Part 1Asymmetric information in equity contracts is known as the ______________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer. Part 2
A. debt deflation B. principal-agent C. free-rider D. adverse selection

Question

Part 1Asymmetric information in equity contracts is known as the​ ______________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer. Part 2
A. debt deflation B. ​principal-agent C. ​free-rider D. adverse selection

BlackTom AI · Accepted Answer

The question describes a situation in equity contracts where the manager has information that stockholders do not, leading to misaligned incentives. This is a classic description of the principal-agent problem in corporate finance and contract theory.
Option A: debt deflation. This term refers to a macroeconomic phenomenon where falling prices increase the real burden of debt, potentially reducing spending and investments. It is not related to asymmetric information between managers and shareholders, so this choice misattributes the concept.
Option B: principal-agent. This is the correct framing: asymmetric information between owners (principals) and managers (agents) creates incentives problems, such as managers not maximizing profits to the same extent as stockholders would prefer.
Option C: free-rider. The free-rider problem concerns individuals benefiting from resources or services without paying for them, often in public goods contexts. While it involves incentive issues, it does not capture the specific asymmetric-information dynamic between managers and shareholders.
Option D: adverse selection. Adverse selection occurs before a contract is signed when one party has more information than the other, leading to suboptimal contracting; while related, the standard label for the ongoing incentive misalignment between owners and managers in equity contracts is the principal-agent problem, not adverse selection.
In sum, each option frames a distinct concept, but only principal-agent directly addresses the asymmetric information between a firm's managers and its stockholders and the resulting incentive misalignment.

Homework:Chapter 8 Homework

Part 1Asymmetric information in equity contracts is known as the ______________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer. Part 2 A. debt deflation B. principal-agent C. free-rider D. adverse selection

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