Two U.S.-based academics — Oliver Hart and Bengt Holmstrom — were named co-winners of the 2016 Nobel prize in economics for their pioneering and separate research on contract theory that includes influencing corporate governance and shedding light on setting CEO performance-based pay.
Mr. Hart, a U.S. citizen born in London, is the Andrew E. Furer professor of economics at Harvard University. Mr. Holmstrom, a Finnish citizen and permanent U.S. resident, is the Paul A. Samuelson professor of economics at Massachusetts Institute of Technology.
The two will share the 8 million Swedish kronor ($932,307) Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, awarded by the Royal Swedish Academy of Sciences.
Their work spotlights how shareholders can control a company and hold top executives accountable “through the design of corporate governance and capital structure,” according to a prize announcement Monday by the Royal Swedish Academy of Sciences.
Their work can “provide a lens through which we can view CEO compensation data with the objective of understanding good (or bad) corporate governance.”
“For investors, the most interesting implications (of their work) have to do with structuring incentive pay, corporate governance and corporate financial structure,” Bruce I. Jacobs, principal, Jacobs Levy Equity Management, said in an e-mail.
Mr. Hart's work “illuminates the link between corporate finance decisions and corporate governance,” Mr. Jacobs said.
Under Mr. Hart's analysis, “a contract cannot foresee every possible eventuality; nor may it be possible to arrive at objective signals of performance. In lieu of specifying rewards, then, it may be more practical to specify the allocation of the rights to control assets or make decisions.” Mr. Jacobs said.
Mr. Holmstrom developed insights into the concept of informativeness, “which suggests that one way agents can be motivated to work in the interests of principals is to tie their remuneration to signals that provide reliable information about their actions,” Mr. Jacobs said. ”Stock prices … may provide a good signal of how management is acting.” In doing so, it is better “to attempt to filter out unrelated factors” by linking CEO's company stock price relative to those of similar companies, such as those in the same industry.
In more recent work, Mr. Holmstrom “has also examined issues of market liquidity, asset prices and financial regulation,” Mr. Jacobs said. A paper Mr. Holmstrom co-wrote with Tri Vi Dang, lecturer, department of economics, Columbia University, and Gary Gorton, Frederick Frank Class of 1954 professor of management and finance at Yale University School of Management, “after the 2007-2009 financial crisis looks at the popularity of debt securities created from other debt securities, such as mortgage-backed securities, and how liquidity in this market can dry up, potentially leading to market crashes, when these usually information-insensitive securities become suddenly information-sensitive,” Mr. Jacobs said.
Messrs. Hart and Holmstrom broke new ground in research on managing conflicts of interest and determining whether public-service institutions should be publicly or privately owned, among other areas of their work, the academy said.
“As an investor, recognition of conflicts of interest among market participants is critical as such conflicts can and do affect security prices,” Mr. Jacobs said. “Properly motivating investment managers requires measuring investment manager performance and paying performance fees relative to risk-adjusted benchmarks.”
On whether to privatize, Mr. Hart examined the desirability of privatization depending on the “trade-off between cost reduction and quality,” the academy announcement said.
Mr. Hart co-authored an article on the subject with Andrei Shleifer and Robert Vishny, both of whom are co-founders of LSV Asset Management, that “showed that incentives for cost reduction are typically too strong. … In their article, Hart and his co-authors were particularly concerned about private prisons.” the academy said.
Such investment has come under scrutiny at pension funds. In September, the $53.3 billion New York City Employees' Retirement System trustees voted to study divestment of its holdings in companies that run private prisons.
Mr. Hart was a fellow of the European Corporate Governance Institute in 2002, while Mr. Holmstrom served on its executive board from 2000 to 2005, according to their websites. The institute's 25 institutional investor members are mainly European-based but also include the $305.8 billion California Public Employees' Retirement System, Sacramento. Mr. Holmstrom also served as a director on the board of Nokia Corp. from 1999 to 2012, and he has been a consultant to what is now Mercer LLC.
Messrs. Hart, Holmstrom, Shleifer and Vishny couldn't be reached for comment. Alayna Francis, Mercer spokeswomen, was unable to respond by press time.