In recent work, Hart introduced contract theory as reference points (Hart and Moore 2008). The basic idea is that the role of a contract is to shape the expectations of the parties and put them „on the same page” to avoid future misunderstandings. Misunderstandings make the parties feel hurt and lead to a nuance of ex post performance, leading to windfall effects.  The incomplete contract paradigm was developed by Sanford J. Grossman, Oliver D. Hart, and John H. Moore. In their fundamental contributions, Grossman and Hart (1986), Hart and Moore (1990) and Hart (1995) argue that contracts in practice cannot specify what to do in all possible eventualities.    At the time of contract award, future contingencies may not even be descriptible. In addition, the parties cannot commit to never engaging in mutually beneficial renegotiations later in their relationship. A direct consequence of the incomplete contractual approach is therefore the so-called hold-up problem.  Since the parties, at least in some countries of the world, will renegotiate their contractual arrangements at a later date, they have insufficient incentives to make relationship-specific investments (since the returns on one party`s investments go in part to the other party during renegotiations).
Oliver Hart and his co-authors argue that the problem of blocking can be mitigated ex ante by choosing an appropriate ownership structure (the incomplete contractual paradigm excludes more complex contractual arrangements). Therefore, the ownership approach of business theory can explain the pros and cons of vertical integration, thus providing a formal answer to important questions about the boundaries of the enterprise first raised by Ronald Coase (1937).  Oliver Hart and Bengt Holmström were jointly awarded the 2016 Nobel Prize in Economics. The award was so well deserved that the news was received with comments from other Nobel laureates such as „Didn`t they already have it?” (Paul Krugman) and „The Nobel Prize at Its Best” (George Akerlof). In this article, I focus on Oliver Hart`s contributions to contract theory, particularly to our understanding of incomplete contracts. In other words, debt contracts are the optimal incomplete contracts. Venture capital contracts also generally have the characteristic that the entrepreneur retains more control rights over companies that perform well, while investors have full control over underperforming companies. Hart and Moore were the first to model the control change triggered by default.  2016 BREAKING Prize in Economics. to Oliver Hart @Harvard & Bengt Holmström @MIT „for their contributions to contract theory” #NobelPrize pic.twitter.com/xosZ27WVee Coase`s (1937) response was that market and internal transactions have their costs and are organized in such a way as to minimize transaction costs. Williamson (1975, 1985) focused on a particular cost factor for market transactions: the problem of blocking. If a productive relationship requires an investment that has a much lower value in other uses, the investor can only make the investment if the relationship exists within the company, because in the market such a relationship-specific investment is likely to be expropriated in negotiations when contracts are incomplete.
Williamson was less clear about the costs of integration, which he said were related to bureaucratic decision-making. These are economic contracts which do not explicitly mention the conditions under which future questions may be decided between the contracting parties. In fact, it is argued that most contracts are inherently incomplete because the parties cannot foresee all possible future eventualities and have perfect solutions to deal with them. In addition, both parties may voluntarily decide to renegotiate the contract in the future, which renders the current terms invalid. The study of incomplete contracts was conducted by American economists Oliver Hart and Sanford Grossman through their 1986 work „The Costs and Benefits of Ownership.” Hart`s 1997 work with Andrei Shleifer and Robert Vishny applied property law theory to the privatization of tax-funded social services such as schools, prisons, and garbage collection. Government contracts with a service provider, but the contract is incomplete, especially in terms of quality of service. The supplier can invest in cost reduction, but the owner has the control rights to decide whether cost innovation will be implemented. Oliver Hart made a fundamental contribution to contract theory.
Photo: iStock.com/Gajus Hart and his co-authors have applied the contracts as a benchmark for the company`s reach (Hart and Holmström 2010) and more recently for ongoing contracts (Halonen-Akatwijuka and Hart 2016). This theory of enterprise is now known as the Grossman-Hart-Moore Property Rights Theory (GHM). .