For showing how contracts work best, pair wins Nobel
Let insiders easily cash in stock options, as Enron did, and you risk seeing executives abandon a failing company. Encourage contractors to sacrifice quality to cut costs and you might cause problems like those that led the U.S. Justice Department to phase out privately run prisons.
Designing contracts is a tricky business. For their groundbreaking work on how to make contracts fairer and more effective, Oliver Hart of Harvard University and Bengt Holmstrom of the Massachusetts Institute of Technology won the 2016 Nobel prize for economics Monday. They will share the $930,000 award for their contributions to contract theory.
Pay packages, Holmstrom’s work suggests, are best tailored to avoid either punishing or rewarding CEOs for happenings beyond their control.
Likewise, companies fare best when they establish pay packages that incentivize executives to prioritize the long-term as much as the short-term.