Harvard University’s Oliver Hart and MIT’s Bengt Holmstrom were awarded the Nobel Prize for Economic Sciences on Monday “for their contributions to contract theory.”
Modern economies are held together by innumerable contracts, read an official Nobel Prize press release. “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,” it added.
Society’s many contractual relationships include those between shareholders and top executive management, an insurance company and car owners, or a public authority and its suppliers.
As such relationships typically entail conflicts of interest, contracts must be properly designed to ensure that the parties take mutually beneficial decisions.
“This year’s laureates have developed 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,” added the Nobel Prize press release
OPTIMAL CONTRACT
In the late 1970s, Holmstrom demonstrated how a principal (such as a company’s shareholders) should design an optimal contract for an agent (the company’s CEO), whose action is partly unobserved by the principal.
Holmstrom’s 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.
INCOMPLETE CONTRACTS
In the mid-1980s, Hart made fundamental contributions to a new branch of contract theory that deals with the important case of incomplete contracts.
“Because it is impossible for a contract to specify every eventuality, this branch of the theory spells out optimal allocations of control rights: which party to the contract should be entitled to make decisions in which circumstances?” continued the press release.
Hart’s findings on incomplete contracts 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.
CONTRACT THEORY
Through their initial contributions, Hart and Holmstrom launched contract theory as a fertile field of basic research. Over the last few decades, they have also explored many of its applications.
“Their analysis of optimal contractual arrangements lays an intellectual foundation for designing policies and institutions in many areas, from bankruptcy legislation to political constitutions,” concluded the press release.
Read more here.
RELATED TOPICS: Greece, Greek tourism news, Tourism in Greece, Greek islands, Hotels in Greece, Travel to Greece, Greek destinations , Greek travel market, Greek tourism statistics, Greek tourism report
Photo Source: Wikimedia Commons Copyright: Jonathunder License: CC-BY-SA
