Bengt Holmström

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Bengt Holmström.

Bryce Vickmark

Bengt Holmströmis a Finnish economist who, with Oliver Hart, was awarded the 2016 Nobel Prize for Economics for his contributions to contract theory. Starting in the late 1970s, Holmström and various colleagues undertook pioneering research on the design of employment contracts that are optimal (from the point of view of the employer) in situations in which the employee’s performance is only indirectly or imperfectly observable or is otherwise difficult to assess. Holmström’s work illuminated debates about the proper design of compensation packages for chief executive officers (CEOs) and other senior managers of publicly owned corporations, for older employees relative to younger ones, for employees (such as teachers) who perform multiple tasks that are not equally easy to evaluate, and for employees who work in teams.

Holmström received a B.S. degree from the University of Helsinki (1972) and M.S. (1975) and Ph.D. (1978) degrees from Stanford University. After working as a corporate planner (1972–74), he served as assistant professor of systems and operations research at the Swedish School of Economics and Business Administration (1978–79) and as assistant and associate professor of managerial economics at Northwestern University (1979–83). He then joined the faculty of Yale University as a professor of economics and a professor of economics and organization, becoming Edwin J. Beinecke Professor of Management at Yale in 1985. He was appointed professor of economics and management in the department of economics and the Sloan School of Management at the Massachusetts Institute of Technology (MIT) in 1994, becoming Paul A. Samuelson Professor of Economics at MIT in 1997.

Holmström’s early work on the “principal-agent problem” (the problem of designing optimal contracts between employers and employees) established what came to be known as the “informativeness principle,” according to which an employee’s compensation should be made to depend on all outcomes that might provide relevant information regarding the quality of the employee’s performance. It follows from the informativeness principle that CEOs should not be paid solely on the basis of their company’s stock price, which can be influenced by industry-wide factors that are out of any executive’s control, but rather by the company’s stock price relative to the stock prices of other companies in the same industry. In later work, Holmström showed that the common practice of increasing compensation to retain productive employees in a competitive labour market may be misguided for older workers, who are less motivated than younger workers by concerns about their future careers. In the 1980s he demonstrated that the practice of dividing compensation equally between members of a team tends to result in free riding by less industrious employees, and in the 1990s he and the economist Paul Milgrom argued that, in the case of employees who perform several tasks not all of which can be easily evaluated, tying compensation too directly to easily evaluated tasks leads employees to focus on them and to neglect other tasks that may be equally important. For example, teachers who are compensated solely on the basis of their students’ test scores naturally spend more time teaching the skills or subjects that appear on the tests and less time teaching those that do not.

Holmström’s publications include Inside and Outside Liquidity (2011), written with Jean Tirole, and numerous scholarly papers.