Part- A Introduction Information Asymmetry deals with the access and knowledge of information for parties to any given transaction. Information asymmetry therefore arises when one party to the transaction has better information than the other. Based on this asymmetry, person having specific information therefore may be at advantage as compared to party which is relatively ignorant of this new information. In such a scenario, the overall transaction can go wrong and it is often considered as the market failure also where market is inefficient enough to offer opportunity to everyone to have perfect knowledge.
(Xu, Wang, & Han, 2012) Corporations are incorporated as artificial persons with distinction between the ownership and the management of the firm. Owners of the corporations called shareholders therefore remain separate from the active management of the organization and managers manage the organization as custodian of the shareholders. However, this creates issue of agency wherein though managers act as the agents of shareholders, they pursue their own interests. (Sau, 2003) The actions of managers therefore are assumed to be in direct conflict with the interests of the shareholders.
One of the key reasons for this conflict of interest is the availability and access to information. Since managers are actively involved into the management of any firm therefore they possess relatively superior information as compared to outsiders. This however, can also create corporate failures as shareholders may not be fully aware of the actions of the managers. One way through which both financial and non-financial disclosures can be improved is the effective regulations to make things more transparent. ( Baek, Kim, & Kim, 2008) Information asymmetry As discussed above, information asymmetry arises when one party to the transaction has superior or more information as compared to other party to the transaction.
This imbalance in the possession of information therefore can make transactions biased and can put one party at a receiving ends due to lack of knowledge and relevant information. Information asymmetry can also occur when one party has the knowledge or information about a good or service while other party doesn’t have the same. ( Walsh, and Seward, 1990) There are different models of information asymmetry under which different assumptions are made.
In adverse selection models, it is assumed that one party lacks the understanding and information about a transaction whereas in moral hazards model, ignorant party lacks the information about the performance of a transaction.
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