Organizational Architecture

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Moralhazard problem

Thereare several agency problems in the business environment which resultsinto losses. Moral hazard has become very common in the recent past. According to Zimmerman (2014), a moral hazard problem occurs “whenan individual has an incentive to deviate from the contract and takeself interested actions because the other party has insufficientinformation to know if the contract was honored. This means that oneparty in a contract takes risks because the other party is unable todetermine the significance of the risk and thus carry the burden ofthe risk. Usually, the moral hazard results into undesirablefinancial obligation due to the action of the other party. Theproblem occurs when there is information asymmetry and relationshipbetween the two parties affects their behavior. Hazard problem is amajor problem in the insurance and financial sector (Dionne, 2012).For example, a driver is likely to take more risks on the roadbecause the car has a comprehensive insurance cover. While theinsurer has limited information about the risks the driver is taking,it will cover the cost of the risks. In the subprime mortgage, amortgage company is can ignore information about possible defaulterbecause the bank will bear the cost. It also occurs in day to dayrunning of business organizations. For example, managers can shieldthemselves from responsibilities of poor decisions made in theorganization. There are several ways through which moral hazardproblem can be prevented. The most effective method is providingincentives against moral hazard. For example co-pay and deductibleshave reduced moral hazards in the insurance industry. Penalties canalso deter moral hazards (Finkelstein, 2015). For example, laws thatpenalizes financial institutions who make irresponsible decisions.


Finkelstein,A. (2015). Moralhazard in health insurance.New York: Columbia University Press.

Zimmerman,J. L. (2014). Accountingfor Decision Making and Control.(8th ed.). Irwin, CA: McGraw Hill.

Dionne,G. (2012). Handbookof insurance.New York: Springer.

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