Contracts May Be Boring, But They Won These 2 Men A Nobel Prize

The Nobel Prize in economics just went to two professors' work on contracts.  

It may sound terribly boring (How many of you have actually read Apple's terms and conditions?) but Oliver Hart and Bengt Holmström's work in contract theory may affect you more than you think. 

Flashing back to the late 1970s, Holmström's research dealt with the effectiveness of performance-based pay. 

For example, if teachers were paid based on students' test scores, they might focus too much on that and not enough on fostering creativity.

Hart took contract theory to a new level during the mid-'80s, noting not every situation can be foreseen in a contract. Whether it's supply lines or social institutions, the owner should be the one who can make the best decisions for all. 

A real-life example here is privately owned prisons. Yes, privatization can cut costs but sometimes at the expense of quality. The U.S. Justice Department recently decided to end its use of private prisons to improve prisoner care.  

Contract theory is a lot about give and take. Hart and Holmström's work is about finding the right balance for each situation.