THE ROYAL SWEDISH ACADEMY OF SCIENCES
has awarded its 2016 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel to Oliver Hart (pictured left), Andrew E. Furer Professor of Economics at Harvard University in Cambridge, Massachusetts, and Bengt Holmström, the Paul A. Samuelson Professor of Economics at the Massachusetts Institute of Technology, also in Cambridge.
The laureates were recognized for their individual study of the complex ways contractual relationships drive the economy. In the 1970s and ’80s, Hart and Holmström each contributed to a framework for a then new branch of contract theory. They analyzed the diverse factors affecting contractual design, from performance-based executive pay and contractual incentives to mergers, insurance policies, and privatization of public-sector activities.
For instance, in his early research, Holmström studied the ideal design of a contract between a company’s shareholders and its CEO and found that a CEO’s compensation should be linked to performance; he also examined how risk should be weighed against incentives. Hart’s work looked at how contracts should be designed to account for unforeseen eventualities not addressed in the contracts’ original language—for instance, by spelling out which party makes decisions in what circumstances. His findings on so-called “incomplete” contracts—particularly those related to ownership and control—have influenced the fields of economics, political science, and law.
Their research has implications on how incentives are used in organizations for all stakeholders affected by a company’s actions. “One of the important lessons of contract theory is that whatever contract you write, you always have to think about the other parties involved as well,” said Holmström, by phone at the press conference announcing this year’s winners. “In economics, we are trying to maximize the total pie, meaning we’re trying to make it a win-win situation for everybody.”
According to the Nobel Prize committee, Hart’s and Holmström’s work on optimal contractual arrangements “lays an intellectual foundation for designing policies and institutions in many areas, from bankruptcy legislation to political constitutions.”
Hart and Holmström will share a monetary prize equivalent to approximately US$900,000.