Question

If the threat of a takeover increases the likelihood that managers will act in the interests of stockholders or bondholders, what type of asymmetric information problem is eliminated?

a. moral hazard b. adverse selection
c. borrowers know more than lenders
d. address the potential harm

Answer 1

The answer is a. moral hazard.

Moral hazard is the asymmetric information problem that arises when one party takes risks because they know that another party will bear the costs of those risks. In the context of a takeover threat, managers may be more likely to act in the interests of stockholders or bondholders because they know that if they don't, the company may be taken over and they could lose their jobs. This eliminates the moral hazard problem, as managers are now incentivized to act in the interests of the owners of the company.

Adverse selection, option c, is a different type of asymmetric information problem that occurs when one party has more information about the quality of a product or service than the other party.

Option d, "address the potential harm," is not an example of an asymmetric information problem.

So the correct answer is a. moral hazard.