Severe adverse selection and moral hazard problems can prevent the formation of business relationships between principals and agents. For example, people may be unwilling to buy stock in a firm because they believe that managers may use that money for their own benefit rather than for the company's interests.

Question

Quizplus · Accepted Answer

Severe adverse selection and moral hazard problems can lead to a lack of trust and uncertainty between principals and agents, making it difficult to form business relationships. In the given example, the fear of managers using the money for personal gain instead of working towards the company's goals is an example of moral hazard. This can make investors wary of buying stock and investing in the company.

Severe Adverse Selection and Moral Hazard Problems Can Prevent the Formation