Provide an example of a moral or ethical hazard an organization might face relating to labor markets. How can this affect employees, an organization, and the economy?
The perfect example for the moral hazard in the labor market is principle-agent relationship and the problem attached to it. An arrangement in which one entity legally appoints another entity to act on its behalf. In a principal-agent relationship, the agent acts on behalf of the principal and should not have a conflict of interest in carrying out the act. The relationship between the principal and the agent is called the “agency,” and the law of agency establishes guidelines for such a relationship. The formal terms of a specific principal-agent relationship are often described in a contract.
For example, when an investor buys shares of an index fund, he is the principal, and the fund manager becomes his agent. As an agent, the index fund manager must manage the fund, which consists of many principals’ assets, in a way that will maximize returns for a given level of risk in accordance with the fund’s prospectus.
The problem in this case is related to the information asymmetry that changes the whole paradigm of the decision making. Due to superior information the agents (managers) act inappropriately (as seen by the principle) if the interest of the agent and principle are not aligned.
This affects the employees as they would not get the freedom of work by the principle and attracts more oversight by the company. It affects the organization as it affects their real profits due to the under performance of the managers. It affects economy indirectly as the performance of the company is linked to the performance of the economy.
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