I am happy to hear this theory got Nobel Prize. This theory reveals side effect of miscalculated profit which imposed to workers or employees by companies for ambition in the process of contract between employer and employee or worker and companies.
This theory indicates about gap between employer and employee. Somewhere employees are in horrible situation particularly in pvt companies which exploit by Sr management of company.
Harvard's Oliver Hart and Bengt Holmstrom from the Massachusetts Institute of Technology have won the Nobel Prize for economics for their research into contract theory. Their contributions have helped our understanding of the often conflicting incentives that operate in the contracts that enable cooperation between individuals, between employers and their workers, between governments, and which affect all of our lives.
I am sharing extract basis conversation between Arnab Bhattacharjee, Professor of Economics, Heriot-Watt University andJoseph Byrne, Professor of Economics, Heriot-Watt University.
Some extract are following -
A comprehensive framework for analyzing many diverse issues in contractual design, like performance-based pay for top executives, deductibles and co-pays in insurance, and the privatization of public-sector activities.
Risk sharing
Holmström, from Finland, developed research on optimal design of contracts from the perspective of an employer and their arrangements with a worker. This is work in the area of the “principal-agent problem”, where the employer is the principal. Here, there is potentially an issue in designing the best contract since there are competing incentives for the principal and agent, although they would still like to cooperate.
Risk sharing is an important part of this relationship, since workers would rather not have to bear all the uncertainties a firm experiences with variable revenue and profits. Firms would rather pass on some of these risks to workers, such that their costs are aligned with revenue. Holmström developed the informative principle, setting out how optimal pay should be linked to performance.
In our post-financial crisis world, we would all probably now agree that we should not reward the chief executive of a company with a large bonus for outcomes that are random. Further, career path matters for optimal contracts, for example we should pay different bonuses to younger or older workers, because younger workers can be rewarded with potential promotion in the future.
In the context of insurance contracts, problems can arise because individuals can become more careless after the contract has been agreed. Specifically there may be a conflict of interest between the less-than-moral contract holder or issuer. Indeed, the fact that it is difficult to measure compliance with a contract, and who was responsible for violations, can also present a challenge.
The Relevance -
The award award tends to reflect the world’s economic preoccupations, rewarding work which sheds light on areas which have demanded, and perhaps confounded, financial and political attention.
Hart and Holmström’s work has made a significant contribution to age old questions and new issues in economics. They can resolve some of the competing incentives in contract design while allowing cooperation. In many ways, their contributions are fundamental to modern ways of thinking in economics, but also have substantial cross-overs with many other areas of society and policy where contracts are very important.
In deciding to award the prize, the Royal Swedish Academy of Sciences have perhaps emphasized the point that the applications of these methods and theories are pervasive, and anyone interested in contracts may benefit from an understanding of the key principles behind their contributions. In some ways, that probably includes almost all members of society and the economy – individual households, workers and firms, the government and multilateral agencies.
Now the question of relevance to this theory. Need of hour is implementation and utilization of this theory for prosperity of employees.
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Ajay kumar - ajay.mrim@gmail.com
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