ECO 550 Case Study 2 Economics Coursework Research

Dealing with Risk and Uncertainty: A Case of Carnival Corporation
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Dealing with Risk and Uncertainty: A Case of Carnival Corporation
Many factors affect the profitability of companies in different industries. Dealing with these factors is necessary for business survival and companies need to be prepared for any risks and uncertainties. This is where the concept of risk management comes in. According to Firoozye and Ariff (1), risk management involves identifying potential risks and taking the necessary preventative measures based on incomplete knowledge. Also, due to the nature of incomplete knowledge, risk management is characterized by uncertainty. Since the beginning of this year, the world economy has experienced challenges following the outbreak of Covid-19. Many industries have been affected and some industries face more risks and uncertainties than others. One such industry is the Cruise Line Industry which has been hit hard by the Covid-19 pandemic. This paper will explore Carnival Corporation, one of the companies in this industry that has faced risk and uncertainty over the last few months. Also, recommendations on how Carnival can improve its risk management will be provided. The paper will also examine adverse selection, moral hazard, and principal-agent problems that Carnival is facing.
Risk and Uncertainty Facing Carnival
Carnival Corporation is one of the world’s largest cruising companies that provide people with opportunities to vacation at sea and the shores (Carnival, 2). Given the nature of its business, Carnival has lost customers following the Covid-19 pandemic in the last six months. One of the major risks and uncertainties that cruise line companies face is the spread of viral, contagious diseases as well as outbreaks of pandemics. In a recent news release, Carnival indicated that the Covid-19 outbreak creates risk and uncertainty for its future, especially in relation to its financial position and liquidity (Carnival Corporation & PLC, 3). The company has paused its operations, albeit temporarily, and forecasts a net loss for its financial year ending in November 2020. Further, the company faces uncertainties in terms of their ability to receive external financing to cater for any challenges that arise from low cash due to their slow operations. Carnival is particularly facing an operational risk and operational risks can arise from events such as natural or manmade calamities (Lam, 4), which is the case for Carnival. The risk that Carnival is facing is so real such that within a few months, the value of its shares has dropped by 80% (Sigalos, 5). Also, the company faces uncertainties about when it will resume operations because of the restrictions on international travels and closure of ports in many parts of the world. Further, the willingness and ability of people to travel have been negatively affected by the pandemic, which consequently puts Carnival at risk. The company has also been downgraded by the credit rating agency S&P (Sigalos, 5). Carnival has taken several actions to ensure that it remains liquid while facing this risk and uncertainty. It has made considerable efforts to reduce its capital expenditure, as well as other expenses (Carnival Corporation & PLC, 3). Also, the company is looking for additional financing to ensure that it stays afloat.
Recommendation on how Carnival Corporation Can Improve Risk Management
Given that some of the risks and uncertainties are specific to some industries, it is important for companies to mitigate the risks through operational hedging. Operational hedging involves diversification of operations and business units so that companies can limit risk exposure (Lam, 4). For instance, Carnival can open a new business in a different industry, such as the food and beverage industry, which will be less affected by the risks and uncertainties that affect the cruise line industry. As such, even when the company is facing risks that threaten its financial position close to the point of insolvency, it can still stay liquid by relying on the other businesses.
Adverse Selection Problem in Carnival
When buyers and sellers have access to different information and one party uses the information to selectively participate in some activities at the expense of another, inefficiencies are likely to occur in the market. This information asymmetry causes what is commonly referred to as adverse selection (Saeedi, 7). Carnival faces one crucial adverse selection problem because of its role in heightening the rate of infection of Covid-19 among passengers. The top executives of the company were aware that they had a coronavirus problem but instead of sharing that information with the passengers, they kept the operating as if everything was normal (Carr & Palmeri, 6). The company added new stations for hand sanitizers and ensured that crew members wore gloves. This points to their knowledge of their vessels being contaminated or being at the risk of contamination. Yet, the passengers participated in various activities, such as dancing classes and theatre in big crowds, thus increasing the risk of infections. As a result, many consumers have lost their confidence with the company (Levine, 8).
Carnival can mitigate the negative effects of this adverse selection problem by rebuilding its reputation. A company’s reputation plays a major role in mitigating the effects of adverse selection problems (Saeedi, 7). This is done by increasing the value of a reputation such that the customers feel that the company is not withholding any information. Carnival can minimize the negative effects by providing some sort of warranties or guarantees to their customers. Some cruise companies are already removing the existing restriction on cancellation such that if customers are not satisfied with the cruises’ health measures, even after the Covid-19 pandemic, they can cancel their bookings and get their money back (Levine, 8). This is a strategy that Carnival can employ in light of the current adverse effect problem.
Moral Hazard Problem in Carnival
Carnival is also facing a moral hazard problem because of the possibility of a governme...