowing National Express to pay a lesser financial penalty through terminating a contract than they would have done by paying Au150m to exit consensually, and by choosing to not hold the termination against National Express in future bids.
We are, however, concerned that the department created a moral hazard by allowing National Express to pay a lesser financial penalty and by choosing to not hold the termination against National Express in future bids.