Press Release: The Prize in Economic Sciences 2016
10 October 2016
The Royal Swedish Academy of Sciences has decided to award the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2016 to
Harvard University, Cambridge, MA, USA
Massachusetts Institute of Technology, Cambridge, MA, USA
“for their contributions to contract theory”
The long and the short of contracts
Modern economies are held together by innumerable contracts. The new theoretical tools created by Hart and Holmström are valuable to the understanding of real-life contracts and institutions, as well as potential pitfalls in contract design.
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. 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.
In the late 1970s, Bengt Holmström demonstrated how a principal (e.g., a company’s shareholders) should design an optimal contract for an agent (the company’s CEO), whose action is partly unobserved by the principal. 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. In later work, Holmström generalised these results to more realistic settings, namely: when employees are not only rewarded with pay, but also with potential promotion; when agents expend effort on many tasks, while principals observe only some dimensions of performance; and when individual members of a team can free-ride on the efforts of others.
In the mid-1980s, Oliver Hart made fundamental contri-butions 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, this branch of the theory spells out optimal allocations of control rights: which party to the contract should be entitled to make decisions in which circumstances? Hart’s findings on incomplete contracts have shed new light on the ownership and control of businesses and have had a vast impact on several fields of economics, as well as political science and law. 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.
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.
The Nobel Memorial Prize in Economic Science has just been awarded to Oliver Hart and Bengt Holmström for building the foundations of contract theory.
Contract theory is not merely the study of legally binding contracts. Broadly defined, it studies the design of formal and informal agreements that motivate people with conflicting interests to take mutually beneficial actions. Contract theory guides us in structuring arrangements between employers and employees, shareholders and chief executives, and companies and their suppliers.
In essence, contract theory is about giving each party the right incentives or motivations to work effectively together.
Hart and Holmström have developed elegant and powerful methods that are taught to all students in economics. Their work forms the fundamental building blocks of many areas beyond economics, such as finance, law, public policy and management.
Previously, general equilibrium theory had already shown how efficient outcomes can be achieved under ideal circumstances, through detailed contractual agreements. In fact, research in this area has already led to a number of other economic science prizes (John Hicks and Kenneth Arrow, 1972; Gérard Debreu, 1983; Ronald Coase, 1991).
However, this research ignored two potential issues: informational problems and incomplete contracts. By studying these two issues, Hart and Holmström developed what has become modern contract theory. Here we examine a few of the papers that explore those problems and made substantial contributions to the field.
Holmström’s work focuses on informational problems in which some parties do not observe what others are doing.
Consider the problem of motivating an employee to work hard. If the employer can perfectly monitor the employee, then she can simply reward the employee if he works, and punish him if he shirks. However, such monitoring is often unrealistic. Often, employers can base employee rewards only on the outcome of the employee’s work.
Holmström’s 1979 paper, “Moral Hazard and Observability”, shows how employers should optimally link employee rewards to performance outcomes. One key insight is that a CEO’s pay should not depend only on his or her company’s share price. Such a scheme would unnecessarily penalize the CEO for factors beyond his or her control, such as commodity prices.
A better reward scheme would seek to eliminate such factors by, for example, linking the CEO’s pay to the company’s share price relative to competitors in the same industry.
Another paper, published in 1982 and titled “Moral Hazard in Teams”, extends his 1979 analysis to settings in which a team of employees contributes individual efforts towards a collective output, such as a team of inventors working together to develop a new product.
A partnership scheme that simply shares profits amongst team members creates a free-rider problem: Each team member is insufficiently motivated by his or her share of profits and thus exerts too little effort. Holmström shows that the free-rider problem can be resolved by introducing a “budget-breaker”, a third party such as a venture capitalist who assigns rewards and penalties to the team members and keeps what is left for herself.
Holmström’s 1991 paper with Paul Milgrom, “Multitask Principal Agent Analyses – Incentive Contracts, Asset Ownership and Job Design”, considers situations in which the employee allocates effort amongst multiple tasks. The employer only observes the outcome of some tasks. For example, a teacher may devote effort towards improving test scores or towards inculcating student creativity.
One insight is that the school should not make teacher pay too sensitive to observable outcomes. Rewarding teachers for high test scores may distort teacher effort away from hard-to-measure tasks such as developing student creativity.
Hart, for his part, developed foundations for the theory of incomplete contracts.
The basic idea is that it is impossible to write a contract that anticipates every potentially relevant future contingency. Consequently, the allocation of control rights becomes a powerful tool for creating incentives. This perspective enables the analysis of fundamental questions such as whether companies should outsource or integrate production, which assets they should own and how they should choose between equity and debt financing.
Hart’s 1986 paper with Sanford Grossman, “The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration”, studies incomplete contracting in which various parties invest to increase the productivity of an asset. When unforeseen contingencies arise, the parties have to bargain over what to do.
Crucially, asset owners have stronger bargaining power, which motivates them to invest. Therefore, the asset should be owned by the party whose investment is most important.
A paper Hart published in 1990 with John Moore, “Property Rights and the Nature of the Firm”, extends his 1986 analysis to study optimal ownership of multiple assets. It shows that highly synergistic assets – whose values are enhanced when used together – should be owned by a single party, rather than separately by multiple parties.
Concentrating bargaining power in the hands of one party is more effective than diffusing bargaining power across multiple parties. This paper paints a compelling picture of large integrated firms where all physical and intellectual assets are owned by a single corporate entity.
From theory to real-world application
We have merely highlighted a few of Holmström’s and Hart’s fundamental contributions to contract theory.
These economists as well as others have applied this work to study key features of real-world contractual agreements: liquidity provision by governments and banks, long-term compensation and promotion schemes for senior managers and executives, and public versus private ownership of institutions such as prisons and utilities.
Contracts have governed the workings of the economy since ancient times. As technology improves and organizations become more complex, the theory and practice of contract design will only increase in importance.
As such, we owe a great debt to Holmström and Hart for giving us powerful tools to structure effective contracts.
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مقدمة 1-اقتصاديان يفوزان بجائزة نوبل لرؤيتهما حول وضع الأجور والمكافآت
(دانيال ديكسون ونيكلاس بولارد)
من لإضافة اقتباسات وتفاصيل
ستوكهولم 10 أكتوبر تشرين الأول (رويترز) – فاز أوليفر هارت
البريطاني المولد وبنجيت هولمستروم الفنلندي المولد بجائرة نوبل في
الاقتصاد اليوم الاثنين لعملهما الذي يجيب على مجموعة من الأسئلة
تتراوح بين أفضل وسيلة لمكافأة الرؤساء التنفيذيين للشركات وما إذا
كانت المدارس أو السجون يجب أن تكون مملوكة للقطاع الخاص.
وقالت الأكاديمية الملكية السويدية للعلوم لدى الإعلان عن
الجائزة التي تبلغ قيمتها ثمانية ملايين كرونة سويدية (928 ألف
دولار) إن النتائج التي توصلا إليها حول نظرية العقد لها تأثيرات
على حوكمة الشركات وتشريعات الإفلاس والدساتير السياسية وغيرها من
وقال بير سترومبرج عضو لجنة جائزة نوبل والأستاذ في كلية
ستوكهولم للاقتصاد "هذه النظرية هامة للغاية ليس فقط للاقتصاد ولكن
أيضا لغيره من العلوم الاجتماعية."
وتبحث نظرية العقد على سبيل المثال ما إذا كان ينبغي أن يحصل
المديرون على مكافآت أو خيارات أسهم وما إذا كان المدرسون أو
العاملون في الرعاية الصحية يجب أن يحصلوا على رواتب ثابتة أو
استنادا إلى معايير قائمة على الأداء.
ويعمل هارت أستاذا للاقتصاد في جامعة هارفارد فيما يعمل
هولمستورم أستاذ اقتصاد وإدارة في معهد ماساتشوستس للتكنولوجيا.
وفي المجمل فإن الأكاديميين التسعة الذين فازوا بجائزة نوبل
هذا العام في الطب والفيزياء والكيمياء والاقتصاد من بينهم خمسة
ولدوا في بريطانيا وفرنسي وفنلندي وألماني وياباني.
وبينما لا يوجد من بين الفائزين أي شخص أمريكي المولد إلا أن
ستة منهم بما في ذلك البريطانيون الخمسة يعملون في جامعات أمريكية.
ونقل الحساب الرسمي لجائزة نوبل على موقع تويتر عن هارت قوله
"استيقظت في نحو الساعة 4:40 وتساءلت عما إذا كان الوقت متأخرا هذا
العام لنيل الجائزة ولكن لحسن الحظ رن جرس الهاتف. أول ما قمت به
أن عانقت زوجتي وأيقظت ابني الأصغر."
وقالت الأكاديمية في بيان إن عمل هارت يركز في جزء منه علي فهم
أي الشركات يجب أن تندمج والمزيج الصحيح للتمويل ومتى يجب أن تكون
المدارس والسجون والمستشفيات مملوكة للقطاع الخاص أو العام.
وقال هارت إن حوافز خفض التكلفة في الخدمات التي جرى خصخصتها
كالسجون الخاصة في الولايات المتحدة عادة ما تكون قوية للغاية.
وقالت الأكاديمية إن هولمستورم درس إعداد عقود العاملين من
المدرسين حتى رؤساء الشركات خالصا إلى أنه "في الصناعات ذات
المخاطر المرتفعة فإن الأجور يجب…أن تنحاز نسبيا نحو الراتب
الثابت بينما في بيئة أكثر استقرار فيجب أن تنحاز نحو معيار
وقال هولمستورم إن أجور المدرسين يجب ألا تستند إلى درجات
اختبار الطلاب لكنها يجب أن توضع بطريقة من شأنها مكافأة تدريس
المهارات صعبة القياس مثل الابتكار والتفكير المستقل.
وقالت الأكاديمية "نتائج هذا النموذج متعدد المهام غيرت
الكيفية التي يفكر بها الاقتصاديون في البرامج المثلي للأجور
والمكافآت وتصميم الوظائف."
(الدولار = 8.6231 كرونة سويدية)
(إعداد معتز محمد للنشرة العربية – تحرير)