Daily Management Review

The Nobel committee names Nobel economics prize winners


10/10/2016


Nobel winners in Economics in 2016 became Oliver Hart and Bengt Holmström "for their contribution to the development of the theory of contracts", announced the Swedish Royal Academy of Sciences. They will receive 8 million Swedish kronor (about $ 931 thousand).



scholar.harvard.edu
scholar.harvard.edu
Briton Oliver Hart of Harvard University and Finn Bengt Holmström at the Massachusetts Institute of Technology have developed a theory of contract. Their research gives a comprehensive basis for analysis of many different issues in contract design, including contracts for payments to top management, franchises, surcharges in insurance, and privatization activities the public sector.

The contract theory is one of the youngest and fastest growing industries in the economic theory. It is based on basic assumptions of neoclassical economics, assumes rationality of economic agents, widely used economic equilibrium theory and game theory. The contract theory considers definition of parameters of a contract under asymmetric information.

Many contractual relationships within society include an agreement between shareholders and top management, or insurance company and car owners, public authorities and suppliers, and so on. Such contracts must be properly designed. As a rule, they entail a conflict of interests to ensure that the sides take mutually beneficial decisions.

This year's laureates did the groundwork of the contract theory, creating "fertile ground for fundamental scientific research" in this area, according to the Nobel Committee. In recent decades, the award winners have used many ways to analyze application of this theory.

"Analysis of optimal contractual arrangements laid intellectual foundations for development of policies and institutions in many areas, from bankruptcy law to political constitutions", - stated in the committee report.

Bengt Holmström

At the end of the 1970s, Bengt Holmström demonstrated how to draft an optimal contract. Holmström’s informativeness principle implies that a contract must bind the agent to implementation of meaningful work or providing information. 

Using the basic principal-agent model, he showed how an optimal contract carefully weigh risks against benefits. Later, Bengt Holmström generalized these results with more realistic data, namely when employees are rewarded not only with money but also with potential advance in office; when agents expend efforts on many tasks, while managers only see some aspects of their work; when individual team members are "parasitic" on others’ efforts.

Oliver Hart

In the mid-1980s, Oliver Hart created a fundamental rethinking of the contract theory, pointing to need to address incomplete contracts. It is not possible to consider all cases within a contract, so Hart tried to determine circumstances under which each party has the right to make decisions. 

Results of Hart’s research on incomplete contracts had a significant impact on several sectors of the economy, as well as political science and law. His study provides a new theoretical tools to study a number of questions: what types of companies should merge, what is the right mix of debt and equity financing, whether the various institutions, schools and prisons should be in private or public ownership.

source: ft.com






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