Harvard and MIT professors win Nobel Prize in economics for research on contracts and executive pay

Two professors at American universities on Monday were awarded the Nobel Prize in economics for their contributions to the understanding of contracts and how they apply to such arrangements as performance-based pay for top executives.

Oliver Hart, a British-born American citizen who teaches at Harvard University, and Bengt Holmstrom of Finland, a professor at MIT, worked independently in advancing the field of contract theory.

Holmstrom showed how company shareholders, for example, should write an optimal contract for a chief executive by carefully weighing risks and incentives, taking into account such less-apparent factors as career concerns and cases where rewards are given for performance that is not easy to measure.

Hart focused on an area known as incomplete contracts. His work showed, among other things, the importance of specifying decision rights in contractual relationships because parties are often unable to write detailed terms because they don’t know what will happen in the future.

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Thanks to the work of Hart and Holmstrom, “we now have the tools to analyze not only contracts’ financial terms, but also the contractual allocation of control rights, property rights, and decision rights between parties,” said the Royal Swedish Academy of Sciences in announcing the award.

“The contributions by the laureates have helped us understand many of the contracts we observe in real life. They have also given us new ways of thinking about how contracts should be designed, both in private markets and in the realm of public policy,” the academy said.

Hart and Holmstrom will share the prize money of about $924,000.

In learning of the award early Monday, Hart, 68, said in a video conference with the academy that “my first action was to hug my wife.” Hart received his doctorate in economics from Princeton University and has been teaching at Harvard since 1993.

Holmstrom, who is 67 and earned his doctorate degree from Stanford University, described the day as “surreal.” He has been a professor at MIT since 1994.

The economics award, officially called the Sveriges Riksbank Prize in Economic Sciences in memory of Alfred Nobel, was created in 1969 to celebrate the 300th anniversary of the Bank of Sweden, the world’s first central bank.

Last year the Nobel prize in economics was awarded to Scottish American Angus Deaton of Princeton University for his study of consumption and income, particularly as they relate to poverty and development.

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UPDATES:

7:20 a.m.: This article was updated with staff reporting.

6:50 a.m.: This article was updated with additional details.

This article was originally published at 4:05 a.m.