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Economist Bengt Holmström’s Nobel Prize win delights MIT colleagues

Faculty members cite his transformative work on contract theory.

By Amy MacMillan Bankson  |  October 11, 2016

2016-Holmstrom2

Bengt Holmström. Photo: Bryce Vickmark

MIT Sloan Professor Bengt Holmström has won the 2016 Nobel Memorial Prize in Economic Sciences. Calling his work “pathbreaking,” Holmström's colleagues are lauding the decision by the Royal Swedish Academy of Sciences.

Holmström, the Paul A. Samuelson Professor of Economics in the MIT School of Humanities, Arts, and Social Sciences, with a joint appointment at MIT Sloan School, was named winner of the award Oct. 10, along with Oliver Hart, a professor and economist at Harvard University.

“If there is any surprise about Bengt Holmström’s Nobel Prize, it is the timing—that it has taken the committee so long to recognize his towering contributions,” said Daron Acemoglu, the Elizabeth and James Killian Professor of Economics, and a colleague of Holmström’s in MIT's economics department. "This is a testament to the influence of Bengt's work on contracts, incentive theory, and the internal organization of the firm, which has fundamentally reshaped not just the way we think about these topics but the entire field of economics,”  Acemoglu said.

“MIT has a long and rich tradition of having distinguished economists both on the faculty and amongst its graduates. Nothing is more fitting than having Bengt receive the Nobel Prize, won earlier by Paul Samuelson, who built the MIT economics department to its current greatness and whose professorship Bengt now holds,” said MIT Sloan finance professor Stephen Ross, the Franco Modigliani Professor of Financial Economics and a longtime colleague and friend of Holmström’s.

The Swedish Academy cited Holmström and Hart for “their contributions to contract theory.” In the late 1970s, Holmstrom, who has held a joint appointment with MIT Sloan and the MIT Department of Economics since 1994, demonstrated how contracts should be designed to weigh risks and incentives, as well as how they should link pay to performance.

“Professor Holmström’s work holds real insights for business leaders everywhere, in every industry,” said David Schmittlein, the John C Head III Dean at MIT Sloan. “He continues a long tradition of inventive economic thinking at MIT, and his ideas remain central to how we think about contracts and employee incentives. I know the faculty at MIT Sloan joins me in congratulating Professor Holmström and Professor Hart on this signature achievement.”

Melissa Nobles, the Kenan Sahin Dean of MIT’s School of Humanities, Arts, and Social Sciences, said that MIT was “very proud to celebrate Bengt Holmström’s pioneering economics research today. Bengt’s foundational research in contract theory, which has provided practical tools for many areas of modern society, represents MIT’s profound commitment to basic research that can generate new and deep understandings of the human complexities—the political, cultural, and economic realities that shape our existence. Bengt has been a much-admired member of MIT’s School of Humanities, Arts, and Social Sciences since 1994, and on behalf of the entire school community, I want to wish him—and his co-winner, Oliver Hart, of Harvard—our warmest congratulations.”

“It’s been tremendous to have been Bengt's friend and colleague for the past 22 years,” said Glenn Ellison, the Gregory K. Palm (1970) Professor of Economics at MIT and current head of the department of economics. “He is a remarkable economist. And he has also been a remarkable contributor to the department in so many other ways: He was a dedicated department head; he taught innovative graduate and undergraduate classes; he worked with a number of our top PhD students; he cared greatly about his undergraduate advisees. The prize could not be more deserved and our department could not be happier for Bengt.”

Groundbreaking work
“Contract theory is a pathbreaking approach to a whole host of fields in economics and in law. Almost all human interactions in economics can be characterized as contractual—either implicit or explicit,” Ross said. “Bengt and Oliver built on this intuitive insight and developed a set of models and results that allow us to clearly understand their economics from the perspective of the incentives of agents and the information they possess.” The theories developed by Holmström and Hart have provided a framework that enables an understanding of a broad swath of problems, from labor market interactions to the relationship between owners and enterprises to the role of control rights, Ross said.

Holmström’s work has “provided economists with a new framework to think about the role that incentives play in shaping the behavior of employees and how they interact within complex economic organizations,” said Antoinette Schoar, the Michael M. Koerner (1949) Professor of Entrepreneurship. “The modern economy is dominated by ever larger and more decentralized firms, where incentive contracts are key in ensuring the successful coordination of the workforce.”

Finance professor David Thesmar, who joined the MIT Sloan faculty from HEC Paris this year, has studied Holmstrom’s research for years, and said, “I have read, taught, and done research on many of Bengt’s papers, as he is a founding father of contract theory. His insights on relative performance evaluation, the notion of liquidity, and career concerns are essential to our understanding of organizations and finance.”

“Holmström’s pathbreaking work created some of the most widely used tools in every economist's toolkit,” said Jim Poterba, the Mitsui Professor of Economics and president of the National Bureau of Economic Research. "His insights on incentive theory and contract design informs topics that range from the creation of pay structures for corporate managers, to the design of health insurance exchanges, to the sharing of risks between banks and other large financial institutions. Bengt and Oliver Hart have not only helped us to better understand incentives and institutions, but also to design better ones.”

MIT Sloan Distinguished Professor of Management Robert Gibbons, who has worked closely with Holmström for years, said his work is “vitally important” for both economics and management. “I think of contract theory as analyzing how to govern collaboration—how to use all the available instruments to help a fixed set of people collaborate as well as possible. Applications range from small work groups and partnerships, to tussles between divisions of corporations, to joint ventures and other interactions between firms, to public-private partnerships between firms and governments, to interactions between countries or other autonomous entities,” Gibbons said. “I’m delighted that economics has added these issues to its agenda, to complement the analysis of markets. Bengt's decades of award-winning work played a key role in getting this started.”

Applying contract theory to management practice
Scott Stern, the David Sarnoff Professor of Management of Technology, said Holmström’s “clear and deep understanding of how to bring economic theory to bear on the core challenges facing managers has been an inspiration and a guide.”

“Consider the challenge of motivating ‘innovation,’” Stern said. “How can you tell when your worker is someone [who] is working hard at innovation? This is needless to say not an easy problem. Bengt provided the foundational stepping stones that inform our teaching and research in this area. In a series of classic papers, Bengt highlighted how difficult it is to provide incentives that actually encourage the behavior that managers are hoping to encourage. For example, if you are constantly monitoring the progress of innovators, you are likely to end up with a lot of short-term deliverables but few home runs.”

“Bengt’s pioneering work pervades our teaching and our research,” Stern said.

A focus on research
Although the accolades and the Nobel Prize are gratifying, Holmström said in a phone interview Monday, he is looking forward to getting back to his research.

“I don’t have any intention to use this as a platform for throwing myself into a public debate. There are various styles of reacting to [winning] the Nobel Prize. Some people become experts on everything when they get the Prize, and others continue to be themselves, so to speak. I think I will be more of the latter,” Holmström said.

Ross said his friend’s attitude doesn’t surprise him at all. “Given his talents, Bengt is an uncommonly modest man,” he said.

MIT Sloan Professor Robert C. Merton, who won the Nobel Memorial Prize in Economic Sciences along with Myron Scholes in 1997, said he was “extraordinarily excited” Holmström won the Prize.

When asked if it will change Holmström’s life, Merton, the School of Management Distinguished Professor of Finance, said, “yes and no.”

“He will forever have access [to meet more people], but I suspect he’ll go right back to doing his research. He’s known [around the world] already, so this will just add to it,” Merton said.

Read more about Holmström's win here.