moral hazard

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Related to Moral hazards: Adverse selection, Physical Hazards

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.
Copyright © 2012, Campbell R. Harvey. All Rights Reserved.

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.
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved

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.
Collins Dictionary of Business, 3rd ed. © 2002, 2005 C Pass, B Lowes, A Pendleton, L Chadwick, D O’Reilly and M Afferson

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.

Collins Dictionary of Economics, 4th ed. © C. Pass, B. Lowes, L. Davies 2005
References in periodicals archive ?
We outlined the extent to which family moral hazards exist within four network types and offered mechanisms for altering moral hazard.
The propensity for moral hazard associated with each network type is explicated, and mechanisms for mitigating the cost/benefit of such dysfunctions are addressed.
Lack of moral character gives rise to a class of risks known by insurance men as moral hazards. The most familiar example of this class of risks is the danger of incendiary fires.
Note, first, the pluralization of moral hazard[s] and second that this quote contains no bellwether reference to incentives to identify moral hazard. In this quote, the term "moral hazards" has embodied the notion of adverse selection, which was, as discussed above, often evident in the insurance-industry literature.
Moral hazard was the term Arrow (1963) used to describe this kind of change in the behavior of the insured people, which has been shown to be welfare decreasing (Pauly 1968).
To attempt to legislate out moral hazard through redefinition of insurance language does not directly address the issue and will undoubtedly result in excessive and unneeded litigation, creating additional bureaucratic insurance requirements for everyday business.
By the end of Moral Hazard, the resolution of this basic tension feels inevitable.
A major argument for the privatization of Social Security is that the current system creates "moral hazard"--harming recipients by giving them a perverse incentive to avoid responsibility for themselves in retirement.
Somewhat related to the moral hazards problem is the peculiar nature of the demand for insurance in health care.
The question becomes: Is society willing to pay more in time and money to develop stem-cell therapies that dodge the moral hazard of the destruction of human embryos or the harvesting of tissue from fetal cadavers?
A moral hazard exists when a decision maker takes risks that he otherwise would not have taken, because the adverse consequences of the risk-taking have been transferred to a third party in a manner that is advantageous to the risk-taker and, more important, is disadvantageous and potentially even destructive to the party to whom the risk has been shifted.