Bengt Holmström

• Massachusetts Institute of Technology

The inaugural dean of Oxford University's Said Business School and academic director of the British Academy's Future of the Corporation program begins by identifying four alternatives to Milton Friedman's Shareholder Value doctrine: (1) enlightened shareholder value maximization; (2) stakeholder value; (3) shareholder welfare; and (4) corporate pur...

Short-term debt that can serve as a medium of exchange is designed to be information insensitive. No one should be tempted to acquire private information to gain an informational advantage in trading that could destabilize the value of the debt. Short-term debt minimizes the incentive to acquire information among all securities of equal value backe...

Incentives are often associated with narrow fnancial rewards such as bonuses or executive stock options. But in general such rewards are just a small part of the design of incentives. Properly designed incentive systems have to take into account the full portfolio of activities that the agent can engage in, the array of instruments, many nonfnancia...

Banks produce short-term debt for transactions and storing value. The value of this debt must not vary over time so agents can easily trade it at par like money. To produce money- like safe liquidity, banks keep detailed information about their loans secret, reducing liquidity if needed to prevent agents from producing costly private information ab...

Banks are optimally opaque institutions. They produce debt for use as a transaction medium (bank money), which requires that information about the backing assets – loans – not be revealed, so that bank money does not fluctuate in value, reducing the efficiency of trade. This need for opacity conflicts with the production of information about invest...

Introduction In the standard economic treatment of the principal–agent problem, compensation systems serve the dual function of allocating risks and rewarding productive work. A tension between these two functions arises when the agent is risk averse, for providing the agent with effective work incentives often forces him to bear unwanted risk. Exi...

June, 1998--T.p. -- April 6, 1998--P. 1

Two leading economists develop a theory explaining the demand for and supply of liquid assets. Why do financial institutions, industrial companies, and households hold low-yielding money balances, Treasury bills, and other liquid assets? When and to what extent can the state and international financial markets make up for a shortage of liquid asset...

Asymmetric information can reduce trade (possibly to zero) due to adverse selection. Symmetric information can facilitate trade. We show that trade between agents is maximized, and welfare highest, when neither party to a transaction has any information about the future payoffs of the securities used to trade. Trade is best implemented by debt whic...

The formal literature on firm boundaries has assumed that ex post conflicts are resolved through bargaining. In reality, parties often simply exercise their decision rights. We develop a model, based on shading, in which the use of authority has a central role. We consider two firms deciding whether to adopt a common standard. Nonintegrated firms m...

Executive compensation and corporate governance problems need to be seen in a larger historical context than is commonly done. The proximate causes of corporate scandals and executive pay problems have been identified, but the real drivers have not. A need for corporate restructuring, which emerged already in the 1970s, led to the remarkable rise i...

This paper reexamines Grossman and Hart's (1980) insight into how the free-rider problem excludes an external raider from capturing the increase in value it brings to R firm The inability of the raider to capture any of the surplus depends critically on the assumption of equal and indivisible shareholdings–the one-share-per-shareholder model In con...

The U.S. corporate governance system has recently been heavily criticized, largely as a result of failures at Enron, WorldCom, Tyco and some other prominent companies. Those failures and criticisms, in turn, have served as catalysts for legislative change (Sarbanes-Oxley Act of 2002) and regulatory change (new corporate governance listing standards...

Largely as a result of failures at Enron, WorldCom, Tyco, and other prominent American companies, U.S. corporate governance practices have come under attack. These much publicized failures and the resulting popular outcry have served as catalysts for legislative and regulatory changes that include the Sarbanes‐Oxley Act of 2002 and new governance g...

This paper describes and considers explanations for changes in corporate governance and merger activity in the United States since 1980. Corporate governance in the 1980s was dominated by intense merger activity distinguished by the prevalence of leveraged buyouts (LBOs) and hostility. After a brief decline in the early 1990s, substantial merger ac...

This paper describes and considers explanations for changes in corporate governance and merger activity in the United States since 1980. Corporate governance in the 1980s was dominated by intense merger activity distinguished by the prevalence of leveraged buyouts (LBOs) and hostility. After a brief decline in the early 1990s, substantial merger ac...

Firms and financial institutions are best viewed as ongoing entities, whose project completion may require renewed injections of liquidity. This paper proposes a contract-theoretic framework integrating three dimensions of corporate financing and prudential regulation: (a) liquidity management, (b) risk management, and (c) capital structure. It con...

The paper explores the economic role of the firm in a market economy. The analysis begins with a discussion and critique of the property rights approach to the theory of the firm as exposited in the recent work by Hart and Moore ("Property Rights and the Nature of the Firm"). It is argued that the Hart-Moore model, taken literally, can only explain...

The paper studies how a person's concern for a future career may influence his or her incentives to put in effort or make decisions on the job. In the model, the person's productive abilities are revealed over time through observations of performance. There are no explicit output-contingent contracts, but since the wage in each period is based on e...

Both transaction cost-economics and property-rights theories offer explanations of the boundaries of the firm based on ideas of ex post bargaining and holdup. These theories are quite distinct in their empirical predictions, but neither offers a satisfactory account of a large variety of observed practices. The authors discuss a number of such exam...

The intertemporal CAPM predicts that an asset's price is equal to the expectation of the product of the asset's payoff and a representative consumer's intertemporal marginal rate of substitution. This paper develops an alternative approach to asset pricing based on corporations' desire to hoard liquidity. Our corporate finance approach suggests new...

The authors study an incentive model of financial intermediation in which firms as well as intermediaries are capital constrained. They analyze how the distribution of wealth across firms, intermediaries, and uninformed investors affects investment, interest rates, and the intensity of monitoring. The authors show that all forms of capital tighteni...

The asymptotic distributions of cointegration tests are approximated using the Gamma distribution. The tests considered are for the I(1), the conditional I(1), as well as the I(2) model. Formulae for the parameters of the Gamma distributions are derived from response surfaces. The resulting approximation is flexible, easy to implement and more accu...

This paper addresses a basic, yet unresolved, question: Do claims on private assets provide sufficient liquidity for an efficient functioning of the productive sector? Or does the state have a role in creating liquidity and regulating it either through adjustments in the stock of government securities or by other means? In our model, firms can meet...

Eastern Europe suffers from a worsening capital shortage problem. This paper studies ways to find the needed funds. It is argued that firms need funds in order to transform illiquid ideas into liquid claims, possibly through a chain of intermediaries. It shows that collateral (proven assets) plays the central role in increasing liquidity of liabili...

Eastern Europe suffers from a worsening capital shortage problem. This paper studies ways to find the needed funds. It is argued that firms need funds in order to transform illiquid ideas into liquid claims, possibly through a chain of intermediaries. It shows that collateral (proven assets) plays the central role in increasing liquidity of liabili...

We analyze twenty years of personnel data from one firm. The hierarchical structure is quite simple and stable. Career movements suggest that the employee's rate of learning and the firm's learning about ability are important. There are promotion “fast tracks.” Exit rates vary little with tenure or salary. The firm has personnel policies like those...

Salary data from a single firm are analyzed in an effort to identify the firm's wage policy. We find that employees are partly shielded against changes in external market conditions; that wage variation within a job level is large both cross-sectionally and for individuals over time, often leading to substantial real wage declines; that wage increa...

The authors explore the twin hypotheses (1) that high-performance incentives, worker ownership of assets, and worker freedom from direct controls are complementary instruments for motivating workers, and (2) that such instruments can be expected to covary positively in cross-sectional data. They also relate their conclusions to empirical evidence,...

This paper shows that the stock price incorporates performance information that cannot be extracted from the firm's current or future profit data. The additional information is useful for structuring managerial incentives. The amount of information contained in the stock price depends on the liquidity of the market. Concentrated ownership, by reduc...

Long-term contracts are valuable only if optimal contracting requires commitment to a plan today that would not otherwise be adopted tomorrow. We show that commitments are unnecessary, and hence short-term contracts are sufficient if (1) all public information can be used in contracting, (2) the agent can acess a bank on equal terms with the princi...

January 1987, first draft, May 1987, latest revision

The theory of the firm has long posed a problem for economists. This chapter discusses the analytical models of the firm that go beyond the black-box conception of a production function. The firm is seen as a contract among a multitude of parties. The main hypothesis is that contractual designs, both implicit and explicit, are created to minimize t...

According to the advocates of a "Generalized Darwinism" (GD), the three core Darwinian principles of variation, selection and retention (or inheritance) can be used as a general framework for the development of theories explaining evolutionary processes in the socio­economic domain. Even though these are originally biological terms, GD argues that...

The authors develop two themes in the theory of incentive schemes. First, one need not always use all of the information available in an optimal incentive contract. Accounting information, which aggregates performance over time, is sufficient for optimal compensation schemes in certain classes of environments. Second, optimal rules in a rich enviro...

A model of optimal contracts between two infinitely-lived parties, a borrower and lender, is presented and analyzed. The objective is to explain the phenomenon of finite-length, multi-period contracts. It is shown how costly information acquisition can account for multi- period contracts which are of bounded length. Comparative-statics results on h...

The paper shows how career concerns rather than effort aversion can induce a natural incongruity in risk preferences between managers and superiors. A model, based on learning about managerial talent, is developed to study second-best contractual remedies. We show that the optimal wage contract is an option of the value of the manager's human capit...

This paper was presented at the World Congress of the Econometric Society, Cambridge, Massachusetts, 1985

One of the main findings of the principal-agent literature has been that incentive schemes should be sensitive to all information that bears on the agent's actions. As a manifestation of this principle, incentive schemes tend to take quite complex (non-linear) forms. In contrast, real world schemes are often based on aggregate information with a ra...

In Holmstrom (1982) an example is given, which shows that a manager's concern for the value of his human capital will lead to a natural incongruity in risk-preferences between himself and the owners, even when no effort considerations are involved. In this paper we present a formal model of this channel of incongruity based on learning about manage...

We compare six concepts of efficiency for economies with incomplete information, depending on the stage at which individuals' welfare is evaluated and on whether incentive constraints are recognized. An example is shown in which an incentive-efficient decision rule may be unanimously rejected by the individuals in the economy. We define durable dec...

The paper investigates the New Soviet Incentive Scheme and managerial target-setting in a general framework of incentive scheme design. The New Soviet Incentive Scheme is an example of delegation of decision-making responsibility due to asymmetrically informed agents. Its superiority to a system, where targets are set by the planner, is established...

We explore a managerial model of investment behaviour in which an incentive problem arises because one input factor (managerial effort) is not publicly observed. We show that an optimal incentive contract leads to investment levels which are below first-best in low states and that this phenomenon can account for greater cyclical variability in aggr...

This article studies moral hazard with many agents. The focus is on two features that are novel in a multiagent setting: free riding and competition. The free-rider problem implies a new role for the principal: administering incentive schemes that do not balance the budget. This new role is essential for controlling incentives and suggests that fir...

A dynamic, equilibrium model of long term (implicit) labour contracts under incomplete but symmetric information is developed. Workers are assumed to be risk averse and of unknown ability or productivity. Risk neutral firms learn, as do workers, about each worker's productivity by observing the worker's output over time. It is shown that equilibriu...

In placing a new security issue, an investment banker has an opportunity to obtain private information by conducting preselling activities during the registration period. The task of the issuer is to design a contract that both induces the banker to use this information to the issuer's advantage and provides a disincentive for the banker to price t...

The role of imperfect information in a principal-agent relationship subject to moral hazard is considered. A necessary and sufficient condition for imperfect information to improve on contracts based on the payoff alone is derived, and a characterization of the optimal use of such information is given.

Thesis--Stanford University. Includes bibliographical references (leaves 274-278). Photocopy of typescript.

In this paper we provide a theory of money markets and private money. We show that preserving symmetric ignorance in liquidity provision is welfare maximizing and strictly dominates symmetric or even perfect information. A key property for the functioning of money markets is when agents have no need to ask questions and no incentive to produce priv...