Transaction costs economic essay
According to the theory of the firm, a transaction cost is a cost of providing goods and services through the market rather than providing it through the company. To carry out a market transaction, one should identify the individual they wish to deal with, conduct negotiations, and draw up a contract. They should also undertake inspections needed to ensure the terms of the contract are being observed. The social costs incurred while undertaking these activities is termed as the transaction cost. They include search and information costs, bargain and decision costs, and policing and enforcement costs. Certain implicit trading costs can be termed as transaction costs. One such transaction cost is the arrival cost. This is the difference between an asset’s value immediately before order and the actual price the consumer incurs. To manage transaction costs, it is inherent that a firm invests in the best execution strategies in all transactions. It should also perform accurate calculations for transaction costs using PRIIPs methodology.
Information asymmetries
Conceptualization
Information asymmetry is a situation in management where one party in a transaction or business has more information than the other. Therefore, a situation arises where one enterprise is more privileged than the other. Various approaches result in information asymmetries. These include:
Private information. Here, information asymmetry occurs when one party has access to privileged or private information. This information could be proprietary, legally protected, or could arise from certain assets. Private information withheld from individuals who could otherwise use it to make wiser decisions result in information asymmetries.
Different information. Information asymmetry can also occur when firms have different information. Data is not homogeneously distributed in the market. Furthermore, access to relevant information is not open to all firms in the market. When such market signals are withdrawn, a firm’s status and reputation determine its success in the market.
Lack of perfect information. Here, participants in the market have vivid information about one another. To distinguish the quality of competitors, a firm could interview the advantaged buyers. These practices, therefore, provide information about the otherwise unobservable qualities.
Consequences
Asymmetric information that occurs in financial markets of borrowing and lending will result in lenders charging higher rates to compensate for risks. Since the lender has little information and difficulty knowing if the borrower will default, he will consequently charge higher rates. Furthermore, asymmetric information can lead to the itch of adverse selection. For instance, an insurer may not have enough information regarding a customer’s ability to look after a piece of property. It could thus incur more expenses by choosing to provide an insurance cover while uninformed.
Mitigation strategies
To reduce information asymmetries’ incidences, a firm should seek incentives with its partners to disclose information available between the two parties. This increases the breadth of available information crucial for making informed decisions. Information asymmetry can also be resolved by pre-commitment. Here, one focal company demonstrates the seriousness of their intentions to another actor within the enterprise by financing their debts. Firms can also monitor the behaviors of agents to avoid incidences of concealment of information.
Covid-19 pandemic
The covid-19 pandemic has thrown vehicle manufacturers into financial hardships and uncertainties. To seek leverage and debt coverage, firms could conceal relevant financial information that could taint their image. The coronavirus pandemic has resulted in companies realizing reduced sales of vehicles due to the restriction of movement measures to contain the spread of the disease. Profit margins from car sales have, therefore, drastically dropped. While requesting debt from banks, a vehicle company may classify its current financial situation and avail previous data so that banks can offer financial aid.
Mitigation
To mitigate this situation, a bank should provide a window for information concealment for all borrowers requesting financial cover. Through such practices, the company is convinced to reveal their financial information, and the bank analyses the firm’s ability to pay back the requested debt from this data. A financial institution will offer loans to institutions with competitive advantages over their rivals.