While economics has mostly turned to data-mining and econometric analysis of complex problems, especially those related to monetary policy, consumption and inflation, the Nobel committee has done well to reward the work in a field that not only benefits corporates and government, but also the common man. This year the committee decided to give the much coveted prize to Oliver Hart and Bengt Holmstrom. Although most will be unaware of their work, but one can attribute their bonuses and incentives to Hart’s and Holmstrom’s work on contract theory, especially related to the principal-agent dilemma. The principal-agent dilemma is a problem where one party works in favour of another party in return for some incentives, which creates a moral hazard on the part of the hired party. The work of Hart and Holmstrom deals with this conundrum, suggesting ways as to how both can reach a Pareto optimal—the best—outcome. Their research also helps in determining as to who should have the power of decision in what cases.
Although the contract theory has its limitations, given that it is virtually impossible to work out each and every exigency, it is important in assessing and determining rewards and enforcing all kinds of contracts. Over the last few years, it has been used in designing bankruptcy laws as well. At a time when the world is dealing with strengthening trade and taxation regimes Hart’s and Holmstrom’s research can certainly come in handy for designing new laws.