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Assumptions Of Agency Theory Essay

472 words - 2 pages

Business Finance
Bounded it is an idea that in making a choice, rationality of person(s) is restricted to the information they have, the cognitive limitations of their minds, and the finite amount of time they have to make a decision. It was suggested by Herbert A. Simon as an alternative basis for the mathematical idea of decision making, as used in economics and related disciplines; it adds up rationality as optimization, which views decision-making as a fully rational sequence of finding an absolute choice given the information available. Thus the decision-maker is a satisfier, one seeking a satisfactory solution rather than the optimal one. Simon used the analogy of a pair of scissors, where one blade is the "cognitive limitations" of ...view middle of the document...

Opportunism is sometimes also defined as the ability to capitalize on the mistakes of others: to utilize opportunities created by the errors, weaknesses or distractions of opponents to one's own advantage.
Information asymmetry: models assume that at least one party to a transaction has relevant information whereas the other(s) do not. Some asymmetric information models can also be used in situations where at least one party can enforce, or effectively retaliate for breaches of, certain parts of an agreement whereas the other(s) cannot. In adverse selection models, the ignorant party lacks information while negotiating an agreed understanding of or contract to the transaction, whereas in moral hazard the ignorant party lacks information about performance of the agreed-upon transaction or lacks the ability to retaliate for a breach of the agreement. An example of adverse selection is when people who are high risk are more likely to buy insurance, because the insurance company cannot effectively discriminate against them, usually due to lack of information about the particular individual's risk but also sometimes by force of law or other constraints. An example of moral hazard is when people are more likely to behave recklessly after becoming insured, either because the insurer cannot observe this behavior or cannot effectively retaliate against it, for example by failing to renew the insurance.

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