Moral hazard occurs when

Question

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Moral hazard refers to a situation where an agent, who is hired to act on behalf of a principal, has an incentive to pursue their own interests instead of the principal's interests, and the principal cannot observe the agent's actions. This creates a risk that the agent may take actions that are contrary to the principal's interests, thus leading to the possibility of losses for the principal. Examples of moral hazard include situations where insurance companies face the risk that policyholders will increase their exposure to risk (e.g., by engaging in reckless behavior) once they have obtained insurance coverage, and situations where managers may not work in the best interests of shareholders because they do not bear the full costs or benefits of their actions. Choice C best describes the situation where moral hazard occurs.

Moral Hazard Occurs When