Holmström wins Nobel prize for work on contract theory

Economics professor Bengt Holmström was awarded the 2016 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel alongside Harvard economist Oliver Hart for their work on contract theory.

“Modern economies are held together by innumerable contracts,” said a press release from the Royal Swedish Academy of Sciences announcing the award. Contract theory provides “a comprehensive framework for analysing many diverse issues in contractual design.”

Holmström’s work on contract theory and the theory of incentives explains how contracts should be devised to maximize benefits for workers and corporations. Using a principal-agent model, his informativeness principle states how a contract should link an agent’s pay to performance-relevant information.

“One of the theory’s goals is to explain why contracts have various forms and designs. Another goal is to help us work out how to draw up better contracts, thereby shaping better institutions in society,” the Royal Academies press release said. It can help answer questions such as: “Should providers of public services, such as schools, hospitals, or prisons, be publicly or privately owned? Should teachers, healthcare workers, and prison guards be paid fixed salaries or should their pay be performance-based? To what extent should managers be paid through bonus programmes or stock options?”

Holmström’s research “holds real insights for business leaders everywhere, in every industry,” Dean of MIT Sloan David C. Schmittlein told the MIT News Office. “He continues a long tradition of inventive economic thinking at MIT, and his ideas remain central to how we think about contracts and employee incentives.”

“Bengt’s foundational research in contract theory, which has provided practical tools for many areas of modern society, represents MIT’s profound commitment to basic research that can generate new and deep understandings of the human complexities — the political, cultural, and economic realities that shape our existence,” Melissa Nobles, Dean of MIT's School of Humanities, Arts, and Social Sciences, said.

Holmström and Hart are close friends who have worked largely in parallel, occasionally publishing together. Hart himself was a professor of economics at MIT from 1985 to 1993. They will share the prize of 8 million Swedish krona, roughly $925,000.

“I’m so glad that I won it with [Hart],” Holmström said. “He’s my closest friend here, and you know we have worked together and talked together over the years, and he has been a great inspiration for my research.”

Holmström received his PhD from Stanford University’s Graduate School of Business in 1978. He served as an associate professor at the Kellogg Graduate School of Management at Northwestern University, and Edwin J. Beinecke Professor of Management at Yale University’s School of Management. He joined  MIT in 1994, where he is currently the Paul A. Samuelson Professor of Economics.

Holmström is the fifth person to win the Nobel while a member of MIT’s Department of Economics, President L. Rafael Reif wrote in an email to the MIT community. He follows Nobel laureates Paul A. Samuelson (1970), Franco Modigliani (1985), Robert M. Solow (1987), and Peter Diamond (2010). An additional 10 MIT alumni and seven former MIT faculty have won the Nobel Prize in economic sciences, and 87 people affiliated with MIT have won Nobel prizes overall.