If an agent is risk averse and a principal is risk neutral, and if the agent pays the principal a fixed fee,
A)all risk is eliminated.
B)the risk neutral person bears all the risk while the risk averse person bears none.
C)the risk averse person bears all the risk while the risk neutral person bears none.
D)the principal and agent share risk equally.

Question

Quizplus · Accepted Answer

When the agent is risk averse and the principal is risk neutral, the agent will want to avoid any form of risk. If the agent pays the principal a fixed fee, the risk averse person bears all the risk while the risk neutral person bears none. This is because the fixed fee guarantees the principal a certain amount regardless of the outcome, while the agent's earnings are dependent on the outcome and therefore subject to risk. Thus, the risk averse agent bears all the risk in this scenario.

If an Agent Is Risk Averse and a Principal Is