STOCKHOLM (AFP) - Two US-based academics won the Nobel Economics Prize on Monday (Oct 10) for groundbreaking research on contract theory that has helped design insurance policies, executive pay and even prison management.
Dr Oliver Hart, a British-American economist, and Dr Bengt Holmstrom of Finland “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”, the Nobel jury said.
Their pioneering work has laid “an intellectual foundation” for designing policies and institutions in many areas, it added.
Working separately, the two created tools to help determine whether teachers, healthcare workers, and prison guards should receive fixed salaries or performance-based pay, and whether providers of public services, such as schools, hospitals, or prisons, should be publicly or privately owned.
“The new theoretical tools created by Hart and Holmstrom are valuable to the understanding of real-life contracts and institutions, as well as potential pitfalls in contract design.”
Dr Hart, born in 1948, is an economics professor at Harvard University in the United States, while Dr Holmstrom, 67, is a professor of economics and management at Massachusetts Institute of Technology.
The pair will share the eight million kronor (S$1.2 million) prize.
“My first action was to hug my wife, wake up my younger son... and I actually spoke to my fellow laureate,” Dr Hart told the Nobel Foundation website.
Dr Holmstrom, meanwhile, told reporters via video link at the Nobel press conference in Stockholm that he was “very surprised, and very happy” to win the prestigious award.
Dr Holmstrom is known for his research into how contracts and incentives affect corporate behaviour, including governance, as well as liquidity problems in financial crises.
A board member at Finnish telecoms company Nokia from 1999 to 2012, Dr Holmstrom was asked by reporters whether executives’ bonuses were too big today.
“My theories don’t take a stand on that... My personal view is that (top executives’ labour contracts) are too complicated today,” he said, adding: “What improved in later years is... that they don’t get everything in a very short period, they get things over time.”
In the late 1970s, Dr Holmstrom showed how the optimal contract carefully weighs risks against incentives.
In later work, he generalised those results to more realistic settings, such as when employees are not only rewarded with pay, but also with potential promotion, or when individual members of a team can coast on the efforts of others.
In the mid-1980s, Dr Hart made fundamental contributions to a new branch of contract theory that deals with so-called 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?” the jury said.
Dr Hart’s research has provided 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.
Last year, the Nobel economics prize award went to US-British researcher Angus Deaton for his groundbreaking work on poverty.
The economics prize is unique among the Nobel awards in that it was created by the Swedish central bank in 1968 – the others were all set up through the 1895 will of Swedish inventor and philanthropist Alfred Nobel.
The economics award is the fifth of the six Nobel prizes to be announced this year.
Last week, the awards for medicine, physics, and chemistry were announced, as well as the peace prize, which went to Colombia’s President Juan Manuel Santos for his efforts to end a half-century war with the FARC rebels.
The final prize, for literature, will be announced on Thursday (Oct 13).
For that award, the Swedish Academy could tap a superstar novelist such as Philip Roth of the United States or Haruki Murakami of Japan, or a lesser-known writer such as Norwegian playwright Jon Fosse or Syrian poet Adonis.