Harvard's Oliver Hart and MIT's Bengt Holmstrom on Monday won the Nobel Memorial Prize in Economic Sciences for their contributions to contract theory.
Their work applies to real life situations such as whether executives should get paid bonuses or stock options.
In a phone interview on CNBC's "Squawk Box" on Monday, Holmstrom said: "Mistakes have been made in the design of these [executive] incentives."
"If you're an entrepreneur, you can't cash out quickly. You have your own skin in the game," said the Finland-born Massachusetts Institute of Technology economics and management professor.
"The biggest design flaw in the executive compensation," he argued, "[is] they didn't force these executives to hold onto their incentives for longer."
The Royal Swedish Academy of Sciences said the theories of Holmstrom and the British-born Hart are "valuable to the understanding of real-life contracts and institutions, as well as potential pitfalls in contract design."
"All of economics is about incentives. This is about incentive contracting. This is about trying to motivate people to do things that are mutually beneficial," Holmstrom said.
The economics prize is worth about $930,000.
— The Associated Press and Reuters contributed to this report.