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In economics, moral hazard occurs when an entity has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk knowing that its insurance will pay the associated costs. A moral hazard may occur where the actions of the risk-taking party change to the detriment of the cost-bearing party after a financial transaction has taken place.
In legal theory, a default rule is a rule of law that can be overridden by a contract, trust, will, or other legally effective agreement. Contract law, for example, can be divided into two kinds of rules: default rules and mandatory rules. Whereas the default rules can be modified by agreement of the parties, mandatory rules will be enforced, even if the parties to a contract attempt to override or modify them. One of the most important debates in contract theory concerns the proper role or purpose of default rules.
In economics, contract theory studies how economic actors can and do construct contractual arrangements, generally in the presence of information asymmetry. Because of its connections with both agency and incentives, contract theory is often categorized within a field known as Law and economics. One prominent application of it is the design of optimal schemes of managerial compensation. In the field of economics, the first formal treatment of this topic was given by Kenneth Arrow in the 1960s. In 2016, Oliver Hart and Bengt R. Holmström both received the Nobel Memorial Prize in Economic Sciences for their work on contract theory, covering many topics from CEO pay to privatizations. Holmström (MIT) focused more on the connection between incentives and risk, while Hart (Harvard) on the unpredictability of the future that creates holes in contracts.
In economics, insurance, and risk management, adverse selection is a market situation where buyers and sellers have different information, so that a participant might participate selectively in trades which benefit them the most, at the expense of the other party. A standard example is the market for used cars with hidden flaws ("lemons").
In contract theory and economics, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. This asymmetry creates an imbalance of power in transactions, which can sometimes cause the transactions to go awry, a kind of market failure in the worst case. Examples of this problem are adverse selection, moral hazard, and monopolies of knowledge.
The law of agency is an area of commercial law dealing with a set of contractual, quasi-contractual and non-contractual fiduciary relationships that involve a person, called the agent, that is authorized to act on behalf of another to create legal relations with a third party. Succinctly, it may be referred to as the equal relationship between a principal and an agent whereby the principal, expressly or implicitly, authorizes the agent to work under their control and on their behalf. The agent is, thus, required to negotiate on behalf of the principal or bring them and third parties into contractual relationship. This branch of law separates and regulates the relationships between:
Experimental economics is the application of experimental methods to study economic questions. Data collected in experiments are used to estimate effect size, test the validity of economic theories, and illuminate market mechanisms. Economic experiments usually use cash to motivate subjects, in order to mimic real-world incentives. Experiments are used to help understand how and why markets and other exchange systems function as they do. Experimental economics have also expanded to understand institutions and the law.
The principal–agent problem, in political science, supply chain management and economics occurs when one person or entity, is able to make decisions and/or take actions on behalf of, or that impact, another person or entity: the "principal". This dilemma exists in circumstances where agents are motivated to act in their own best interests, which are contrary to those of their principals, and is an example of moral hazard. Issues also arise when companies have an incentive to become increasingly deferential to management that have ownership stakes. As shareholders are dis-incentived to intervene, there are fewer checks on management. Issues can also arise among different types of management.
Build–operate–transfer (BOT) or build–own–operate–transfer (BOOT) is a form of project delivery method, usually for large-scale infrastructure projects, wherein a private entity receives a concession from the public sector to finance, design, construct, own, and operate a facility stated in the concession contract. This enables the project proponent to recover its investment, operating and maintenance expenses in the project.
An option contract, or simply option, is defined as "a promise which meets the requirements for the formation of a contract and limits the promisor's power to revoke an offer".
The theory of the firm consists of a number of economic theories that explain and predict the nature of the firm, company, or corporation, including its existence, behaviour, structure, and relationship to the market.
In economics, the hold-up problem is central to the theory of incomplete contracts, and shows the difficulty in writing complete contracts. A hold-up problem arises when two factors are present:
- Parties to a future transaction must make noncontractible relationship-specific investments before the transaction takes place.
- The specific form of the optimal transaction cannot be determined with certainty beforehand.
Jean-Jacques Marcel Laffont was a French economist specializing in public economics and information economics. Educated at the University of Toulouse and the Ecole Nationale de la Statistique et de l'Administration Economique (ENSAE) in Paris, he was awarded the Ph.D. in Economics by Harvard University in 1975.
Oliver Simon D'Arcy Hart is a British-born American economist, currently the Lewis P. and Linda L. Geyser University Professor at Harvard University. Together with Bengt R. Holmström, he received the Nobel Memorial Prize in Economic Sciences in 2016.
Jean Tirole is a French professor of economics at Toulouse 1 Capitole University. He focuses on industrial organization, game theory, banking and finance, and economics and psychology. In 2014 he was awarded the Nobel Memorial Prize in Economic Sciences for his analysis of market power and regulation.
Screening in economics refers to a strategy of combating adverse selection, one of the potential decision-making complications in cases of asymmetric information, by the agent(s) with less information. The concept of screening was first developed by Michael Spence (1973), and should be distinguished from signalling, a strategy of combating adverse selection undertaken by the agent(s) with more information.
Property rights are theoretical socially-enforced constructs in economics for determining how a resource or economic good is used and owned. This idea of ownership must be constrained from the views of absolute ownership to a right to use the good within its expected scope of use. Ownership goes beyond the basic notions of property rights to this idea of viewing the ability to own as one of the most basic human rights. Resources can be owned by individuals, associations, collectives, or governments. Property rights can be viewed as an attribute of an economic good. This attribute has four broad components and is often referred to as a bundle of rights:
- the right to use the good
- the right to earn income from the good
- the right to transfer the good to others, alter it, abandon it, or destroy it
- the right to enforce property rights
In economic theory, the field of contract theory can be subdivided in the theory of complete contracts and the theory of incomplete contracts.
David Martimort is a French economist and Professor at the Paris School of Economics. Martimort is one of the most highly cited researchers in the field of contract theory. His research has been awarded the Best Young French Economist Award in 2004.