Dealing with risk asymmetric information and incentives

Document Type:Essay

Subject Area:Economics

Document 1

Information economics comprises some key subjects including asymmetric information, risk sharing, moral hazards, adverse selection, etc (Stiglitz, 2000). To address some of these issues, I will use a case of Wells Fargo & Company, an American multinational financial services company. Evaluate a Wells Fargo’s recent actions dealing with risk and uncertainty. Running a business in the information age can be challenging. The risks and uncertainties that face businesses in the modern world are both extensive and pervasive. Trouble kept coming as the company was again implicated in another scandal in the following year concerning its wealth management business. Ever since, the company has been trying hard to convince regulators and customers that it is out to find and prevent such situations from happening in the future (PYMNTS, 2018).

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Their recent reputation has exposed them to many risks and uncertainties. Also, the company faces another potential risk concerning its earnings owing to the uncertain number of litigation expenses as a result of the scandal. To deal with such risks and uncertainties, Wells Fargo has resulted in rebuilding their image. To add to that pressure, the senior management pushes them further by using reward systems such as bonuses, promotions, attention, etc. When there is an adequate remuneration policy, managers will focus on achieving the long-term interests of an organization as opposed to the situation at Wells Fargo where they were focused on meeting the short-term targets. Moving forward, the company should endeavor to integrate their management information to enable the senior and the mid-level managers to have a similar view on issues such as performance levels and risk exposure.

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Examine an adverse selection problem your company is facing and recommend how it should minimize its negative impact on transactions. In microeconomics theory, information asymmetry also referred to as information failure occurs when in an economic transaction, one party is privy to more or better information than the other party. It, for instance, tricked them and the potential shareholders into believing that the bank was meeting its profit targets without knowing the fraud that was happening behind their backs. There are several ways in which Wells Fargo can ensure that such risks to its reputation are never to happen again. As aforementioned, the reason why the implicated employees kept the other stakeholders off the loop in their actions was the undue pressure they were being subjected to by the senior management.

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As such, the best solution to this problem is to make employees work towards realizable targets and hence ease the pressure. In the same way, doing away with reward systems that trigger unfair competition will hugely enhance transparency. To avoid such from happening in future, the company also added rebuilding trust to a list of its priorities. Wells and Fargo also removed the sales goals targets and changed their bonus payment method to emphasize “teamwork, customer satisfaction, and growth in total deposits, loans and investments” (Keller & Nasiripour, 2018). In addition to that, I would also suggest a way to make the information less asymmetric. Centralizing the company’s organizational structure, for instance, will make information flow much more comfortable and more accurate (Becker & Baloff, 1969).

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Identify a principal-agent problem in your company and evaluate the tools it uses to align incentives and improve profitability. Previously, the company used an incentive scheme where employees were required to reach a certain level of sales target to earn a bonus (PYMNTS, 2018). That has, nonetheless, changed following the scandal as currently, the company emphasizes “teamwork, customer satisfaction, and growth in total deposits, loans and investments” (Keller & Nasiripour, 2018). This will ensure the employees’ (agents) interests align with those of the top management and the shareholders (principals). Examine the organizational structure of your company and suggests ways it can be changed to improve the overall profitability In general, Wells Fargo’s organizational structure is a matrix in nature. The actions of the lower level employees are as a result of decisions that have been made by different departments.

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Asymmetric information is a significant hindrance to the proper discharge of information. It refers to an economic transaction where one party is privy to more or better information than the other party. The behavior could sometimes amount to adverse selection or moral hazard problems. Adverse selection refers to a situation where buyers and sellers have information about some aspects of the product that the other party. A moral hazard is an information asymmetry problem where one party changes their behavior after a deal has been struck. Administrative Science Quarterly , 14 (2), 260-271. Corkery, M. (2016, September 08). Wells Fargo Fined $185 Million for Fraudulently Opening Accounts. Retrieved December 11, 2018, from https://www. M. Moral Hazard and Adverse Selection: The Question of Financial Structure. The Journal of Finance , 41 (2), 501-513.

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