What does the term 'inherent, asymmetric-information risk' refer to?

The term 'inherent, asymmetric-information risk' specifically highlights the imbalance of information between different parties involved in a company, particularly between management and the board of directors. In this context, managers typically possess more detailed and nuanced insights about the company's operations, performance, and challenges than the board, leading to the potential for misalignment in expectations and decision-making.

This asymmetry creates risks because the board may not have complete visibility into critical issues affecting the company's strategy or operations, which can lead to uninformed or suboptimal decisions. For instance, if management knows about operational challenges or market trends that could impact future performance but does not fully communicate these to the board, the board might make decisions that do not align with the true state of the company.

Understanding this concept is crucial for effective governance and oversight, as it emphasizes the need for transparency and open communication between management and the board to mitigate risks associated with information disparity. This understanding can also guide the establishment of systems and practices that ensure the board receives comprehensive and accurate information necessary for oversight.