Stockholders of ComfortAir Corporation, an air conditioner and furnace manufacturer, are concerned that the company's executives may take on greater risks than stockholders desire. This example illustrates
A)moral hazard and market risk.
B)moral hazard and firm-specific risk.
C)adverse selection and market risk.
D)adverse selection and firm-specific risk.

Question

Quizplus · Accepted Answer

This scenario illustrates moral hazard and firm-specific risk. Moral hazard occurs because executives, who make decisions on behalf of the company, might take on more risks than the stockholders would prefer, due to differences in risk appetite and incentives. The risk mentioned is firm-specific because it pertains to the decisions and actions within a specific company, ComfortAir Corporation, rather than the broader market.

Stockholders of ComfortAir Corporation, an Air Conditioner and Furnace Manufacturer