Oliver Hart and Bengt Holmstrom were on 10 October 2016 awarded the 2016 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for their contributions to contract theory.
They have developed a contract theory, a comprehensive framework for analysing many diverse issues in contractual design, like performance-based pay for top executives, deductibles and co-pays in insurance and the privatisation of public-sector activities.
The new theoretical tools created by Hart and Holmstrom are valuable to the understanding of real-life contracts and institutions, as well as potential pitfalls in contract design.
Bengt Holmstrom's Theory
• In the late 1970s, Bengt Holmstrom demonstrated how a principal should design an optimal contract for an agent, whose action is partly unobserved by the principal.
• Holmström’s informativeness principle stated precisely how this contract should link the agent’s pay to performance-relevant information.
• Using the basic principal-agent model, he showed how the optimal contract carefully weighs risks against incentives.
• Later, Holmstrom generalised these results to more realistic settings, namely: when employees are not only rewarded with pay, but also with potential promotion and when individual members of a team can free-ride on the efforts of others.
Oliver Hart's Theory
• In the mid-1980s, Oliver Hart made fundamental contributions to a new branch of contract theory that deals with the important case of incomplete contracts.
• Hart’s findings have shed new light on the ownership and control of businesses and have had a vast impact on several fields of economics, as well as political science and law.
• His research provides new theoretical tools for studying questions such as which kinds of companies should merge, the proper mix of debt and equity financing, and when institutions such as schools or prisons ought to be privately or publicly owned.
Oliver Hart is a Professor of Economics at Harvard University, Cambridge, USA. While, Bengt Holmstrom is a Professor of Economics and Professor of Economics and Management at Massachusetts Institute of Technology, Cambridge, MA, USA.
Now get latest Current Affairs on mobile, Download # 1 Current Affairs App
When: 10 October 2016