This year’s Nobel prize in economics has been awarded to UK-born Oliver Hart and Bengt Holmström of Finland for their work on contract theory, which has covered a range of issues from public-private partnerships to executive pay.
As it announced the prize, the Royal Swedish Academy of Sciences described the pair’s work as key to the understanding of the real-life contracts and institutions that hold together modern economies.
Their research was praised for shedding light on how contracts help people deal with conflicting interests in areas such as insurance and employment. They were also recognised for helping with the design of better contracts, “thereby shaping better institutions in society”.
Holmström, now working at the Massachusetts Institute of Technology, and Hart, of Harvard University, were praised and congratulated by fellow economists, although they had not been seen as frontrunners for the honour, officially known as the Sveriges Riksbank prize in economic sciences in memory of Alfred Nobel.
Holmström said he certainly had not expected the 8m Swedish krona (£746,000) prize and described himself as “very lucky and grateful”. Hart appeared to have been a little more expectant. After the announcement, he tweeted:
“I woke at about 4:40 and was wondering whether it was getting too late for it to be this year, but then fortunately the phone rang” O. Hart
— The Nobel Prize (@NobelPrize) October 10, 2016
“My first action was to hug my wife, wake up my younger son ... and I actually spoke to my fellow Laureate” Oliver Hart #NobelPrize
— The Nobel Prize (@NobelPrize) October 10, 2016
The prize givers said the award reflected the pair’s role in launching contract theory as a “fertile field of basic research” and their subsequent work that had helped lay a foundation for designing policies and institutions in areas from bankruptcy legislation to political constitutions.
“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,” the Royal Swedish Academy of Sciences said.
“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.”
Hart’s research work has included a damning assessment of America’s private prisons. He showed that the pressure to cut costs was too great, leading to an unacceptable drop in quality. At the core is the issue of “incomplete contracts” – the fact that contracts are not detailed enough to cover every small point.
Holmström is known for pioneering research into executive pay. His work on employment contracts has considered a range of professions from teaching to management and whether they should be paid fixed salaries or work on the basis of performance-related pay.
Leonardo Felli, head of the economics department at the London School of Economics, where Hart is a visiting professor, said the winning pair were “two of the most distinguished economists of our time”.
“Their analysis of the contractual relationship between individuals has enhanced our understanding of the inner functioning of modern firms, corporations and organisations, as well as providing a key insight into the basic contractual relationships between economic agents, the building block of all economic activities,” said Felli.
