COURSE: FINANCIAL INSTITUTIONS

FACULTY: SIR SHARIQUE AYUBI

SECTION M-5911; SPRING 2020
TOPIC: ANALYSIS OF INFORMATION ASYMMETRY

STUDENTS:
SYEDA RAHEELA QADRI 24066
BUSHRA NASIR 24124
MAHEKASH KUMAR 24449
SHEZIL WAQAR 24805

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Contents
ACKNOWLEDGEMENT......................................................................................................................................... 3

INTRODUCTION.................................................................................................................................................. 4

BACKGROUND (MAJOR CONTRIBUTORS)............................................................................................................. 5

ANALYSIS OF INFORMATION ASYMMETRY 6

INFORMATION ASYMMETRY IN BANKING........................................................................................................... 6
THE CHAIN OF DISRUPTION DUE TO INFORMATION ASYMMETRY.............................................................................................6
BANK SIZE & INFORMATION ASYMMETRY:........................................................................................................................7
IMPACT OF BANK & BUSINESS RELATIONSHIP IN INFORMATION ASYMMETRY:..........................................................................8

INFORMATION ASYMMETRY IN INSURANCE MARKET.......................................................................................... 8

INFORMATION ASYMMETRY IN LABOR MARKET:.............................................................................................. 11

INFORMATION ASYMMETRY WITH IMMIGRANT LABOR/WORKERS:.......................................................................................11

IMPACT OF INFORMATION GAP IN CONTRACTS & OFFERS:.................................................................................................12
INVESTMENT IN HUMAN CAPITAL WITH INFORMATION IMBALANCE:.....................................................................................13

INFORMATION ASYMMETRY IN STOCK MARKET:............................................................................................... 13

INFORMATION ASYMMETRY IN HEALTH CARE:.................................................................................................. 15

INFORMATION ASYMMETRY IN GAME THEORY................................................................................................. 17

INFORMATION ASYMMETRY IN REAL ESTATE MARKET......................................................................................17

INFORMATION ASYMMETRY IN CORPORATE GOVERNANCE..............................................................................18

OVERCOMING INFORMATION ASSYMETRY:....................................................................................................... 20

ACCESSIBILITY OF INFORMATION:.........................................................................................................................20
GUARANTEES AND WARRANTIES:.........................................................................................................................21
MANAGING AND MONITORING:............................................................................................................................21
LIABILITY LAWS AND LICENSING:...........................................................................................................................21
DUTIES AND SUBSIDIES:.........................................................................................................................................21
SPECIFIC STANDARDS OF AN INDUSTRY:...............................................................................................................22

MINIMIZING INFORMATION SYMMETRY IN DIFFERENT SECTORS.......................................................................22

HEALTH CARE MARKET:.........................................................................................................................................22

FINANCIAL MARKET:..............................................................................................................................................22
 FINANCIAL INTERMEDIARY/INSTITUTION:..................................................................................................22
 GOVERNMENT PROVISION FOR INFORMATION:........................................................................................22
 PRIVATE INFORMATION:.............................................................................................................................23
 COLLATERAL:...............................................................................................................................................23
 NET WORTH/EQUITY:..................................................................................................................................23

ADVANTAGE OF INFORMATION ASYMMETRY................................................................................................... 23

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ADVANTAGE OF INFORMATION SYMMETRY...................................................................................................... 24

PROBLEM OF INFORMATION ASYMMETRY........................................................................................................ 24

ADVERSE SELECTION:.................................................................................................................................................. 24
MORAL HAZARD:........................................................................................................................................................25
MONITORING COSTS:..................................................................................................................................................26

MAJOR TAKEAWAYS FROM INFORMATION ASYMMETRY..................................................................................26

CONCLUSION.................................................................................................................................................... 27

REFRENCES....................................................................................................................................................... 28

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 ACKNOWLEDGEMENT
I would like to express my gratitude to IOBM in giving the opportunity to accomplish the report
and being the platform of excellence and knowledge.
I am highly indebted to Sir Sharique Ayubi for his guidance and providing us the necessary
information regarding the term report and made us learn the concepts of financial institutions
also for the motivation to continue learning for the maximum knowledge. His immense efforts
made us capable of creating this report .
I, Syeda Raheela Qadri would like to extend my sincere thanks to my fellow partners
Mahekash Kumar, Bushra Nasir and Shezil Waqar for their kind co-operation, efforts and
encouragement which helped in accomplishment of the project.

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INTRODUCTION
In context of economics, Information asymmetry exists when one party in a transaction has more
information than the other. Individuals with superior information can earn excess profits at the
expense of those who are not privileged with good information. Information asymmetry could
lead to market failure. Information asymmetry extends to non-Economic behavior as well. For
example, Doctors would have more knowledge about medical practices than their patients as
they have years of education and medical degree. The same concept also applies in terms of
teaching; the teacher of the course has more information compared to the student as the teacher
has studied and has teaching experience in that course. This asymmetry leads to a higher risk and
a greater number of problems in the future, whether it is at buyer’s side or at the seller’s side.
This leads to market failure.
Market failure due to Information asymmetry in a Product market
Considering a real incident of Volkswagen (VW) cars, where they announced that their diesel
cars now are more environmentally, they did this by cheating on emissions tests. Consumers had
this information which made them buy this car, which means demand with asymmetric
information was higher than it actually would have been if the buyers had the correct
information. More VW cars were purchased and sold at a higher price than the socially optimal
level because of this wrong information. This wrong information led to an over allocation a a
good. Hence Marginal social benefit from this car was higher than it was supposed to be,
similarly as the cars still harmed the environment, marginal social costs were also
underestimated. This shows Marginal social benefit (MSB) and Marginal social costs (MSC)
reported were incorrect and unequal.
Market failure due to Information asymmetry in a Resource market
This concept could be explained using an example of a factory where harmful substances are
used. It is a historic incident where workers in rich industrialized factories were exposed to
harmful substance such as asbestos. Asbestos is a chemical that is used in factory production that
has high chances of cancer among those who inhale it. Many times workers in these factories had
no idea about being exposed daily to these toxic chemicals that could cancer in life later because
employers kept this information from their employees. Because of this misinformation workers
in the factory think it is safer to work in the factory than it actually is. Therefore, the supply of
willing workers to work in this factory is higher than it actually would be with symmetric
information. If the workers had the information of how dangerous it is to be working in that
factory, there would be a much lesser supply of willing workers. Since more workers are willing
to work in this factory so the wage rate the factory owners have to pay is lower and the quantity
of these employed workers in this factory is higher than the socially optimal level. Hence,
because of this asymmetric information the MSC reported are lesser than it actually would be
with the correct information in the market.

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BACKGROUND (Major Contributors)
The three main contributors of Information asymmetry are:

 George Akerlof: He wrote an article based on the market of used secondhand cars called
“The market of lemons”. A lemon is a car which doesn’t meet the market standards and is
found defective after being purchased. A peach is a good conditioned car. He believed
that there is a lot of information asymmetry in the used car market, where the buyer isn’t
a car expert and there isn’t complete information to differentiate between a good car and
a lemon. Akerlof's paper shows how prices can determine the quality of goods traded on
the market. Low prices drive away sellers of high-quality goods, leaving only lemons
behind.

 Michael Spence: He originally proposed the idea of signaling, which meant that one party
conveys some information about itself to another party. He based his theory in the labor
market. A firm would want to employ a worker who is ‘skilled’ but at the same time all
employees would claim to be ‘skilled’ only they themselves know if they are that skilled
or not. So this shows the information asymmetry in the market. Spence proposed that
employees graduated from college are likely to be skilled, as finishing a college degree
requires skills.

 Joseph E Stiglitz: He proposed the theory of Screening; screening combats the problem
of adverse selection, which is one of the major problems of the buyer with lesser
information. The particular market with asymmetric information that Stiglitz analyzed
was the insurance market. He believed that the people buying the Insurance has more
information about the relevant characteristics compared to the Insurance selling
company.
All three won a Nobel Prize for their contribution on Information asymmetry.

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ANALYSIS OF INFORMATION SYMMETRY
INFORMATION ASYMMETRY IN BANKING
The significant reason why people prefer to indirectly lend or borrow; through financial
intermediaries like Banks is because of the security it provides as compared to directly
performing the exchange where there is already too much left unsaid and hidden between two
parties thus raising the chance of default. The banks’ one of the most integral functions is to
gather information from both the parties and be a secure medium through which the two parties
can interact. Borrowers could have the chance to take the money and lenders could have the
chance to submit their money into a fruitful avenue to earn a return. But even after the protection
of an intermediary like Bank, information asymmetry makes it way inside the chain. Borrowers
are the superior power here in terms of the amount of information they have about their own
projects in which they are going to invest the lenders’ money.

The chain of disruption due to information asymmetry

Borrowers can easily hide their risky financial or credit status, even counterfeit the authentication
documents, and at times even Banks are unable to distinguish between a good borrower who is
likely to return the amount with interest and a bad borrower “lemon” who is likely to default and
be unable to pay even half of the amount. So banks usually try to increase the rate to the point
where it is an average rate for borrowers and lenders both. But this leads to the injustice with the
high quality borrowers who would be paying much higher than they should according to their
good credit rating, and low quality borrower would be paying comparatively a lower amount
than they should be if their real financial risky situation is disclosed. This leads to the high
quality borrowers to step back from using this intermediary and in fact at times, remove
themselves from the market as well hampering the productivity they could bring with their
programs or projects.

As mentioned in the research done by Thabani, N. 2018, Zimbabwe went through the similar
condition where banks there started to charge higher interests rates as a protection from
information asymmetry. The investors backed out of the banking chain, withdrew their deposits

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and opted to not be a part of financial market, it led to the closure of Genesis Investment Bank,
Interfin Bank and others.

This process of increasing interest rates leads to another aspect of the coin called Credit
Rationing where borrowers are denied being given loan due to economic or financial condition
of bank, or due to poor payback record of the borrower. Because after most of the good
borrowers have left the financial market; the riskiest borrowers would remain filtered out seeking
attractive loans so Banks have to be more cautious handing out loans. Whenever they feel that
the data is fabricated or there could be potential risks involved, or they have had bad history of
paying back their loans, then Banks tends to reject at these cases. So the supply of loans in the
market decreases due to this instead of the high interest rates. The adverse selection problem due
to the high demand of credit is worsening by credit rationing. Economic activities are highly
dependent on Banking sector as well, if Bank is not lending, its activities are compromised. To
boost up the economy and to not lose the sole purpose of its business some banks even start to
lend to high risk borrowers, leading to increase number of bad debts and the situation instead of
being saved gets worsened yet again. Another problem of moral hazard occurs after this is that
borrowers might take the loan in the name of some professional work but ends up misallocating
the funds and utilizing it for personal gain. That raises the conflict of interest between lender and
borrower, due to information asymmetry lender would not know the exact allocation of funds;
therefore, lender won’t be able to stop it. In these situations, when situation gets worsen with
each step, Bank Run becomes a common consequence. People immediately take the step to take
their savings, deposits out of the bank with an information gap about which bank is in crisis and
which bank is handling things well. But due to unawareness and panic situation, loans level goes
down along with the deposits level, that is where bankruptcy happens. So here we could see how
information asymmetry at initial level can create a chain of disruptions.

Bank Size & Information Asymmetry:

The research paper by Geir H. Bjonnes, Carol L. Osler and Dagfinn Rime suggests about the
difference of information structure is different in currency and equity market and foreign
exchange bank with a bigger customer size have more information. Dealers seem to extract
major information from financial firms of customers. Foreign exchange dealers agree that large

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foreign exchange banks are much more packed with information compared to others. Because
the customer base is so immense that it is has some strong and private information gauged out of
them.

Impact of Bank & Business relationship in Information Asymmetry:

Specifically in the relationship of bank & business, the amount of information and the honesty in
the information entirely depends on the relationship between business and bank. To grant any
credit, the bank has to take all the information about the business in consideration, that can lead
to bank’s superiority in many cases according to information terms, that disclosed financial or
other operation related information or upcoming project information can be found to be in
client’s competitor databases and can adversely affect the client and can even overtake him.
Secondly, once the bank has got the information it needs, the chances of exploitation for its own
benefits increases but to save long term relationship and further transactions, Banks usually abide
by the integrity. But the risks of disclosed information remain there. The quality of information
provided to the Bank is proportional to the duration of relationship of bank and business and also
depends on how much and how many services bank has given to that business or client to build
that trustworthy relationship where bank has the superiority of information.

INFORMATION ASYMMETRY IN INSURANCE MARKET

Markets are contaminated with the information gap between both exchanging parties; insurance
market is not unknown to the gap related to information. Now the race in every market is about
gaining more and more information to get the competitive advantage and excel at less risky
dealings. As George Akerlof has mentioned in “The Market for Lemons” that markets fail to
achieve its purpose if there is an excessive amount of information lack, exchange will suffer.
Usually insurance market is mostly prone to such information gap mishaps; their unawareness
regarding the honesty about their client can cost them thousands. If we discuss the health
insurance company, it would be willing to provide a better incentive, better program to a non-
drinker, because the risk of default here and the risk of client having health issues would be
much lesser than the one who is suffering from alcoholism; the one who will be provided with
lesser rates. But that would only be happening in ideal information symmetry situation which
can’t be achieved. We can minimize the information symmetry by research and authentication

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here in asymmetric market of insurance but never fully eradicate it so in result there will always
be information gap. Insurer would not be able to provide the cheaper plans to all, the riskier
would select the cheaper one without insurer’s knowledge and that must hurt the equilibrium of
insurer. And as the health insurer will have no way to check the claim if someone is lying or not,
he will consider everyone a ‘lemon’; A risk deal. Due to this generalization emerged out of risk
lead by information asymmetry; potential less risky clients are not getting the deserving and right
rate. If we consider vehicle insurance market, similarly the insurer is typically unaware of the
driving pattern of the driver. Even if he considers the location he drives on, or other parametric
like per mileage, he would not be sure if the driver will deliberately or not deliberately will do
harsh driving. So the parameters being considered to at least get some security are of experience
of driver and the car they have and drive, also past tickets regarding driving along with
authentication of documents of license and vehicle. In both of these chances, it is highly
significant for insurance companies to find the relevant information and effective means to
gather it, so that the ones who are not ‘lemons’ do not suffer and get provided with attractive
rates and security. This would increase the market share and brand value for the insurance
company as well. At times if the savings and incentives or risk coverage facility is attractive,
customers also willingly share the information that can be helpful. Second thing they can do is
that they can provide the policy along with market odds; insurer would be earning no loss or
profit just breakeven, but that depends if both; high risk and low risk customer is ready to bear
the odds. The challenge here is that the lesser risk clients; safe customers would be paying more
than they should considering their risk-averse risk profile. And the unsafe or risky customers
would be paying less-premium than in ideal conditions. But in real life situations, information
asymmetry leads to safe customers losing out of the market or paying high premium despite
being safe. Risky customers due to being in majority end up buying insurance with lower prices
and deem themselves as non-risky at times to gain the benefit. That is where adverse selection
plays its part.

The adverse selection issue regarding insurance market relates to the insure having the superior
knowledge about the risk which directly bears an effect on the costs of insurer. The profit of
insurer will be hampered as when there is more risk, the cost of providing security or coverage
becomes higher as the risk is deemed to be frequent. According to the contract theory’s aspect of

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common values; the features which harms the equilibrium and similarly the risk is the feature
which takes away competitive advantage from insurance companies. There is also an aspect that
whoever buys the most insurance plans, they would be of higher risk side because they are
buying more as they have an idea about the condition and probability of risk more than the
insurer. Usually in studies or theoretical structures, the focus relies more on the risk factor but it
is not always the source of creation of adverse selection, at least until other third party sources or
external conditions have not been taken into consideration. Like in life insurance or annuity
insurance, the factor to consider is mortality; sudden death. Usually, to cater the imbalance
problem of safe or risky customer, insurance companies offer two difference policies; designed
in a way to attract the relevant category of customer. Like one offering is of partial insurance, the
other is of full-insurance. The safe ones would buy partial as they would belief they already have
lesser chances of risk or default, why would they require a bigger coverage with higher cost. This
would provide the avenue of breakeven for the company. While, the risky customers will take
the full insurance because he would believe he has more chances to default. The cost of that
insurance policy would be higher, gaining a profit margin for company. But more grounded
realities of life can be cruel and can incur losses for the insurer. But as insurer would not be
having one customer, he could earn profit from others which would offset the loss incurred by a
few.

The probability of fraud by customers can be in the form of wrong information that eventually
widens the information asymmetry spectrum. But even insurance companies act as a loan shark,
creating fraudulent schemes to trap the customers and that leads to the down trend of behavior in
insuring things or life. Along with that inflation raises the price of premium; tax obligations on
insurance policies also affect the buying behavior. The lesser asymmetry there is regarding the
information between or among the parties involved, the better price there could be for the
customer. In short, Information asymmetry has a huge shackling impact on insurance market.

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INFORMATION ASYMMETRY IN LABOR MARKET:
One of the imperfections of labor market is the uncertainty between the employer and employee.
It can be one sided or both side. Employers would have nothing extraordinary information about
workers, workers’ abilities, temperament, riskiness and the amount of effort they can put.
Similarly, employers are not sure about the way things work in an organization, the projects, the
abilities of people they might serve. This is usually an impactful matter especially when none of
the parties have signaled each other regarding any sort of information. That lacking in the
information department can lead to wrong hires frequently; the skills will not match the
requirements so that will be detrimental in terms of productivity and cost for the organization
and also time consuming for the hiring department, who took too much time and yet still due to
not getting enough information, ended up hiring the wrong candidate. To save the wage/salary
cost in the times of information asymmetry, employees prefer to determine the pool wage;
average wage based on the mean skill and abilities. In this way, the skilled workers end up being
paid much lesser than they deserve and unskilled workers end up getting the higher pay. This
inequality and this injustice against the skills of skilled people drive people towards turnover.

Information Asymmetry with Immigrant Labor/Workers:

The absence of information is more critical case when it comes to hiring the immigrants, the
culture they have come from, the ways they have been accustomed with, different social contexts
and language barrier, these factors indeed impact the asymmetry that already exists generally
between employee an employer. So even signaling if provided by immigrants have higher
chances of being misinterpreted, or maybe the type of signaling the immigrant employees are
giving might not be acceptable or comprehendible in this particular country. The information
gathering in this case and verifying would become costly and employers might try to use this
information lack for their own advantage to safeguard only their interest, because there would be
a lack of communication as well as information lack, exploitation and manipulation can occur.
Pooled waging is commonly done with immigrants in rich immigrant receiving countries; no
matter how highly skilled an immigrant would be, he would end up being exploited. Otherwise,
with such exploitation from native firms, highly skilled workers also possess the abilities to be
self-employed which is a great in terms of human capital for firms who rely on productive
human force.

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Impact of Information Gap in Contracts & offers:
The information asymmetry effects not only the selection but also the retention of employees
which is through contracts and offer. Such unawareness with information gives a disadvantage to
potential employers. When there is a skilled labor in the market, and he is already employed so
the word of mouth of his productivity remains circulating in the market that attracts the other
employers to hire him. A highly skilled labor would know of his worth and with the offers and
calls he is receiving, he would know he is demanded as well. Retaining such sought-after
employees tend to be a hard job that is where current employers have the advantage of
information and the potential employers have disadvantage of information asymmetry. Because
the current employee would get to know more about the employee by working with him for some
time, so he has better idea of what sort of incentives and counteroffers would keep the employee
in the company and not be persuaded by outside offers. The potential employers; even if they are
a better opportunity for the employee, due to lack of information about the employee are unable
to create the targeted contracts and offering to get the employee. They can’t get the information
regarding the abilities and job performance, workplace behavior; they utilize the present
signaling parameters like education, experience, certifications to understand the employee. And
these observable characteristics are not often as effective as the aspect of actually experiencing
the worker’s ways of work that is only possible for current employee.

In order to make the information asymmetry problem for outside employers much worse, current
employees provides training and promotions to higher level for retaining the employee. With
training, the employee who is already highly skilled, benefits more and become more productive
but the outsider employers might be unaware of this and still keep the wage and offers similar to
his previous level of skill, so with this information asymmetry from their side, their contracts or
offers become less attractive. That is how current employers also gathers more information
regarding their employees, training is about collaboration as well and generates data to ponder
for the current organization. Similarly, if the current employer has already promoted the
employee with additional benefits, then the chances of his selection for outsider employees
reduce themselves. As mostly the outsider employers is trying to poach the employee for his
previous level of position.

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Investment in Human Capital with Information Imbalance:
Investment on skills and abilities of employees is done by employers when they have the
necessary information regarding the progress update, productivity, pressure handling data,
collaboration and other job aspects of employee. Because training and development programs are
a massive cost to the employers, so they must know if the employees they are going to invest in
will be giving returns or not. Without the relevant information about the employees’ personality,
work behavior, interpersonal skills, it is impossible for an employer to make the right decision.
Human capital requires development avenues, but if an employee is low skilled, and possess low
potential, then there is no point in investing on him and carrying a loss.

In short, we can see the impact information asymmetry puts on labor market; labor’s selection,
retention and also on the investment decisions on them. Information if possessed is like a
security for any part on which he can safely base his decisions or consider other opportunities or
even create other opportunities for himself and others.

INFORMATION ASYMMETRY IN STOCK MARKET:

Asymmetric knowledge is a situation where there is an absence of perfect information. To be
specific, it indicates the difference between the knowledge of the parties dealing with each other.

For instance, when we go for shopping we meet a lot of sellers. Due to our lack of knowledge
about the product we are willing to buy, we end up doubting the seller. Sellers tend to have more
knowledge about the product they sell than we do. They know the positive aspects of their
product; however they do know the imperfections of the product too. But because our knowledge
is just restricted to the exterior of the product, it is where the asymmetric information occurs.

The problem of asymmetric information can be found in any sector of the market, it could be
found in financial markets, labor markets, insurance markets or in stock markets. Thus,
asymmetric information can cause unfavorable selection, insufficient markets and it is a type
of market collapse.

Asymmetric information has been widely found in the stock markets where the managers,
directors and officers of the companies have the perfect internal knowledge i.e. the fortuity of the

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company. Comparative to market prices, whether the company's shares are under-valued or over-
valued is primarily in the knowledge of the company's management. Therefore, they get engaged
in "insider-trading". Insider-trading is basically the trading of shares by those who has the
confidential information of the company or who are involved with the company. This is the
reason for considering "insider-trading" as an illegal act, as the company make profits out of
unfamiliar share traders only due to the prior knowledge it holds. The management owns the
opportunity to control what information should be displayed, it is able to retain or misrepresent
some information, and hence the information disclosed in financial statements could not unfold
the true picture of the entity, and the management is the only party that has the real information
about it, and this so-called Information Asymmetry, which appears when a party has private
information about the entity's value, while other parties only possess general information
published and available to public.

In general, awarded parties seek to take benefit from their information directly or indirectly in
the stock market, and this is at the expense of the unaware parties, these attempts of informed
parties to get benefit of the doubt, that is, benefit from private information will increase the
agency cost which will reduce the present value of the predicted cash flows. The management
may act based on information it has, in a way that maximizes its benefit on the expense of the
uninformed parties. For instance, management could choose to disclose higher profits in order to
maximize its compensation. Management may also make decisions that increase profits in the
short term at the expense of the long term profits such as choosing the lower salary and efficient
employees, or lowering the R&D expenses. The uninformed parties recognize the presence of
information asymmetry circumstance which is not suitable for them; this will increase the risk of
investing in such entity, which will be reflected in requiring higher returns. In other words,
information asymmetry will reduce the stock price for two reasons: First, the higher the agency
cost, the lower the present value of expected cash flows. Second, the higher the investment risk,
the higher the required return, where the financial market responds to the higher agency cost with
lowering the stock price, as a reaction to this and to maintain their interests, management
increases the degree of conservatism in the financial reports, which will give management higher
credibility from the investors’ viewpoint (uninformed parties), which will lower the agency cost,
and increase the stock price. For stock trading, informational asymmetry has positive impacts on

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return, liquidity and risk of the shares. Moreover, size of the company and the cost of equity are
also positively influenced by it. However, a market having greater degree of information
asymmetry may experience critical inferences for the trading of assets specifically in growing
markets, such as the Brazilian market, because it also creates an opportunity for insider trading.
In addition, when taking into account the conservative accounting policies practiced by
management, this effect shall fail. Further, there is a need to enhance the level of financial
disclosure, since it is recognized that information asymmetry occurs due to weak system of
financial disclosure and delay of information.

INFORMATION ASYMMETRY IN HEALTH CARE:

As we all are aware of the emerging need of paying attention towards an individual's health, it
has been the most important aspect for a person's welfare. It is highly recommended to visit a
doctor, and take health care facilities when one feels sick or even before on every 6 months in
order to avoid future sickness. Information related to an individual's health as to what they are
suffering through, what is the disease behind a patient's growing symptoms, or what are the
preventive advices can only be explained by a doctor (a person who has the degree or the proof
of specialty in health field), it can't be understand by the patient himself because he doesn't hold
proper knowledge about the medical phenomena’s. Consequently, a high degree of information
asymmetry occurs between the both healthcare parties i.e. the doctor and the patient. Hence, the
doctors take benefit of the doubt by manipulating the information or consultation they give to the
patients and by charging high fees from them for what that doesn't need to be paid.

When doctors or healthcare providers deliver information to patients about their health condition,
they cover the simple common phenomena’s into tough medical terms that the patient gets
influenced by the doctor and due lack of knowledge trust the doctor and approach for the
treatment that is not necessary all that much how it is shown to him but it is source for the
doctors or health care providers to maximize profit, to earn more and more revenue. Some
overwhelmed patients, having faith in their respective doctor's ability follow their doctor's advice
without doubting them and without doing extra researches or without asking people or internet
for the doctor's reviews. That's the reason why asymmetric information could not be balanced,
that way patient end up paying extra to doctors than their services actually deserve.
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In addition, nowadays, we are fond of using a number of health care products. That's the result of
asymmetric information use by the companies to promote their health care product with higher
prices. Most of the people don’t possess a true and correct assessment of their health condition;
therefore they try to treat themselves using the health products being commercialized on TV and
social sites on Internet. Specifically the vitamin supplement markets are having higher degree of
advantages because people don’t know what vitamins are deficient in them and end up taking
supplements to improve their overall health i.e. improving all the vitamins in their body even
those that are sufficient in them.

They just read the description written on them which usually utilize the usage of general
common symptoms that everyone might have, and decide they indeed need to purchase them.
Nevertheless, in most scenarios additional supplements are not necessary for people to maintain
their health. But with restricted knowledge, people may spend extra money on products that have
neither benefit nor harm to their health.

The basic reason why asymmetric information is efficient for doctors and retailers of healthcare
product, i.e. the both is the necessity and no one compromises on necessities people have no
choice but to adjust with their high charges.

To summarize, a huge variance in information about individual’s health condition has led to
patient’s unnecessary expenditure on health care products. In order to solve the issue of
asymmetric information in a medical field, in order to reduce this excess unwanted spending by
people, people should seek for a second opinion or do some additional research before they
decide to follow their doctor’s advice or purchasing health care products. Furthermore, world has
become socially advanced, we can see reviews of professionals on Internet as official websites
do exist for all the well-known health care institutions. Reviews doesn't tell the doctor's
efficiency as a whole because sometimes it happened that some medicines does not suit one
person but works for the other but this assessing reviews can save us from asymmetric
information to a greater extent if we notice the pattern of the reviews, the commonality in
reviews. Nevertheless, in case of emergency or severe cases, following the instruction from
doctor is always the best choice with no harm.

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INFORMATION ASYMMETRY IN GAME THEORY
Game theory is based upon the idea of Information Asymmetry. In almost every sport, each
player has no prior knowledge of opponent’s skills and tactics for the game but don’t have
perfect information. Hence the dynamics of the games are based upon the existence and the level
of the game theory. James Fearon in his studies explained that war could be a consequence of
Information asymmetry- two countries will not reach a non-violent settlement because they have
incentives to distort the amount of military resources they possess.

INFORMATION ASYMMETRY IN REAL ESTATE MARKET

George Akerlof’s theory explained why lemons are rarely sold in the market, this theory has
been extended and applied in Real estate. In every case, the seller has greater information
compared to the buyer. At first, considering this is a diverse business a lot of factors need to be
considered before making the transaction. At first, the buyer may decide their budget and area in
which they want to buy a place, and then look in newspapers or other ads on some other sources;
chances are that the prices will there be overstated. As you dig deeper about that area, you will
gain a better sense of information and get to know the better and actual price in that
neighborhood. In short, the price discovery mechanism in real estate markets is not efficient. As
a result, the publically available information is not very useful when it comes to decision
making. To reduce the chances of adverse selection the buyer will look for more information
through broker. As the buyer cannot find as good quality of information even if he/she visit the
neighborhood daily. The real deals after negotiations are much more different than the how they
float in the neighborhood. On the other hand, the broker knows the real deal and has the
information of both the sides. The broker will provide the information of old and current
situation and value of the property, this means we are using private information to reduce our
information asymmetry. At the same time, we will also consider the future aspects of that
neighborhood. It includes the future developments and infrastructure planned for that
neighborhood. For instance, if a new mall is to be built in that area it would increase the value of
that neighborhood. However, such information is not available with general Public but
Bureaucrats are likely to have that information as they are the ones making the law. A buyer if is
able to get that level of information will benefit more with this transaction compared to the

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person who doesn’t have access to such information. The bureaucrats pass on this information to
their friends who will purchase the property and when that information is made public, the prices
of that neighborhood increase and the buyer can resell them at a higher price. Thus, there are
many levels of information available in that market. Some are freely available to everyone but
for some information, you need to dig a little deeper and also may have to pay a price to gain that
level of information. The amount of money the buyer puts and the level of risk the buyer takes
highly depends upon the available information in the market. The greater the information in the
market, more the money the buyer will be willing to put as the lesser are the chances of adverse
consequences in the future. After the transaction, with time the buyer will realize about the moral
hazards, if there are no problems discovered with the house or in the neighborhood, it means it’s
a good buy. Just like all other markets, Information asymmetry is also very high in Real estate
market.

INFORMATION ASYMMETRY IN CORPORATE GOVERNANCE

Corporate governance is a system that defines how the company will be organized and guided. It
shows the kind of relationship that exist between the managers, CEO, shareholders and
stakeholders and also explains the division of rights and duties on different members of the
organization. Governance is a mechanism which helps to set up the objectives of the
organization. It is viewed as a process through which the matters of the business are well
managed in a way that enhances the company performance and assist to maintain long term
relationship with the shareholders. The information asymmetry begins when the conflicts
between the manager and shareholder arises. This is known as agency problem where there is
divorce between ownership and management. Managers knows more about the company and its
investment project compared with shareholders who have very less knowledge regarding the
insights of the company. The shareholders usually focus on the forms such as dividends and
capital gains which will help to increase their wealth. Therefore, they invest in those companies
which provide them with highest possible return. However, the company in turn has different
aim who believes in long term profitability. This can only be possible if the continuous
investments are made on time to increase the size of the business. Here, arises the differences
which are known as conflicts of interests. This can ultimately affect the performance of the

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company. Moreover, the financial lender wants the interest from the company which should be
higher than the bank interest and other companies. This is because the decisions involves the
opportunity cost as they could invest in other company as well. On the other hand, the company
invest money into profitable projects in order to earn profit to repay the loans with an interest
rate. This is the problematic situation for the shareholders because the payment of high interest
rate will reduce their profit. The conflict of interest exist as the lenders wants the best interest
rate on their capital and the company wants to give interest as low as possible. So, a compromise
should be made by the shareholders to give up their profits so that the business could expand and
long term profitability could be sustainable. The company and the stakeholders do not have same
information. The difference in the behavior of individuals and different decisions greatly affect
the performance of the company. Moreover, the creditors does not full information about how
the company is going to perform in the future. Therefore, the creditor has to monitor the
activities of the company. This in turn helps to regulate and reduce the information asymmetry.

The three mechanisms of corporate governance are: intensity of board monitoring, the exposure
to market discipline and CEO pay for performance sensitivity. The research conducted in these
field has shown that the corporate and shareholder value will increase greatly if these
mechanisms of corporate governance are utilized regularly (Shleifer and Vishny 1997, Bertrand
and Mullainathan 2003, Gillan 2006). If the CEOs of the companies have private and valuable
information regarding the company and the power is in the hands of CEO then he will surely act
in a way which also benefits the shareholders of the company. Monitoring cost is reduced when
there low asymmetric information. However, the monitoring of the board will be costly when
there is asymmetric information. So the company is managed and controlled with the help of
external control and incentive for compensation. Managers are the agents of the shareholders
who manages the business on behalf of the shareholders. The principals are usually unaware of
the behavior of the agents after investing into a particular company. They cannot even monitor
them perfectly to know whether the managers are working in their interests. The manager’s
reaction and their behavior can be change in two ways. Firstly, they can be provided with
incentives such as shares of the company so that they will also participate increasing the
profitability of the company and so their interests will be aligned with the shareholder’s interests.
Moreover, the behavior can be changed indirectly by monitoring the actions of managers.

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Bonuses can be awarded to the mangers for revealing more information about the company. This
is likely to reduce information asymmetry regarding the changes in the actions of managers.
Information asymmetry can be alleviated by enhancing and improving the monitoring system of
the company and by giving directors more power to become on the board. The independence of
directors on the board reduces the information asymmetry which helps to make fair and
transparent financial statements. The board size can also affect the information asymmetry. For
instance, the larger the size of the board, the more independent members will display accurate
information about the performance of the company and better decisions will take place. The
power should not be retained by the one executive as he is going to dominate the board of
directors. However, the CEO interests can be same as shareholders by providing CEOs with
equity-based compensation. Conclusively, if the managers are given performance related
bonuses and other incentives, they can easily align their interests with that of shareholders.
Moreover, the CEOs should also be given the incentives so that the agents and principles can
work towards the same goal. Hence, this will access in removing information asymmetry and
solve the agent-principal problem.

OVERCOMING INFORMATION ASSYMETRY:

The issues in information asymmetry is a long standing marvel that anticipated prevailing,
because of lack of smooth communication and correspondence and distinction in views and
perceptions of different people. The information asymmetry can’t be finish; however, it can only
be minimized or reduced to some certain extent by managing adverse selection.

ACCESSIBILITY OF INFORMATION:
Availability of information is of central significance which includes noteworthy access to
information to consumers by creating opportunities. It is practically impossible to provide all the
data one after another, but adequate data ought to be accessible for the client to settle on a good
choice. Consequently, improves the quality of the product of the commodity and as well as
consumer loyalty. This clears route for consistent communication and resolves numerous issues
before they emerge.

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GUARANTEES AND WARRANTIES:
These warranties are considered very beneficial for consumers against defective products. It
gives them incentives and offers that the specific item is of superior quality and if there is any
issue with the item, the choice of return/substitution to the vendors is accessible in a given span
of time. In negotiating the cost, it is also very useful.

MANAGING AND MONITORING:

Other enormous challenges for government are adequate checking and controlling. The
government ought to accept obligations for interceding in all sectors which have information gap
issues. If there is lack of controlling and checking, then firms might be suffer a lot due to
different issues raised by unlawful recipients. The government guidelines must be organized and
refreshed in A PROPER MANNER through which holes are limited and one party isn't
exploiting over the other. It must be joined with rigorous checking and controlling procedures.

LIABILITY LAWS AND LICENSING:

These license and laws are for consumer assurance or protection guidelines whereby specific
license and grants are required to sell particular goods and services. If least industry guidelines
are not set, then firm has to bear severe punishment. This law must be deliberately set and
consistently observed in such a case that licenses are not acquired or it's causing an
unsatisfactory increment in costs, it might offer ascent to accumulating, hoarding and black
marketing exercises.

DUTIES AND SUBSIDIES:

Government mediation through arrangements is exceptionally normal if there is a rise of an
occurrence of information asymmetry and sellers are earning more by making buyers fool. The
government should intervene and complete the market or find some kind of harmony between
the gainers and losers. Regularly, this is executed by forcing higher charges on the gainers and
endowments to recipients.

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SPECIFIC STANDARDS OF AN INDUSTRY:
There should be some specific standards set by each and every industry before selling goods and
services in the markets. If industry met those standards, it means the particular sector or industry
is offering high quality goods and services in the markets as well as information asymmetry
reduces.

MINIMIZING INFORMATION SYMMETRY IN DIFFERENT SECTORS

HEALTH CARE MARKET:
Healthcare market possess information asymmetry, obviously doctors knows better than their
patient about their disease, but it essential to give true and complete information regarding
their disease to a patient. The more patient know about their disease the more empowered
they will be and able to oversee the chronic disease, consequently, diminishing the general
expense of medicinal services, both for the patient and the doctor.

FINANCIAL MARKET:

 FINANCIAL INTERMEDIARY/INSTITUTION:
In indirect finance, information asymmetry is higher because the contract between lender and
borrower might be risky, there might be a lack of trust as the borrower may be a stranger, which
means transactions are more risky and difficult in direct finance as a result of this, there is higher
information asymmetry. However, on the other hand, in indirect finance the information
asymmetry is less. As banks have better exposure and experience in lending money. Banks know
how to identify and recognize good and bad borrowers and have enough knowledge about the
credit worthiness of good and bad borrowers, their background their ranking, and loyal
customers. Therefore, if indirect finance is more in the economy, there will be less information
asymmetry.

 GOVERNMENT PROVISION FOR INFORMATION:

Government can make laws where the listed companies on the stock exchange will have to share
their information with the public. This reduces information asymmetry to a great extent.
Government could make it compulsory for the listed companies to share their financial
statements, director’s report, and auditor’s report. Quality of information and frequency of

22
information government work on both by publishing more and helpful information in the form of
quarterly, semi-annually and yearly reports and minimize information asymmetry.

 PRIVATE INFORMATION:
Some companies collects information through surveys and researches all over the world, compile
it and then sell it for price. This reduces information asymmetry and help in making a better and
safer decision. Banks also use this information by purchasing reports in order to give loan to
companies/corporations and reduce their information asymmetry as much as possible.

 COLLATERAL:
Collateral reduces the risk to great extent as the lenders have the satisfaction that they can get
their money back by selling the collateral in case the lender isn’t able to repay. And lenders are
able to reduce information asymmetry and safeguard their interest by reducing the risk.

 NET WORTH/EQUITY:
Assets-liability= net worth/net equity

Two companies of the same industry, same size; the good customer to lend money will be the
company with the higher percentage of equity as their more of own money is involved, so that
company will work harder to save their own money. Hence, it will be a safer decision and it
reduces risk and asymmetric information.

ADVANTAGE OF INFORMATION ASYMMETRY

Information asymmetry is not always a bad thing. This is because there are some significant
advantages that cannot be neglected. It is better to specialize in a specific field and have more
information related to that field. It is totally impractical for the person to concentrate on every
field and have maximum knowledge for all the fields. Therefore, it is necessary to get specialized
in specific field. For example, a doctor specializes in a medical field and has full information
about this field. This is helpful as the doctor can help the patient in the best way possible.
Moreover, the broker has full knowledge about the shares of the different companies listed on the
stock exchange market. He can provide a better insight to the investors about the performance of
the companies in exchange for a fee. Hence, information asymmetry aids in making people more
productive and provides greater value to the other people.

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ADVANTAGE OF INFORMATION SYMMETRY
Information symmetry means that both the parties involved in the transaction are well-formed
about each other. Both the parties have equal knowledge about the commodities they are trading.
When parties have sufficient information, they know the characteristics of the other party and
can easily trust. This leads them to carry out a financial transaction. The more the information is
available to the people, the more the financial transactions will take place. As a result, this help
to grow the economy of the country. For instance, the companies publish their financial reports
publicly so that the potential investors can have a better idea about the performance of the
company. In this way, they would be able to make a right decision by choosing the most
profitable company for them.

PROBLEM OF INFORMATION ASYMMETRY

The imbalance of information between seller and buyer creates severe problems which as
follows:

Adverse selection:
Information asymmetry occurs when one party has more knowledge than other party. This
means that one party has accurate or different information than other party. This is likely to put
the less knowledgeable party at a disadvantage because that party will not know the truth and
reliability of the other party in the transaction. On the other hand, the more knowledgeable party
has more information which helps them to manipulate the other party. Therefore, inefficient
outcome is produced and low quality goods and services will be in the market.

The best example of adverse selection is explained by George Akerlof with the help of used car
market where there is a lot of information asymmetry. The owners of the used car knows the car
of the quality better than the buyer the car. The customer do not know whether the car is in good
condition or not. Now, here exist the gap between the buyer and seller of the used car. The more
informed party (owner of the car) is going to use its informational advantage to manipulate the
customer to buy the car. Therefore, the owners of the car are known as lemons. The” lemons”
will sell their car at lower price so that they can trick the less knowledgeable customers.
However, most of the customers knows that there might be people in the market with bad quality

24
cars as well and they would not be able to distinguish among the good and bad quality cars.
Those with the good quality cars may not be able to sell their cars in the market. As a result, they
will decide not to buy from the private dealers because the insufficient knowledge has made
them reluctant to carry out a transaction. This is the reason why the customers prefer not to take
from the private dealers. Instead, they usually buy from reputable and profitable companies as
they know that these companies wants to have long term business and profitability. Hence, they
will sell bad quality cars to ruin their image.

For instance, take an example of Health Insurance Company where information asymmetry is
very common. For instance, suppose that there are two individuals willing to apply for health
insurance policy. Both of them are same in all respects, however, not in health condition. The
insurer does not have sufficient knowledge to appropriately measure the health status of both
individuals. Moreover, the insurer charge $10 monthly premium to the healthy one and will
charge $20 to unhealthy one. If the insurer does not have equal knowledge, he will charge take
the average i.e. $15. The healthy individual retains the health and will not buy the insurance
policy. So the company will be left with only unhealthy individuals. From the unhealthy
individual’s perspective, this is going to be gain as he will be paying $15 instead of $20. If the
health deteriorated, the company has to pay more than the premium he is paying. Hence, the
company will have to bear losses and may become insolvent.

Moral hazard:
Information asymmetry has another problem known as moral hazard which occurs after the
transaction has taken place. This happens due to the hidden activity being carried out by other
party involved in the transaction. This may put the less knowledgeable party at risk as that party
have to bear the losses more. For instance, before the car was insured, the car owner showed
himself as a safe and careful driver who comply with all rules and regulation. However, after the
car is insured, there might be change in the behavior of a driver which the insurance company
was not aware of. He may drive recklessly as any damage to the car will be paid by the insurance
company. Therefore, the insurance company has to bear more loss.

Take an example of commercial banks where the moral hazard problem is very common. The
guarantees and commitments are given to back the loan on time. However, there are so many

25
people who carry out activities which are undesirable for the other party. The big risk takers used
to apply for loans. The banks do not have sufficient knowledge to analyze whether they will pay
back the loan. As a result, they gives loans to them. The risk takers then invest in big risky
projects. They do not invest their own money. Instead, they put bank’s money at risk. If the
projects fail, they will become default and bank will not be able to redeem the money.

Monitoring costs:
They are the costs which are being taken by the creditors and lenders of the loans. These costs
are incurred because of the information asymmetry. These individuals have less knowledge that
whether the borrowers would be able to pay back the loan. The creditors have less information as
to how the borrowers are going to behave after taking the money. Therefore, they have to
monitor them to ensure the safety of their money. For example, the banks have insufficient
knowledge about the actions of the borrowers. If the banks are giving huge loans so they ask one
of their employee to participate in the company’s meeting to safeguard the rights of the banks.
Moreover, the creditors or lenders may hire an accounting firm to access the accuracy of the
financial statements.

MAJOR TAKEAWAYS FROM INFORMATION ASYMMETRY

 Asymmetric information, also known as "information failure," occurs when one party to
an economic transaction possesses greater material knowledge than the other party.

 Asymmetry is mainly evident when the seller has more information than the buyer,
however is could also be the other way around. Almost all economic transactions involve
information asymmetry.

 When investing money in any market, always gather the maximum level of information
to reduce the risk of adverse selection and moral hazards.

 The more the money, the higher the risk. Hence the level of information to be gathered
should also be more.

 For the banking sector, training should be provided to loan officers to ensure they take
good credit risk to maintain Bank’s cash flows.
26
  For the investor, before investing in any company’s share or bonds the investor should
gather all sources of information, especially private information as a little added cost can
lead to investor’s safety related to the investment.

 For the patient, don’t just rely on doctor’s degree but also gather feedback of their
previous patients and the doctor’s experience.

 For the buyer of a house, it’s better to keep a good check of the neighborhood and ask the
people living there before making the transaction.

 In a health insurance company, the company should continue to monitor the insurance
holder’s activities whether they are still following a good routine, eating healthy and not
skipping the gym.

 In a labor market, some employers have started conducting tests to find the true
capabilities of the worker before hiring them and should continue to do so.

 In a good market, the buyer should collect information from all sources and only buy the
government verified goods to reduce the chances of adverse selection.

CONCLUSION
Asymmetric information creates an imbalance in market transactions in terms of power, which
may result in making wrong decisions and lead to market failure in the economy. It includes two
major problems; adverse selection-Pre-contractual problem and moral hazards which is a post-
contractual and a hidden problem. To overcome these problems we use internal and external
sources of information to gather data. It creates inefficiency in the economy which leads to
market failure, which means one party is made better off at the cost of the second party
becoming worse off. Welfare loss arises in all these markets because of the asymmetric
information. There may be a lot of solutions to avoid this problem of information asymmetry, but
the most important one solution is to provide adequate information.

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