Moral hazard problems arise when
A) lenders have difficulty in distinguishing between good and lemon firms.
B) a downturn in economic activity makes repaying loans difficult for borrowers.
C) borrowers default on loans.
D) borrowers have an incentive to conceal information.

Question

Quizplus · Accepted Answer

Moral hazard problems arise when borrowers have an incentive to conceal information or take risks that are beyond the boundaries set by the lender. Such behavior can happen because the borrower knows that even if the investment fails to perform, the lender, not the borrower, bears the cost. This situation gives the borrower an incentive to prioritize their interests over the lender's interests, which increases the risk of default and economic losses for the lender.

Moral Hazard Problems Arise When