2016 Economics Nobel Awarded For “Contributions To Contract Theory”

Oliver Hart and Bengt Holmström win prize for showing how contracts affect how people and institutions work in a real-world economy.

Nobel Prize committee

Oliver Hart and Bengt Holmström have been awarded the 2016 Nobel Prize in economic sciences for their work showing how society is shaped by contractual relationships.

Hart, a Briton who works at Harvard, and Homström, a Finnish-American who works at MIT, have spent decades investigating how contracts such as employment contracts or insurance contracts incentivise people and institutions.

They are the developers of “contract theory”, which looks at how contracts manage the conflicts of interest between people or groups. They have looked at complex problems like CEO pay and the privatization of publicly owned businesses, and shown how contracts can be written to best incentivise the signatories.

Per Strömberg, a member of the Nobel Prize committee, said: “Contracts are a fundamental thing that affect most of us – most of us have insurance, so we’ve entered into a contract with an insurance company, or taken a loan to buy a house or a car, so we have a loan contract, or a purchase contract with the vendor, or an employment contract with our employers.

“And it’s wider than this – when we own something, that’s a property contract, and politics is a contract between the government and the people. So contract theory is incredibly important for understanding these institutions.”

Holmström said he was “dazed, very surprised, and very happy” to have won. “I am very lucky and grateful to the committee, my co-workers, my family, and everybody,” he said. “I certainly did not expect it.”

David Chivers, an economist at the University of Durham, told that contracts often push people to behave in ways that are very different to how they are intended to. “For instance, you might contract someone to work a 40-hour week,” he said. “But then you’ve just incentivised them to sit there for 40 hours playing Angry Birds.

“Or you might insure someone against breaking their leg when they’re skiing, but that might incentivise them to ski more riskily and make them more likely break their leg.”

He said contract theory has transformed much of our day-to-day lives, by changing how contracts are written. “It’s about creating and incentivising behavior you want,” he said. “For instance, it’s why we have deductibles in motor insurance.

“It means we don’t insure for small bangs and knocks, because we know that people drive more recklessly if you do.

“It’s one of the better things economists have created – you can see the effect in the real world, for instance in how contracts are designed in insurance markets.”

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