The Nobel prize in economics sciences isn’t strictly a Nobel prize. It was created in 1968 by the Swedish central bank following a donation to the Nobel foundation on the occasion of the bank’s 300th anniversary.
It seems appropriate, consequently, that in the current hysterical blockchain climate — a climate epitomized by the notion that everyone from central bankers to lawyers will soon be dis-intermediated because of smart-contracts on blockchains — the Royal Swedish Academy of Sciences has awarded its latest prize to Oliver Hart from Harvard University and Bengt Holmström from MIT for their work on contracting.
From the Bloomberg write-up about Hart’s work specifically:
Hart has focused his research on the division of power in economic relationships, including in contracts. As part of this work, he in the 1980s developed a “major breakthrough” in analyzing the domain of “incomplete contracts,” according to the academy.
Hart’s idea is that the very basic contract, since the future is uncertain, must spell out who has the right to decide what to do when the parties can’t agree, the academy said.
And from the official press release, regarding Hart’s work in the 1980s (our emphasis):
Because it is impossible for a contract to specify every eventuality, this branch of the theory spells out optimal allocations of control rights: which party to the contract should be entitled to make decisions in which circumstances? Hart’s findings on incomplete contracts have shed new light on the ownership and control of businesses and have had a vast impact on several fields of economics, as well as political science and law. His research provides us with new theoretical tools for studying questions such as which kinds of companies should merge, the proper mix of debt and equity financing, and when institutions such as schools or prisons ought to be privately or publicly owned.
And from a paper by Samuel Bowles and Herbert Gintis in the Quarterly Journal of Economics in 2000:
Where contracts are complete, as Oliver Hart remarked, there is nothing for power to be about, but where much remains to be determined after the handshake, the institutional details of the exchange process determine the strategic opportunities and effectiveness of the parties concerned.
The result of these two consequences of incomplete contracts is that economic analysis must become more social and psychological in its treatment of the human actor, more institutional in its description of the exchange process, yet no less analytical in its model-building and no less dedicated to the construction of general equilibrium models. In Section IV we discuss the problem of public policy and institutional design, observing that we must judge policies and institutions not by how closely they approximate the assumptions of the fundamental theorems of welfare economics, but rather according to their ability to function effectively in the second-best world of ineradicable state and market failures.
And last and not least from the scientific background to Hart and Holmström’s work provided by the committee:
The most important application of incomplete-contracts theory to date is in the Öeld of corporate Önance. Traditionally, financial contracts were seen as devices for furnishing investment capital and sharing risk. With agency theory, the emphasis changed. Economists came to see what many practitioners and legal scholars had seen all along, namely that a major purpose of financial contracting is to ensure that entrepreneurs and managers act in the interests of investors. Perhaps this is the greatest moral-hazard problem of all, at least in the business sector.
We hope the architects of Ethereum-based decentralised autonomous organisations are paying attention?
Related Link:
Legal exploits and arbitrage, DAO edition – FT Alphaville
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