Contributions of Oliver Hart and Bengt Holmström to Contract Theory

Schmidt, Klaus M.

doi:10.1111/sjoe.12245

Cited by 12 publications

(5 citation statements)

References 105 publications

(157 reference statements)

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“…Game theory will set this up as potential for winning or losing, depending on how you play. Contract theory will tell you it is a matter of identifying risks upfront and allocating them to the party that is best positioned to manage them [48]. This will minimize the risk premium and thus give the lowest total cost for the client.…”

Section: Discussionmentioning

confidence: 99%

Preparing for Successful Collaborative Contracts

2020

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Preparing well before entering a contract is always vital, independent of the characteristics of the project and type of contract. However, as projects become larger and more complex, and value for stakeholders and society becomes the dominating perspective on success, the need for well-developed collaboration is becoming more and more critical. In this paper, we investigate how the parties should prepare for a collaborative project. The purpose is to help owners secure the success of the project for its key stakeholders. We choose to address the issues as an active risk mitigation strategy that serves as a vehicle to reduce uncertainty, avoid unnecessary risks, and utilize opportunities as a project owner. We look at the project mainly through a project owner perspective, but on key points, we contrast this with contractor perspectives. The research was performed in Australia in 2020 and includes public and private sector investment projects. The methodology is qualitative case studies and includes primarily in-depth interviews supplemented with document studies and two workshop group discussions. The paper highlights the difference between being collaborative in a contract and using a collaborative contract. The results document significant differences in preparations depending on the degree of complexity of the projects. One major difference is illustrated in the different levels of precision in terms and definitions used in communication. Complex projects require freedom of interpretation only gained by allowing wide and less precise expressions.

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Section: Discussionmentioning

confidence: 99%

Preparing for Successful Collaborative Contracts

2020

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“…This concerns research into issues of broader commercial economic and societal relevance, such as the way in which new contracting technology might alter the way in which firms do business and the size distribution of commercial entities. In 2016 The Nobel Memorial Prize in Economic Science was awarded to Oliver Hart and Bengt Holmström [39] for their work in building the foundations of contract theory, and serves as a reminder that, as technology improves and organisations become more complex, the theory and practice of contract design will only increase in importance. This also includes implications for the legal profession and law.…”

Section: Broader Ecosystem: Impact and Considerationsmentioning

confidence: 99%

Transforming commercial contracts through computable contracting

Cummins¹,

Clack

2022

Journal of Strategic Contracting and Negotiation

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Contracts are an essential and fundamental component of commerce and society, serving to clarify agreements between multiple parties. While digital technologies have helped to automate many activities associated with contracting, the contracts themselves continue, in the main, to be in the form of unstructured, natural language text. This limits the scope for improvements in productivity and automation, as well as the emergence of new business models. To this end, this paper examines the concept of “computable contracts” as objects that are understandable by both humans and computers, and goes on to present a framework that unifies a range of technologies and approaches that collectively will help to make computable contracting a reality.

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“…Moral hazard may also occur in this context as a PE investor is not directly involved in the day-to-day management of its portfolio companies, but instead relies on the management team to run the business properly (Hale & Travers, 2015). Combined with substantially diverging equity stakes (66.7% for the PE investor vs. 30% for management), this may be problematic as both parties may have different goals and engage in shirking behavior (Eisenhardt, 1989;Schmidt, 2017). For instance, whereas the PE investor is likely predominantly interested in maximizing shareholder value, management might focus on limiting risk, for example by an excessive diversification of activities, or in empire building, for example through hiring too many employees or engaging in non-core acquisitions.…”

Section: Agency and Incomplete Contracting Theorymentioning

confidence: 99%

How private equity-backed buyout contracts shape corporate governance

2022

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This paper explores how contracts in private equity-backed buyouts shape corporate governance in portfolio companies. Drawing upon agency theory and incomplete contracting theory, 50 actual contracts are analyzed in detail. Contracts focus on reducing adverse selection risks through limiting pre-investment information asymmetries and aligning the goals of investors and sellers.Moral hazard risks vis-à-vis management are limited through limiting post-investment information asymmetries and limiting shirking behavior through limiting free cash flows. Goal alignment is achieved through high-powered incentive structures combined with shifting risk of underperformance to management. Managerial hold-up problems are addressed through restricting share transactions and limiting managerial actions. Residual powers and contingencies are mainly used to deal with incomplete contract designs due to uncertainties. Few clauses are used to address the reverse agency problem in which management is protected against moral hazard problems created by the private equity investor. PE contracts have transparent and very strong outcomebased cash flow rights, both limiting downside risk and rewarding upside potential. This contrasts with VC contracts which are especially contingency-based given the high levels of uncertainty of the portfolio companies.

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Contributions of Oliver Hart and Bengt Holmström to Contract Theory

Abstract: Oliver Hart and Bengt Holmström were awarded the 2016 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for their fundamental contributions to contract theory. This article offers a short summary and discussion of their path‐breaking work.

Cited by 12 publications

References 105 publications

Preparing for Successful Collaborative Contracts

Preparing for Successful Collaborative Contracts

Transforming commercial contracts through computable contracting

How private equity-backed buyout contracts shape corporate governance

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