Economics professors teaching at Harvard and MIT have been awarded the Nobel Memorial Prize in Economic Sciences by the Royal Swedish Academy of Sciences for their contributions to the field of contract theory.
"Through their initial contributions, Hart and Holmström 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," says the press release. (See also, 5 Nobel Prize-Winning Economic Theories You Should Know About)
British economist Oliver Hart, 68, and Finnish economist Bengt Holmström, 67, will both share the SEK 8 million in prize money. The award has been given since 1969 and was not one of the awards Alfred Nobel mentioned in his will. It was established in 1968 with a donation from Sweden's central bank on its 300th anniversary.
Both prize winners focused their studies on conflicts of interest. Hart researched incomplete contracts and his work helped those studying which party in the contract should make decisions when unexpected circumstances arise. "His research provides us with new theoretical tools for studying questions such as which kinds of companies should merge, the proper mix of debt and equity financing, and when institutions such as schools or prisons ought to be privately or publicly owned," said the press release. Holmström demonstrated how contracts signed by shareholders and CEOs should be written. According to the official statement, "Holmström’s informativeness 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."
Why contract theory ? Professor Per Stromberg, who is the chairman of The Economics Science Prize Committee, explained the basis of the decision himself. In a video tweeted by the foundation he said, "Contracts are very fundamental. We see them everywhere in society. All of us are engaged in different types of contracts. (With) many institutions we see in society, you can also think about contracts, like constitutions, property rights and those kinds of things. So one thing, it's important. The second thing is that this is a theory that has really given rise to lots of other applications. So in many, many fields, not just economics, but in law and politics, people actually use these theories to understand what they are studying."