Nobel Prize for contracts research awarded to Harvard and MIT professors

            The Royal Swedish Academy of Sciences announced that Oliver Hart and Bengt Holmstrom have been awarded the Nobel Prize in economics based on their understanding of how to best design contracts. Hart, a British professor at Harvard, and Holmstrom, a Finnish professor at MIT, have worked independently in the area of contract theory.

            Both Hart and Holmstrom have studied how contracts work, focusing specifically on the need for trade-offs when setting the terms of a contract. Holmstrom applied his analysis to insurance contracts and performance pay. His work proposed that performance-based pay should be closely linked to managerial performance. Yet, if it is difficult to measure performance, then the pay package ought to be a fixed salary.

            Hart’s work analyzed instances where contracts were deemed incomplete because not all of the outcomes could be specified. In these cases, Hart suggested that the rights to make a decision becomes critical to the parties because decision rights are closely associated to ownership rights. Hart’s work is therefore could impact the day-to-day operations of businesses as people may learn how to contract to increase their decision-making power. According to the Academy, both Hart and Holmstrom “have helped us understand many of the contracts we observe in real life. They have also given us new ways of thinking about how contracts should be designed, both in private markets and in the realm of public policy.”