Nobel Laureates Deserved the Prize

In 2016, the Nobel Prize in the economics was awarded to the authors of the contract theory: Oliver Hart of the Harvard University and Bengt Holmstryom of the Massachusetts Institute of Technology. No doubt, these laureates deserve the prize as the outputs of their research are taught at all the universities within the frameworks of contract theory courses.

The above theory is based on the Principal-Agent model where an agent (a chief or “principal”) hires another agent (a subordinate or an agent) for fulfilment of an assignment or “project”. Success of the project is related not only to the agent’s efforts, but also other factors which the agent cannot influence. Importantly, the principal observes only the ultimate result. The principal can only assess whether the project is successful or not, but he has no information as to what factor was behind the failure: the agents’ insufficient efforts or external factors. So, there is a question which contract the principal has to offer the agent to create a motivation for the latter to apply high efforts, while the agent’s efforts are not observed and can be assessed only indirectly on the basis of the ultimate result? In the contract theory, there is a separate unit which integrates models which provide an answer to that question, for example, the “agency relationship” theory which Bengt Holmstryom made a significant contribution to.

Oliver Hart dealt more with another branch of the contract theory, namely, incomplete contracts. That theory takes into account the situation where two agents participate together in implementation of the project and the project’s success depends on decisions and efforts by either side, while distribution of the profit received fr om the project is specified in the contract. In a contract, it is often impossible to link cash payments received by either agent to his/her efforts (in such a case contracts are called “incomplete”). Instead of that, for example, the contract suggests that the total profit from the project is divided between the agents in some fixed ratio. It turns out that such contracts are actually inefficient as they result in insufficient efforts on the part of the agents. Oliver Hart’s works were dedicated to a search for an optimal distribution both of profits from a project and decision-taking rights between the two parties wh ere a likelihood of the project’s success is the maximum one.

From among prizes in the economics awarded for the contract theory one can remember the 2009 prize received by Oliver Williamson and Elinor Ostrom, as well as the 2014 prize awarded to Jean Tirole who carried out research in that field, too.

Euvgeny Goryunov, Researcher