David R. Henderson  

Henderson on the 2016 Nobel Prize Winners Hart and Holmstrom

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To understand their work, start with a pillar of economics that I teach on the first day of class: Incentives matter. Mr. Hart and Mr. Holmstrom take that principle and run with it, seeking to understand incentives within both individual companies and the larger market structure.

Implicit in all of their work is the idea that if it's difficult to design optimal incentives within a single firm, it's well-nigh impossible for central planners to do it for the entire economy. It's telling that much of Mr. Holmstrom's work began when he was a professor at Northwestern's Kellogg Graduate School of Management.


These are two paragraphs from David R. Henderson, "From Corporate Pay to Private Prisons--Lessons From the Nobelists," Wall Street Journal, October 10, 2016 (electronic) and October 11, 2016 (print.)

As has become a tradition, I wrote the Wall Street Journal article on the Nobel Prize winners in Economics this year. If I'm counting correctly, I think that makes 16 out of the last 21 years.

I highlight these paragraphs for two reasons: (1) they're my two favorite paragraphs, and (2) the basic idea for the second paragraph was stated by Bob Lawson in a Facebook discussion and, when I used it, Alex Tabarrok gave me a better formulation.

Some things about writing the piece are getting harder and some easier. The main harder one is that they announced at 2:45 a.m. PDT. So I got up then to see who won and started researching. I started writing, as per usual, around 7:00 a.m. and finished at about 9:30 a.m.

The main easier one is the support and help I got from my economist friends. Once I had a version I was reasonably pleased with, I sent it to Lynne Kiesling, Tyler Cowen, and Alex Tabarrok for comments. All had valuable comments. I incorporated Tyler's and Alex's suggestions. The main comment by Lynne was one I totally agreed with but couldn't figure out how to put in within my word limit: the fact that so much of this work on contracting flows from the now-classic 1972 American Economic Review article by Alchian and Demsetz. I still think that Demsetz should win, but am now very pessimistic about whether he ever will. The Nobel Prize in economics has become much more of a prize for technical economics--read, mathematical modeling--in the last 20 years.

Although their ideas did not get implemented in my piece due to time and word constraints, Edward Lopez and Peter G. Klein had excellent suggestions. Indeed, I think Peter Klein's article on the two winners is competitive with mine and possibly better.

I've had a lot of people ask what my time line is. I start researching as soon as I've watched the live presentation from Stockholm. Then I break for early breakfast and go into my downtown office sometime between 5 and 6 a.m. I research until about 7:00 a.m. and then start writing, going back and forth between the writing and the research from 7:00 a.m. to 9:30 or 10:00 a.m. I then send the draft out for comments, get them back within half an hour, tweak the article, send it to my wife, Rena Henderson, who makes her living editing economists, get it back from her within 15 minutes, tweak, and send. I used to promise to send by noon. I now promise to send by 11 a.m. The one upside of the 2:45 a.m. announcement is that makes the promise easier to keep.


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COMMENTS (5 to date)
Alexandre Padilla writes:

It's absolutely correct that Hart & Holmstrom's works derive from Alchian and Demsetz but there is a difference. Alchian & Demsetz's core argument is about property rights and residual claimants. On the other hand, Hart & Holmstrom (more so in Hart work than Holmstrom) is also about property rights and residual control rights (one could implied they are related to who are the residual claimants but it's not necessary), which are established in these incomplete contracts. All these authors try to build on Coase's seminal article.
What's disappointing is that Hart (1989) clearly states in footnote 32 (p. 1765) that the literature on the property rights theory of the firm owes much to Demsetz's work on property rights.

Obviously the Prize is not specifically about the firm but more about contracts but most contracts are related to the literature on the firm. I have no problem with them getting this prize but I think (my opinion has zero weight) Demsetz should have shared it with them.

David R. Henderson writes:

@Alexandre Padilla,
That’s my view also. They would have made a nice trio.

Paul Walker writes:

I would argued that the complete/comprehensive - Holmstrom - part of the literature owns much to Alchian & Demsetz, eg the "nexus of contracts" view and the "firms as a solution to moral hazard in teams" approach to the theory of the firm, but not so much the property rights and reference point - Hart - approaches to the firm which are based on incomplete contracts. That said having Demsetz as the third in the award would have been great.

Emerich writes:

A good WSJ article, David, and I hope you write more about these Nobelists' work on your blog. But one sentence (the second one below) puzzles me: You say:

"Implicit in all of their work is the idea that if it's difficult to design optimal incentives within a single firm, it's well-nigh impossible for central planners to do it for the entire economy. It's telling that much of Mr. Holmstrom's work began when he was a professor at Northwestern's Kellogg Graduate School of Management."

Why "telling"? Is there something about the Kellogg schools we're supposed to know that makes it obvious that someone who taught there would learn skepticism about central planning? Is the Kellogg School more centrally planned than other business schools? Less? Were there more skeptics about central planning there than at, say, University of Chicago? Fewer?

Probably not even a key point, but you quoted it and it puzzles me. I'm encouraged that the Nobel committee recognized economists who are skeptical about central planning. Straw, in the wind, I hope.

David R. Henderson writes:

@Emerich,
A good WSJ article, David, and I hope you write more about these Nobelists' work on your blog.
Thanks, and we’ll see.
Why "telling"? Is there something about the Kellogg schools we're supposed to know that makes it obvious that someone who taught there would learn skepticism about central planning?
No.
Is the Kellogg School more centrally planned than other business schools? Less?
I have no idea. It’s not relevant to my point.
Were there more skeptics about central planning there than at, say, University of Chicago? Fewer?
I would think fewer. My point is not to focus on Kellogg but to focus on Management in the school’s name. It’s a business school. And people in business schools tend to focus more on how to run businesses and less on how to run economies.

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