Basics of contract theory

(Nobel Memorial Prize in Economic Sciences 2016 — Oliver Hart and Bengt Holmstrom) The 2016 Nobel Memorial Prize in Economic Sciences was awarded to Oliver Hart and Bengt Holmstrom for their contributions to contract theory. In their papers, they have demonstrated that strategic analysis of environments with asymmetric information might be very fruitful in providing answers to many natural economic questions: How should firms reward their managers? Why insurance contracts often include deductibles and co-payments? When do firms outsource and when do they prefer in-house production? In its brief exposition, the paper starts with the basics of contract theory and discusses some most important results of 2016 laureates.