Pioneering way to link pay with performance

Two US-based academics won the Nobel Economics Prize on Monday for ground-breaking research on contract theory that has helped design insurance policies, executive pay and even prison management.

Oliver Hart, a British-American economist, and 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.”

Mr Hart, born in 1948, is an economics professor at Harvard University in the United States, while Mr Holmstrom, 67, is a professor of economics and management at Massachusetts Institute of Technology.

The pair will share the eight million kronor ($924,000) prize. “My first action was to hug my wife, wake up my younger son ... And I actually spoke to my fellow laureate,” Mr Hart told the Nobel Foundation website. Mr Holmstrom, meanwhile, told reporters via video link in Stockholm that he was “very surprised, and very happy” to win the prestigious award.

Mr 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, Mr 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.