Written for smalltalkeconomics.com.
You have probably done this at some point in your life, be it school, work, or organizing a party – you are part of a group assigned to a task, and while working on it, you realize you might as well just let others do the hard part. In the end, you all get the same credit for the final outcome anyway, right? Congratulations, you have just become the so-called free-rider of the group.
The seminal work of one of the two men woken up this morning by a call from the Nobel committee, Bengt Holmstrom, shed more light on this phenomenon. One of his most famous papers, published in 1982, shows that the free-rider problem described above can largely be resolved if ownership and labor are partly separated, which gives capitalistic firms an advantage over partnerships. In other words, if you are in a partnership, it is more likely that there will be a free-rider among your co-workers (partners) than when you own the company yourself and hire workers with assigned jobs. The rather technical paper also discusses some other issues arising due to such moral hazard questions. For example, it assesses the consequences of relative performance evaluation of workers and suggests ways to improve risk-sharing in entrepreneurship in general.
This is is one of the founding works in contracts theory, for which The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel was awarded this year to Bengt Holmstrom and Oliver Hart.
Reference: Holmstrom, B. (1982). Moral hazard in teams. The Bell Journal of Economics,13(2), 324-340. Available here.