Who won the Nobel Prize for contract theory?
Oliver Hart and Bengt Holmström both received the Nobel Memorial Prize in Economic Sciences in 2016 for their work on contract theory. Their research covered topics including CEO pay and privatizations.
Questions about Contract theory
Short answers, pulled from the story.
What is the difference between complete and incomplete contract theory?
Complete contract theory assumes parties can foresee all future scenarios and write rules for each one, treating firms and markets as equivalent forms of contract. Incomplete contract theory, pioneered by Oliver Hart and his co-authors, studies what happens when parties cannot write every contingency - because doing so is too complex or costly - and focuses on how asset ownership determines incentives in those gaps.
What is moral hazard in contract theory?
Moral hazard refers to the situation where an employer cannot observe or verify what an employee actually does - whether they work, how hard, and how carefully. In contract theory, this is called a hidden action problem, and performance-based contracts are the standard tool for aligning the agent's incentives with the principal's interests.
What is adverse selection and how does contract theory address it?
Adverse selection occurs when one party to a contract has private information the other lacks before signing, such as a health insurer not knowing a customer's true health risk. Contract theory addresses it through incentive-compatible menus of contracts, though doing so requires leaving an information rent with better-informed agents. The theory was pioneered by Roger Myerson, Eric Maskin, and others in the 1980s.
What did Michael Spence contribute to contract theory?
Michael Spence formalized signalling theory in 1973 through his job-market signalling model. In his framework, job applicants signal their skills and capabilities to employers, reducing the probability that a less qualified candidate is hired over a more capable one.
What is the origin of contract theory in economics?
Contract theory in economics traces to Ronald Coase's 1937 article "The Nature of the Firm." Coase observed that the longer a contract's duration regarding goods or services, the less appropriate it is for a buyer to specify exactly what the other party must do, laying the groundwork for distinguishing complete from incomplete contracting.