News and Articles

NOBEL PRIZE WINNERS OFFER CRITICAL INSIGHT INTO DRAFTING EMPLOYMENT CONTRACTS

Yogi Patel - Friday, December 16, 2016

The groundbreaking work of Oliver Hart of Harvard University and Bengt Holmstrom of the Massachusetts Institute of Technology, which includes providing invaluable insight into how employment contracts should be structured, recently earned the two professors the 2016 Nobel Memorial Prize in Economic Science. Hart and Holmstrom’s research offers a variety of theoretical models and frameworks through which they analyze the competing interests of employees, managers, CEOs, shareholders, and others, and attempt to reconcile them via contracts.

Over the past few decades, Homstrom and Hart’s findings have been used to evaluate whether particular contracts accurately measure the performance and value of employees and other agents to companies while offering the right amount of incentive. Specific factors that the research contemplates in its assessment of employment contracts include ownership, control, the measurability of an agent’s performance, risk sharing, and the motivations of the parties involved.

Rather than simply pay an individual a fixed salary or reward a manager for the performance of a company in a vacuum, the professors suggest considering alternative compensation structures and contracting terms, including:

Deferred Compensation

In order to ensure that a company’s interests are aligned with those of an employee, it may make sense to tie an individual’s compensation to performance rather than pay her a set amount. By withholding a portion of an employee’s compensation, the company can provide incentives for the individual to earn the full amount by meeting certain goals. Whether or not this type of arrangement makes sense will depend in great part on the measurability of an employee’s performance and the stability of the business environment.

Performance Evaluation based on the Overall Market

Another metric for evaluating an employee’s value, particularly one who is in a decision-making position, is the overall performance of the company. One common mistake businesses make is setting goals or targets based solely on the absolute performance of the company, rather than taking into account the performance of the company as compared to other similarly situated businesses. If a company does well in a thriving market or suffers during a market collapse, the employee should not be rewarded for good luck or punished for misfortune. A company performing well relative to others is a far superior measurement of employee value.

Designation of a Main Decision-Maker

Most contracts cannot contemplate the exact outcome of every situation that may arise in a given relationship. Companies recognize that it is impossible to list specific instructions for every job responsibility, and this in turn may actually be counterproductive. In such cases, the parties should determine who has the power to decide what to do in situations where they cannot reach an agreement. In this manner, the parties are able to avoid having to anticipate every possible future event while entering into a relationship that allows them to move forward with their main, general purpose, i.e. employment.

While Hart and Holmstrom’s work is highly theoretical and informative, it is essential to use their tools in conjunction with a business’s specific needs. Depending on the business type, number of employees, and variety of other factors, businesses may have widely different terms and compensation structures that work best for them. Notwithstanding this, business owners are advised to consider the research finds of Professor Hart and Holstrom’s when making decisions about their own employees and businesses.

This article was prepared with the assistance of Julie Lee, 3L (CUNY School of Law).

 

Legal Update - October 2016 Newsletter

Yogi Patel - Tuesday, October 18, 2016

Dear valued clients and supporters: This month's newsletter will focus on: (1) trademarking website domain names; (2) impact on a business in the event of a divorce; and (3) rethinking employment contracts in light of the recent award of the Nobel Prize in Economic Science.

Trademarks and Website Domain Names
Contrary to the assumption of many, simply registering the name of a business as a domain name does not give the same protections as trademarking the name itself. Domain name registrants lease, rather than own their website domain names, whereas a trademark grants exclusive use of a particular domain name in commerce nationwide. Thus, businesses who fail to trademark their domain names are much more susceptible to infringement and customer confusion due to another entity using the same or similar name. And many businesses that spend countless resources on their brand (often tied to their websites) could find themselves in a position where they lose their ability to use that domain name resulting from their failure to seek federal trademark protection. For further details on the differences between registering a domain name and a trademark and why businesses should strongly consider the latter, an in-depth article can be found here on our website.

Protecting a Business from Divorce (Updated)
In our newsletter last month, we briefly discussed the need for business owners to prepare themselves in the event of a divorce. A more in-depth article on what steps owners should take to protect their businesses from a divorce is now posted here on our website.

Rethinking Employment Contracts

The most recent Nobel Prize in Economic Science was awarded to two professors for their work on improving the design of employment contracts. At the core of Dr. Oliver Hart and Dr. Bengt Homstrom's study were findings that suggested new ways in which businesses should value their employees' contributions and provide incentives to maximize performance. By restructuring its contracts based upon the professors' research, business can more accurately measure and incentivize their employees' performance and provide compensation accordingly. A more in-depth article on this topic will be posted next month here on our website.

Readers are encouraged to follow us on Twitter (@lloydpatelllp) and Facebook to receive updates on these and other issues throughout the month.


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