Moral Hazard

Moral hazard is a situation where the interests of one party are taken care of by another party, making them confident enough to get involved in risky undertakings because they are aware of the cover given to them by the other party. The party offering the cover however, normally consider their interests first. For instance, an organization that is insured will be willing to take many risks concerned with their operations knowing that in case of occurrence of any hazard, the insurance company will bear possible cost and offer them compensation. This awareness of support during times of problems creates temptations for the businesses to engage more in risky undertakings. The insurer’s interest is to clarify if the end will be beneficial to them before stepping in.

Many financial market observers are concerned with moral hazards due to the fact that it is the reason transaction risks are hard to distinguish. It makes it hard to know if the transaction is more risky or not because funded organizations have confidence that their risky actions will be borne by another party hence may become careless or deviate from the initial plan.

Additionally, in the financial market, financers or investors are after gaining profits or receiving back what they lend out and they need to know what the borrower intends to do to pay back the borrowed amount. In this case, performance is the concern for the financiers such that they get convinced that their partnership with the organization is not fraud but a legit business.

It is therefore important that financial observers evaluate the activities of a business that will create successful performance and responsible use of funds for any business before committing to partnering with them so as to determine the financial worth of the partnership.