Nobel Prize for Economics awarded to Oliver Hart and Bengt Holmstrom for innovations in contract theory

Francesca Washtell
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This year's Nobel Prize for Economics will be shared between a Finnish and a British professor (Source: Getty)

British professor Oliver Hart is one of the two laureates of this year's Nobel Prize for Economics, which has been awarded for innovation in contracts theory.

Hart, who is based at Harvard University, and Finnish Bengt Holmstrom, based at MIT, have created valuable new theoretical tools that have helped to "[understand] real-life contracts and institutions, as well as potential pitfalls in contract design", the Nobel committee said in a statement this morning.


The two winners, who will share the 8m Swedish krona (£748,821) prize money, developed a comprehensive framework for analysing diverse issues in contract design, such as performance-based pay for top executives and the privatisation of public sector activities.

Read more: What makes a Nobel Prize winner?

What won it for Hart and Holmstrom?

In the late 1970s, Holmstrom pioneered the principal-agent model, by demonstrating how company shareholders (called a "principal") should design an optimal contract for a chief exec (called an "agent").

His work signalled how the optimal contract carefully weighs risks against incentives. In later studies he generalised these results to more realistic settings, such as potential promotion and how individual members of a team can free-ride on the efforts of others.

In the mid-1980s, London-born Hart made "fundamental contributions" to a branch of contract theory that deals with "incomplete contracts".

Read more: Nobel Prize for Physics awarded to British scientists who revealed "secrets of exotic matter"

As it is impossible for a contract to spell out every eventuality, Hart's work - in simplified terms - has shed light on which party to a contract should be entitled to make decisions in which circumstances.

Hart's theoretical work can be applied to issues such as which companies should merge, what should be the proper mix of debt and equity financing and when institutions such as prisons ought to be privately or publicly owned.

The Nobel committee said:

Through their initial contributions, Hart and Holmstrom 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.

Last year, Edinburgh-born economist Angus Deaton won The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2015 for his analysis of consumption, poverty and welfare.

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