Nobel Laureates.

2016[10]	David J. Thouless; Duncan Haldane; John M. Kosterlitz	Jean-Pierre Sauvage; Fraser Stoddart; Ben Feringa	Yoshinori Ohsumi	Bob Dylan	Juan Manuel Santos	Oliver Hart; Bengt R. Holmström
Year	Physics	Chemistry	Physiology or Medicine	Literature	Peace	Economics

Nobel Prizes 2016

The Nobel Prize in Physics 2016

David J. Thouless, F. Duncan M. Haldane and J. Michael Kosterlitz

"for theoretical discoveries of topological phase transitions and topological phases of matter"

The Nobel Prize in Chemistry 2016

Jean-Pierre Sauvage, Sir J. Fraser Stoddart and Bernard L. Feringa

"for the design and synthesis of molecular machines"

The Nobel Prize in Physiology or Medicine 2016

Yoshinori Ohsumi

"for his discoveries of mechanisms for autophagy"

The Nobel Prize in Literature 2016

Bob Dylan

"for having created new poetic expressions within the great American song tradition"

The Nobel Peace Prize 2016

Juan Manuel Santos

"for his resolute efforts to bring the country's more than 50-year-long civil war to an end"

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2016

Oliver Hart and Bengt Holmström

"for their contributions to contract theory"

Why Hart & Holmstrom won the Nobel Prize in Economics?

Oliver Hart and Bengt Holmstrom won the Nobel prize in Economics  ( also known as Central Bank of Sweden Nobel Memorial Prize in Economic Sciences) in 2016 for their contributions to the ‘contract theory.’  Their work in contract theory helps us to:

• Understand real-life contracts.
• Understand potential pitfalls (difficulties) in designing the contracts.
• Design better contracts.

NOBEL PRIZE IN ECONOMICS

Unlike Nobel prizes in other areas, the economics award is a collaboration between the Central Bank of Sweden, known as the Sveriges Riksbank, and the Nobel Foundation. The Nobel prize in Economics was first awarded in the year 1968. Last year the award was given to Angus Deaton for his analysis of consumption, poverty, and welfare. 

CONTRACT THEORY

Contracts are ubiquitous. We see them everywhere. Some examples of contracts are contracts between employer and employee (employment contract), shareholders and CEO (employment contract), banks and borrowers (credit contract) etc. The employment contract explicitly states rewards for good performance, conditions of dismissal etc.

The parties to the contracts often have conflicting interests. To illustrate: The CEO of a company wants to maximize their own earnings rather than that of the shareholders. It leads to short-termism where CEOs focus on short-term gains instead of long-term stability. The same is the case with employers and employees.

Therefore, contracts must be properly designed such that the interests of the parties are aligned with each other. Example: If the CEOs are given compensation based on market value of shares, interests of CEO and shareholders will be aligned. The CEO will become more interested in taking decisions which will increase the market value of shares in the long run.

A good contract should  give each party (with conflicting interests) the incentive to work with each other.

The research on contract theory had ignored two important issues:informational problems and incomplete contracts. Hart and Holmström made important contributions by filling up the research gap.

HOLMSTROM’S CONTRIBUTION

We know that the shareholders are the owners of the company and the CEO of a company takes decisions only on behalf of the shareholders or owners. It is essentially what is called a principal-agent relationship. The agent is authorised to take decisions on behalf of the principal.

The problem that arises in this relationship is that the principal (shareholders) cannot directly monitor the agent (CEO) and hence there is an information asymmetry (informational problems). The CEO has more information about his performance than the shareholders. This information asymmetry leads to moral hazard. The agent/ CEO want to increase their own pay-off by focussing on short-term goals the expense of the shareholders. (We had already discussed it in the previous head. It is just restating what we already know)

Contract theory basically deals with how the principal (shareholders) should design an optimal contract to incentivise the CEOs to work in the interests of the shareholders. Though this problem was known for a long time, the level of analysis increased only in the late 1970s.

Holmstrom’s research paper states that principal should design an employment contract and link the agent’s compensation to outcomes that convey meaningful information about the efforts put in by him. This is the informativeness principle.

To illustrate: If the CEO is paid based only on the market price of the shares, it would penalize the CEO for external factors beyond his control that affect the market price. The effect of such external factors can be eliminated by linking the CEO’s salary to the company’s share price in comparison to the share price of the competitors (other companies) in the same industry. It will provide more meaningful information about the efforts put in by him by eliminating the external factors.

It was a theoretical work. In later research, Holmström applied these results to realistic situations.

He analysed a dynamic situation in which an employee’s current salary is not linked to his performance (as he had prescribed in the informativeness principle). He found out that inspite of that, young employees were motivated to work hard due to concern about career and future salary. In such cases, performance must be linked to higher future earnings (if not current earnings). This is known as the career-concern model.

Another realistic situation is in which the jobs are made up of multiple tasks (which is true for most cases). For example, a teacher has multiple tasks, improving test scores, developing student creativity etc.

In such cases, performance in one task may be easier to assess. Test scores are easier to measure than student creativity. So, compensation linked to test scores will encourage teachers to spend more time increasing test scores at the expense of other important tasks like creativity

In the same way, salary linked to the easily measured parameters, like profits, can also be counterproductive. Profits will be increased at the expense of other important things like brand reputation or product quality. Therefore, in jobs with multiple tasks, firms  can opt to offer fixed salaries rather than salary based on performance. This is the Multi-tasking model.

Another situation is a partnership scheme that shares profits amongst team members. It creates a problem as individual members of a team can free-ride on the efforts of others. Each team member gets the same share of profit irrespective of the efforts put in by him.

Holmström shows that the free-rider problem can be resolved by introducing an outside owner who will provide compensation based on performance and keep the remaining profit with himself. It will boost individual incentives.

HARTS’S CONTRIBUTION

Hart deals with an important case of incomplete contracts. It is impossible to write a detailed contract which includes respective rights and duties of parties for every possible future situations. Contracts in real-world are generally incomplete as it does not take into account all future contingencies.

There is a lot of uncertainty and it could lead to disputes in the future.  Mr Hart showed that firms can solve this problem by use of the bargaining power.  The main idea is that a contract that cannot explicitly specify what the parties should do, specify who has the right to take decisions decide (bargaining power) in the case of future contingencies.

Asset (machinery etc.) owners have stronger bargaining power, which motivates them to invest. Therefore, the asset should be owned by the party whose investment is most important for the business This will give him the bargaining power and the incentive to invest in the business.

It also shows that highly synergistic assets – whose values are enhanced when used together – should be owned by a single party, rather than separately by multiple parties. Concentrating bargaining power in the hands of one party is more effective than diffusing bargaining power across multiple parties.

The theory has real-world relevance as well. Mr. Hart used it to explain precisely why public prisons are better than private prisons. The managers of both care about the profit, but the incentive to cut costs is greater in private prisons because the private owner gets all the profits directly in his pocket.

CONCLUSION

Through their contributions, Hart and Holmström have explored many of the applications of the contract theory in the real-world. The Academy said, ” “It generates precise hypotheses that can be confronted with empirical data and lays an intellectual foundation for the design of various policies and institutions, from bankruptcy legislation to political constitutions.”

Indian government can use the contract theory in policy-making. It can be used in the design of telecom auctions, Direct benefit transfer scheme etc.

The Solvay Conference: There Are 17 Nobel Laureates In This Photograph

Take a close look at the photograph. This is probably the only evidence that some of the most brilliant minds, the world has ever witnessed, flourished almost during the same time. In this photograph,taken in October 1927, 17 of the 29 attendees went on to become Nobel laureates.

This photograph was taken during the fifth edition of the Solvay Conference.

The year 1912 marked the foundation of the International Solvay Institutes for Physics and Chemistry in Brussels, Belgium. Founded by businessman Ernest Solvay, this was considered a turning point in the world of physics. Since its inception, many great scientists in the world gathered together at three years interval to discuss the most perplexing problems in the world of physics and chemistry. But the 1927 conference remains to be the most famous, where some the most distinguished physicists came together to discuss the newly formulated quantum theory.

The leading figures were Albert Einstein and Niels Bohr. Einstein, disenchanted with Heisenberg’s uncertainty principle, remarked “God does not play dice”, to which  Bohr replied, “Einstein, stop telling God what to do”.

The Scientists attending the Solvay Conference:

Back row  (Left to Right)

Auguste Picarde: Made record-breaking ascent to 53,152ft in a balloon and also designed submarines.

Emile Henriot: He detected the natural radioactivity of potassium and rubidium. He made ultracentrifuges possible and pioneered the electron microscope.

Paul Ehrenfest: He remarked that Special Relativity makes the rim of a spinning disk shrink but not its diameter. This contradiction with Euclidean geometry inspired Einstein’s General Relativity.

Edouard Herzen: A Paris-based artist with an interest in psychoanalysis.  He played a leading role in the development of physics and chemistry during the twentieth century.

Théophile de Donder: He is considered the father of thermodynamics of irreversible processes. He defined chemical affinity in terms of the change in the free enthalpy.

Erwin Schrödinger: Conducted the famous experiment known as Schrödinger’s cat, which postulated that something could exist in two states until it was observed.

Jules Emile Verschaffelt, the Flemish physicist, got his doctorate under Kamerlingh Onnes in 1899.

Wolfgang Pauli: He formulated the exclusion principle which explains the entire table of elements.

Werner Heisenberg: He replaced Bohr’s semi-classical orbits by a new quantum logic which became known as matrix mechanics (with the help of Born and Jordan). The relevant noncommutativity entails Heisenberg’s uncertainty principle.

Sir Ralph Howard Fowler: He supervised 15 FRS and 3 Nobel laureates. In 1923, he introduced Dirac to quantum theory.

Léon Nicolas Brillouin: He practically invented solid state physics (Brillouin zones) and helped develop the technology that became the computers we use today.

Middle Row (Left to Right)

Peter Debye: He pioneered the use of dipole moments for asymmetrical molecules and extended Einstein’s theory of specific heat to low temperatures by including low-energy phonons.

Martin Knudsen: He revived Maxwell’s kinetic theory of gases, especially at low pressure: Knudsen flow, Knudsen number etc.

William Lawrence Bragg: He was awarded the Nobel prize for physics jointly with his father Sir William Henry Bragg for their work on the analysis of the structure of crystals using X-ray diffraction.

Hendrik Kramers: Was the first foreign scholar to seek out Niels Bohr. He became his assistant and helped develop what became known as Bohr’s Institute, where he worked on dispersion theory.

Paul Dirac: Came up with the formalism on which quantum mechanics is now based. In 1928, he discovered a relativistic wave function for the electron which predicted the existence of antimatter, before it was actually observed.

Arthur Holly Compton: He figured that X-rays collide with electrons as if they were relativistic particles, so their frequency shifts according to the angle of deflection (Compton scattering).

Louis de Broglie: He discovered that any particle has wavelike properties, with a wavelength inversely proportional to its momentum (this helps justify Schrödinger’s equation).

Max Born: His probabilistic interpretation of Schrödinger’s wave function ended determinism in physics but provided a firm ground for quantum theory.

Front Row (Left to Right)

Irving Langmuir: He was an American chemist and physicist. His most noted publication was the famous 1919 article “The Arrangement of Electrons in Atoms and Molecules”.

Max Planck: He originated quantum theory, which won him the Nobel Prize in Physics in 1918. He proposed that exchanges of energy only occur in discrete lumps, which he dubbed quanta.

Niels Bohr: Neils Bohr started the quantum revolution with a model where the orbital angular momentum of an electron only has discrete values. He spearheaded the Copenhagen Interpretation which holds that quantum phenomena are inherently probabilistic.

Marie Curie: She was the first woman to earn a Nobel prize and the first person to earn two. In 1898, she isolated two new elements (polonium and radium) by tracking their ionizing radiation, using the electrometer of Jacques and Pierre Curie.

Hendrik Lorentz:  Discovered and gave a theoretical explanation of the Zeeman effect. He also derived the transformation equations subsequently used by Albert Einstein to describe space and time.

Albert Einstein: He developed the general theory of relativity, one of the two pillars of modern physics (alongside quantum mechanics).He is best known in popular culture for his mass–energy equivalence formula (which has been dubbed “the world’s most famous equation”). He received the 1921 Nobel Prize in Physics “for his services to theoretical physics, and especially for his discovery of the law of the photoelectric effect”.

Paul Langevin: He developed Langevin dynamics and the Langevin equation. He had a love affair with Marie Curie.

Charles-Eugène Guye: Guye was a professor of Physics at the University of Geneva. For Guye, any phenomenon could only exist at certain observation scales.

Charles Thomson Rees Wilson: He reproduced cloud formation in a box. Ultimately, in 1911, the supersaturated dust-free ion-free air was seen to condense along the tracks of ionizing particles. The Wilson cloud chamber detector was born.

Sir Owen Willans Richardson: He won the Nobel Prize in Physics in 1928 for his work on thermionic emission, which led to Richardson’s Law.