40915648, Desch, Kelsie_330 Final Essays
TOPIC 1) Asymmetric Information: Adverse Selection and Financial Structure
1.A. Moral hazard and adverse selection influence the financial structure in a negative way because of
lowering the chance that a loan will be paid back because of a borrower’s undesirable behavior. Within
having these negative effects on the financial structure, it puts good firms in a bad place for having
people can invest into them and also negative for the investors because they cannot sort out the good
firms from the bad. The lemons problem is when the less good and desirable buyers are willing to come
into the market because the average quality will be on the lower side (lemon) which is undesirable to
lenders which results in less people on both sides willing to come into the market. With the lemons
problem in the stock market happens when a buyer would not be able to distinguish the good firms with
good predicted profit and the bad firms with not so good predicted profit, which means the buyer will
only want to pay average quality. When the good firms see the average quality numbers they will not
want to sell their stock because they feel as if they should get more than average money for their stock.
Of course, the buyer is not going to want to buy from a bad firm which leaves them with the lemon
problem! This proves that stocks aren’t the most important source of financing. The lemons problem in
the bonds market is when a buyer is only interested in the bond if there is a high interest rate to be able
to compensate them on their money on the debt. The good firms will want to pay a lower interest rate
because they probably don’t have as much debt and won’t pay for a higher interest rate. Only bad firms
will want to borrow and investors don’t want to buy bonds from bad firms. Bonds are also not the
primary source of financing for the businesses in the U.S because it channels funds from savers to
buyers (lemons problem).
