A plant manager whose bonus depends on divisional profit delays a needed maintenance shutdown into next year so that this year’s number is met. Which problem of information asymmetry does this illustrate?

Answer

Moral hazard — a hidden action that owners cannot observe

Options - A. Moral hazard — a hidden action that owners cannot observe - B. Adverse selection — a hidden fact exploited in a trade - C. Uncertainty — nobody could have known the shutdown was needed - D. Comparability — the two years cannot now be compared Why - A. Correct — the manager’s choice is an action the owners cannot see, taken because the reported number stands in for his performance. That is moral hazard. - B. Adverse selection is exploiting an information advantage against a counterparty in a transaction (insider trading is the standard case); no trade is happening here. - C. The manager knows perfectly well the shutdown is needed; the problem is that the owners cannot observe his decision, not that the future is unknown. - D. Comparability is a qualitative characteristic of the statements (L1.5), not a form of asymmetry; it names a symptom, not the mechanism.

L1 §2.1, §2.2, §2.5; BG ch 4; OF §2.4; NI 52-109 (verified-facts 2.3-d)