Contract Theory
Yash Dev Lamba
16116079
Tina Oberoi
16116073
What is Contract?
A Contract is a voluntary arrangement between two or more parties that is enforceable by law as a binding legal agreement.
Contracts are legally binding agreements about who will do what in exchange for what and under what circumstances.
Problems Faced by Contracts Earlier
- Informational Asymmetry
- Incomplete Contracts
- Conflict of Interest
- Different Incentives
Noble Prize in field of Economics for Contract Theory
Bengt Holmstrom
Oliver Hart
What is Contract Theory?
- Modern way to work
- Helps parties better design
- Practical advice for best outcome
- Impact on economics and social sciences
Contract theory in practical situations
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Accident Insurance
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Job Design and Incentives
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Shaping CEO Pay
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Impact on public sector
- Drivers pay partial cost of a crash
- Excess payments prevents reckless drivers
- Incentives for the driver to be careful
Accident Insurance
Shaping Ceo Pay
- Stock option based on performance
- Rewards Based on rivals in same sector
- Enumeration not linked to luck
Job Design and Incentives
Equal emphasis should be laid on developing non-measurable aspects of one's profile
Impact on public sector
- Performance Based v/s fixed salaries
- Private Management of public services
theories of contract theory
- Bilateral Contracting
- Multilateral Contracting
- Long Term Contracting
- Incomplete Contracting
Principal agent theory
Applicable in circumstances where information is diff to obtain.
e.g. Share Marker
Investor - Principal
CEO - Agent
The principal can't directly monitor agent's action leads to moral hazard - Agent might out in self-interest.
Conclusion
In essence, Contract theory is about giving each party the right incentives or motivations to work effectively together.
