British-born Oliver Hart and Bengt Holmstrom of Finland won the Nobel prize in economics for their contributions to contract theory, shedding light on how contracts help people deal with conflicting interests.
Such contractual relationships can deal with anything from CEO bonuses to the deductibles and co-pays for insurance, the Royal Swedish Academy of Sciences said Monday.
"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," the academy said.
Both laureates are economics professors at universities in Cambridge, Massachusetts. The London-born Hart, 68, who is an American citizen, works at Harvard University, while Holmstrom, a 67-year-old Finnish citizen, works at Massachusetts Institute of Technology. Holmstrom has also served on the board of Finnish mobile phone company Nokia.
"(Their work) lays an intellectual foundation for designing policies and institutions in many areas, from bankruptcy legislation to political constitutions," the Royal Swedish Academy of Sciences said.
Speaking to reporters in Stockholm by telephone, Holmstrom said he felt "very lucky" and "grateful."
In the 1970s Holmstrom showed how a principal, for example a company's shareholders, should design an optimal contract for an agent, like the CEO. His "informativeness principle" showed how the contract should link the agent's pay to information relevant to his or her performance, carefully weighing risks against incentives, the academy said.
Hart made fundamental contributions to a new branch of contract theory in the mid-1980s. His findings on "incomplete contracts" shed new light on the ownership and control of businesses, the academy said.
"His research provides us with theoretical tools for studying questions such as which kinds of companies should merge, the proper mix of debt and equity financing, and which institutions such as schools or prisons ought to be privately or publicly owned," the academy said.
The economics prize is not an original Nobel Prize. Formally called the Nobel Memorial Prize in Economic Sciences, it was added to the others in 1968 by Sweden's central bank.
The Nobel Prizes in medicine, physics, chemistry and the Nobel Peace Prize were announced last week. This year's Nobel announcements will finish Thursday with the literature award.
Each award is worth 8 million kronor, or about $930,000. The laureates will collect them on Dec. 10, the anniversary of prize founder Alfred Nobel's death in 1896.
This report contains material from Reuters.