Adverse selection happens when a market rule attracts the least desirable applicants to take action. For instance, life insurance policies tend to attract applicants who take high risks. Or all-you-can-eat buffets tend to attract the heaviest, biggest eaters. In both cases, the seller needs to account for the type of buyers who want the offers and adjust expectations and pricing appropriately.
We can use the same idea to analyze a rule change in a company. For instance, it is useful to consider:
–Who finds a pay cut most desirable?
–Who finds layoffs most desirable?
The answer depends on adverse selection, as explained in Game Theory at Work:
Imagine that your firm faces a budget shortfall and absent salary reductions you soon won’t have the funds to meet your payroll obligations. You have two choices: Give everyone a 10 percent wage cut or fire 10 percent of your workers. Adverse selection shows why you should prefer the firing option.
If you give everyone a 10 percent wage cut, some of your workers will probably leave for better-paying jobs. Unfortunately, your most productive workers will probably have the best job opportunities and will consequently be the most likely to quit. Cutting everyone’s wages by 10 percent will cause adverse selection to come into play, since those whom you would most want to stay will be the ones most likely to leave. In contrast, if you fire 10 percent of your employees, you could obviously eliminate your least-productive workers.
Here’s an interesting study on how counting money affects our mood:
When we are feeling blue we are told to count our blessings, but according to a study recently published in Psychological Science, counting our money might be a more useful activity. Psychologists Xinyue Zhou, Sun Yat-Sen University, Kathleen D. Vohs, University of Minnesota, and Roy F. Baumeister, Florida State University, investigated the psychological, physical and social impact of money.
To examine this, the researchers asked one group of participants to count out eighty $100 bills and another group to count eighty worthless pieces of paper. They then played a computerized ball-tossing game called Cyperball. The participants were led to believe that they were playing with three other gamers when the other players in fact were computer generated. Some participants received the ball an equal amount of times while other participants were excluded. Out of the participants excluded in the Cyperball game, those who had counted the money rated lower social distress than those who only counted paper.
In another experiment, the scientists asked participants to immerse their fingers in hot water for 30 seconds after they counted either money or paper. Surprisingly, those counting money rated a lower intensity of the hot water and physical pain than those who counted paper. In addition, the researchers found that participants who counted out the bills rated themselves as feeling “strong” more often than the paper counting group.
Adding a twist to the experiment, the scientists asked a group of participants to list their monetary expenditures from the past month and another group to list weather conditions in the past month. Both groups were then put through the Cyperball game and the physical pain test. Those who thought about the weather rated normal amounts of social distress or pain; those thinking about their finances experienced higher social distress when they were left out of the Cyperball game and reported greater pain from the hot water.
As the psychologists concluded, “The mere idea of money has considerable psychological power, enough to alter reactions to social exclusion and even to physical pain.”
In Freakonomics, there’s an article which was catchy titled “When to Rob a bank”. I thought an analysis as to the specific reasons was provided, but not. In a way, I presumed that the reason(s) are already obvious. Or to me at least, being a former banker and currently a consultant.
Moreover, the basics of internal controls are obvious but often ignored leading to fraudulent activities. Take those who intentionally do not want to take leave (at work) to keep manipulation under their control. All these remind me of the training I conducted on Fraud. My colleagues-students were asking, “how to do that/those irregularity(ies)”.
I’ve miscalculated the probability that the interest rate for time deposits being offered by my bank will go up. Just in time that I was putting in the formalities, ack! The interest decreased. And there’s no point in waiting for it to skyrocket. So, I settled it that day. At least I’ve secured that rate. Oh yes, I’m sourgraping. I need to balance my risk appetite next time.
Fishermen, in other words, are a lot like American investment bankers. Their overconfidence leads them to impoverish not just themselves but also their fishing grounds. Simply limiting the number of fish caught won’t solve the problem; it will just heighten the competition for the fish and drive down profits. The goal isn’t to get fishermen to overspend on more nets or bigger boats. The goal is to catch the maximum number of fish with minimum effort. To attain it, you need government intervention.
On the other hand, here’s a hilarious banking metaphor. Happy watching!
It pained my head and ass when I was a newbie in auditing a credit card department/and or subsidiary. Starting with the enlistment to be a merchant, interchange and transaction fees, terminals, etc. It was challenging and satisfying to see how this purchasing merry go round happens.
Here’s an interesting and simple analysis of true cost of credit as you use your credit card:
Most of those who came from W generation (meaning ages ago) did not believe in the banking system. Saving money in the bank, in particular. I’ve witnessed one of my late grandparents keeping the cash inside the hankies and stored in the cabinets. Although more likely it’s still practiced by a few people, X generation’s issue now is its faith in having cash on hand as king. No one will object. However, how much cash should be put in Cash in Bank? That is in the savings account earning a very minute rate.
Don’t let your cash be idle. Set enough cash for emergency purposes and a certain amount to meet your obligations within three months to a year. The rest should not be sleeping. We all know it’s recession. But in case you have idle cash, don’t be afraid to at least place some of these in fixed term deposits. Anyway, these can be pre-terminated. No one’s telling you that it’s not readily available.
The financial institutions are encouraging us to hold it longer for us to take advantage of larger interest income. And of course, so that they’ll have enough funds to be loaned to the persons in need (yes, for an onerous rate!). That’s life. Interest is directly proportional to supply and demand.
The Government of Dubai announced a $20 billion bond programme on Sunday to fund its various financial commitments and spending programmes.
When I was in college, the offering and issuance of bonds that I read from the newspaper seemed highfaluting for me. I used to view it as a major liquidity indicator, in a favorable sense. After due orientation, it’s actually a black warning.
A number of government projects were put on hold due to insufficiency of funds (we’re not saying lack of funds). The most elitist remedy is to issue bonds. People would buy bonds in exchange for promise of premium after a certain period. The Government of Dubai will now have the resource to fulfill its financial commitments and other (necessary) spendings. In the future, when the bond certificates are due, the bondholders will get the proceeds with an attractive premium. Hopefully. That’s how it’s packaged.
Hence, the funds have to be profitably and viciously used before the bonds are redeemed. Are government bonds secured? Yes. They are number 1 in the hierarchy. If the government won’t pay, then they’re doomed.
Here’s the bottomline, bond offering = needs funds (aka Help!)
Incidentally, I’m in Abu Dhabi. I don’t think they’re making bond offering in the near future.
