Revisiting the Contract Theory

Clemence Machadu Insight
Howdy folks!
The 2016 Nobel Prize for Economics was last week conferred to economists Oliver Hart and Bengt Holmstrom for their contributions to the Contract Theory. Whereas many people may want to quickly associate crafting contracts with lawyers or human resources practitioners, their (contracts) efficacy in stimulating productivity and business success has to some significant extent been thanks to the contribution of economists, including these recent laureates.

Hart and Holmstrom came up with hypothetical tools that are useful in understanding real-life contracts and institutions as well as pitfalls in contract design.

We are all in an income contract of some sort with someone, and we do experience conflicts at some point.
It is the manner in which those contracts are designed that would guarantee that decisions are made in the best interest of both parties when conflicts arise. It’s certainly not about who can raise their voice higher or who has the bigger muscle.

The Contract Theory is, therefore, important to Zimbabwe as it provides a comprehensive framework for analysing many diverse issues in contractual design such as performance-based pay for top executives, deductibles and co-pays in insurance and the privatisation of public sector activities.
Folks, we have borne witness to a number of unfortunate incidences, both in the private and public sector, all pointing to the need for concrete contract design.

Take, for instance, a top executive of a medical aid society being remunerated about half a million dollars per month, while members contributing to that society fail to access basic healthcare services.

Although we can all outrightly see a moral and ethical anomaly in that scenario, the act may not be criminalised because of what the contract says — he’s legally entitled to that lion’s share.

You may want to ask why top executives of a company should be heavily remunerated when the company is posting losses or is not doing well.
Because their contracts say so? Should they continue to be remunerated until the company is on its knees?
Just when should we stop? Is there a bell that is supposed to ring?

The Contract Theory also helps us better understand the ugly status quo in most of our parastatals.
According to this year’s Mid-term Fiscal Policy Statement, some of the reasons why many State-owned enterprises are posting perennial losses are high staff costs relative to income and non-compliance to good corporate governance.

“The human resources cost structures of local councils have in a majority of cases been the biggest impediment to service provision”, read the policy.
Government is now considering instituting a remuneration framework which relates remuneration levels to size, service delivery, revenue performance and profitability of parastatals.

This might entail revisiting some contracts with employees across the hierarchy, and the Contract Theory can provide some direction on the path to follow for parastatals to turn the corner.

Command Agriculture is also going to be as good as the performance contracts that will be signed with farmers to ensure mbeu haizobikiswe mutakura or promoting the “ndezve mahara” syndrome.

Everything seems to be pointing at the Contract Theory.
One of the theory’s goals is to explain why contracts have various forms and designs. Another goal is to help us work out how to draw up better contracts, thereby shaping better institutions in society.

Folks; the Contract Theory further explores the conditions for paying fixed salaries and where performance-based remuneration should be considered.
For instance, to what extent should managers be paid through bonus programmes or shares?
The first notable insights of the theory were derived in the context of employment contracts involving risk-averse agents/workers whose actions could not be directly observed by the principal/employer.

This is the scenario in many of our local business institutions.
And some workers in these scenarios continue to be paid their fixed salaries for doing nothing.
Should pay day continue to be as usual for them?

In 1979, Holmstrom posited that an optimal contract should link payment to all outcomes that can potentially provide information about actions that have been taken.

In this scenario, it is somehow easier to apportion reward to actual work done.
It surely cannot continue to be pay day as usual for employees who only come to work to mark the register and spend the rest of their day playing Zuma on their computers, in their relentless quest to become “sun gods”.

I would also like to applaud the labour issues spelt out by President Mugabe while outlining the legislative agenda for the new Parliament session.
If implemented well, they will certainly add value to the Contract Theory as it relates to the Zimbabwean context.

President Mugabe highlighted that Parliament will consider the updated and harmonised Occupational Safety and Health Bill, which establishes a tripartite Occupational Safety Council.

Safety and health issues are not given much regard by many companies in Zimbabwe, which is why thousands are injured every year while dozens die at their workplaces due to accidents.

Just imagine that in 2014, only 18 percent of local companies had occupational, health and safety policies. That is totally unacceptable.
President Mugabe also indicated in his speech that a new Labour Amendment Bill, seeking to harmonise the country’s labour laws with the Constitution and relevant international conventions, will be tabled in Parliament.

It’s high time we made our labour laws work optimally for our economic system while ensuring workers are not exploited, as would have happened had the Special Economic Zones Bill, which had been passed in Parliament and sent to the President, been signed into law.

President Mugabe, however, sent the Bill back to Parliament as it had proposed the exclusion of the Labour Act in the zones, which would have left workers at the mercy of employers.
We should not be myopic and try to implement things that failed to work before.

Remember, when export processing zones were implemented in 1995, they excluded the Labour Relations Act from applying in them.
However, in 1998, Government had to put employment regulations to cover the zones and further established a Labour Board for them in 2000.
How about now when we have a Constitution that is more particular about protecting workers’ rights?

The answer to our economic woes can be partly unlocked by fully exploring the Contract Theory and ensuring any identifiable performance activity is linked to remuneration, while also ensuring the worker continues to be motivated to optimally contribute to the success of the business.
Later folks!