A contract’s primary function is to govern future interactions and behaviour. As a subdiscipline of game theory, contract theory supplies fundamental insights into the efficient reconciliation of diverging interests. Now, Hart and Holmström have been awarded the Nobel Prize for their noted and important work. They focus on a comprehensive examination of important economic issues such as dealing with wrong economic incentives (moral hazard) and optimizing the interaction between different hierarchy-levels (principal-agent problem). Today, their work stands as a benchmark for research in this field.
Companies have to decide on efficient forms of collaboration constantly – whether it be between employer and employee or with other companies – and they benefit most of all from Hart and Holmström’s work. Hart and Holmström’s work on contract theory may only have just received the Nobel Prize, but it has long been at the core of the TWS Partners approach, providing companies with clear and tangible benefits in their negotiations.
One example of this are quantity, raw materials and currency clauses. Here, TWS Partners draws on contract theory to ensure that such agreements offer the best possible balance of risk between the company and its suppliers with respect of the total cost of ownership approach. These regulations are useful to minimize suppliers’ risk premiums.
Another example is the implementation of a dynamic bonus/penalty assessment. This relies on a cross-functional alignment to express all the relevant differences between suppliers in monetary terms. This yields a bonus/penalty value that is incorporated into an incentive-driven agreement with the respective suppliers. The goal is to ensure that suppliers are evaluated on their performance and get an incentive to improve their offers significantly.
The TWS Partners expert team would like to congratulate Oliver Hart and Bengt Holmström for winning the 2016 Nobel Prize in Economics.