Hart & Holmstrom: What does it take to be Nobel Prize Economic Winners?

By Xyla Joelle L. Fernandez

Oct 11, 2016 06:00 AM EDT

British-born Oliver Hart and Bengt Holmstrom of Finland had won the Nobel prize in economic for their contributions to contract theory.

"Contracts are essential to the functioning of modern societies" the academic says to its announcement "Hart and Holmstrom research sheds light on how contract help us deal with conflicting interest"

Hart's research has looked at whether providers of public services such as schools, hospitals or prisons, should be publicly or privately owned. The research showed that incentives for cost reduction are typically too strong.

Society's many contractual relationships include those between shareholders and top executive management. This year's laureates have developed contract theory, a comprehensive framework for analyzing many drivers issues in contractual design like performance-base pay for top executives, deductible and co-pays in insurance, and the privatization of public-sector activities.

In 1970's , Bengt Holmstrom demonstrated how a principal should design an optimal contract for an agent whose action is partly unobserved by the principal. Using the basic principal-agent model, he showed how the optimal contract carefully weighs risks against incentives. Holmstrom generalize to more realistic settings.

In the mid 1980's, Oliver 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. Harts findings on incomplete contract have shed new light on the ownership and control of business and have had a vast impact on several fields of economics as well as on political science and law.

Through their initial contributions, Hart and Holmstrom launched contract theory as a fertile field of basic research. Over the pas few decades they have also explored many of its applications. Their analysis of optimal contractual arrangements lay an intellectual foundation for designing policies and institutions in many areas, from bankruptcy legislation and political constitutions.

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