Contract theory is not a determinant for the pay package that you take home but is associated with the analysis of arriving at an accurate figure for the compensation associated with any level of employment in an organization. An economist working on ‘Contract Theory’ winning a Nobel Prize is not just about General Knowledge but an indicator of how closely economists’ work is associated with real life. It is not just of purely academic interest but is relevant to the lives of people at the very basic level of their existence. Knowledge about Nobel Prize winners is essential for Banking, SSC and UG entrance exams. Such discussions are also taken up in a pre-job or pre-MBA interview.
Nobel and the MIT-Harvard Connection
This year’s Nobel Prize for Economic Sciences goes to Bengt Holmstrom and Oliver Hart. These are names associated with the Ivy League Colleges in the United States of America. The former being associated with the Massachussets Institute of Technology while the latter being a much recognized economist and an approachable Professor at the Harvard. Their work was published in the journal ranked the highest in the field of Economics, Econometrics and Political Economy. Their work in the field of ‘Contract Theory’ is the one having been cited as the body of work having made a difference to the compensation structure in organizations. Performance based pay is the norm across positions depending on the kind of vertical one is associated with. Even when it comes to sales, the variable pay has been a part of compensation structure of most organizations for a long time. It is the variable part of the pay structure that earns them a fat pay-cheque while the fixed component happens to be the bare minimum.
Contract Theory: Adopted across Organizations
Is this not exciting for students and near-term professionals to know about it? Yes! It is! The reason being that the work starts finding acceptance in MNCs and then there is a trickle-down effect on policy being implemented for employees. It is important to thus see their work in perspective. Political constitutions and bankruptcy legislation are also areas of work that these economists have worked in, in a manner that is accessible to a certain extent to those who appreciate this work. A paper published today would find place in policies being followed in organizations a decade or two later, this being the norm for a long time now. Nowadays, there is greater acceptance for policy related work with some of it finding its way into implementation in organizations willing to go the extra mile in gaining from that industry-academia interface. Political institutions are a major constituent of the decision and implementation process in a country. Economists’ work on political institutions can thus be seen as the one that forms the very foundation of governance in a country. Nothing can be thus of greater significance than this.
Work beyond the Nobel recognition
Apart from the work already mentioned, these economists have worked on liquidity in markets. Oliver Hart has worked on the ‘The Principal-Agent Problem’. To put it in simple words, the theory finds use or can be applied to the simplest of professional associations. Principal-Agent problem reflects the relationship between a manager and the one availing the services. Principal here is the one availing the services. Information Asymmetry is the problem that plagues such an association. This relates to the difference in detail when it comes to information available to the Principal and to the Agent in the professional equation being talked about.
Therefore, this kind of information is thus relevant for even the man on the street because the biggest of theories with all the details find use in situations that people find themselves in at all times.
Catch 22: Inflation Targeting or Interest Rate Cut
