Contract Options for Buyers and Sellers of Talent in Professional Sports

Duane W Rockerbie,Stephen T. Easton

• Editorial: Palgrave Macmillan
• Año: 2020
• ISBN:
  9783030495138
• Categoría: Business
• Categoría: Business General

This Palgrave Pivot re-examines salary formation in Major League Baseball in light of real option theory to clarify the connection between salary and marginal revenue product for professional baseball players. Current literature has tended to treat single-year and multi-year contracts similarly, ignoring the potential option value for teams and for players. Recent work points to the observation that both high-productivity and low-productivity athletes have salaries that systematically differ from their marginal revenue product, and that free agents signing multi-year contracts are overpaid relative to free agents signing one-year contracts. This book argues that the value of signing an athlete to a contract should be determined similarly to the determination of the value of an investment project or a financial asset.This book demonstrates how to calculate the value of real options to the player and the team owner with a simple two-year contract, and offers extensions to the realoptions model for multiyear contracts or when a player is early or late in his career.

© The Author(s) 2020

D. W. Rockerbie, S. T. EastonContract Options for Buyers and Sellers of Talent in Professional SportsPalgrave Pivots in Sports Economicshttps://doi.org/10.1007/978-3-030-49513-8_1

Begin Abstract

1. On the Rise: Player Compensation and Multi-year Contracts

Duane W Rockerbie¹ and Stephen T. Easton²

(1)

Department of Economics, University of Lethbridge, Lethbridge, AB, Canada

(2)

Department of Economics, Simon Fraser University, Burnaby, BC, Canada

Duane W Rockerbie

Email: [email protected]

Abstract

A salary anomaly has been identified in the sports economics literature suggesting that some athletes are overpaid relative to their marginal revenue product, while others are underpaid. The use of real options theory answers this anomaly by tying the under or overpayment of salaries to contract lengths. We begin this chapter with a brief history of multi-year contracts in Major League Baseball and find that multi-year contracts are much more prevalent after the repeal of the reserve clause in 1976. The so-called Scully method to estimate a player’s marginal revenue product is standard in the sports economics literature and we review it here. We close the chapter by intuitively explaining how real options theory explains the salary anomaly to motivate the rest of the book.

Keywords

Real optionsMarginal productContract lengthsBaseball

End Abstract

1.1 Introduction

Since the beginning of the 1990 season, the date at which systematic financial data for Major League Baseball teams became available, it has been a boom time for the professional sport. Attendance at games has increased from an average of 26,000 per game to over 28,000 and overall league attendance has grown from 54.8 million to 68.5 million in 2019.¹ Between 1990 and 2016 average revenue for clubs increased more than sixfold, and even adjusting for inflation rose 550%. At the same time payroll for the average major league club expanded even faster. From 1990 to 2016 the average payroll paid to players’ salaries rose by 800% in real (inflation adjusted) terms.

Major League Baseball (MLB) finance has undergone considerable change since the 1980s, most notably the rapid increase in salaries has coincided with the even greater increase in revenues. Figure 1.1 plots the average team payroll from 1980 to 2018, the average team revenue from 1990 to 2018, and the payroll share of team revenue.² The average annual rate of increase of average team payroll is 28.4%. The average team payroll increased from $17.3 million in 1990 (39% of total expenses) to $154.7 million in 2019 (53.3% of total expenses).³ Average team revenue increased from $51.5 million in 1990 to $329.8 million in 2018. The payroll share of team revenue increased from 27.6% in 1990 to 32.6% in 2018, however this is still well below the 50% payroll share of revenue in the salary cap systems used in the National Football League (NFL) , National Basketball Association (NBA) , and National Hockey League (NHL) .⁴ Gate revenue’s share of total revenue has decreased from an average of 33.3% in 1990 to 28.7% in 2019. The salary shares presented in Fig. 1.1 are underestimates of the true figures as a number of excluded payroll categories are difficult to measure (Zimbalist 2011). Some of these include deferred salary payments, signing bonuses, non-roster players, player benefits, minor league payrolls, and whether the payroll is measured at the start of the season, mid-season, or end of the season. It is also not clear what revenues should be included in reported revenues and to what extent these are related to baseball operations. For instance, lands adjacent to ballparks that are owned by the team owner that generate annual revenue, and would not otherwise generate revenue if not for the operation of the team in the adjoining stadium, are not included in baseball-related income (BRI). We rely on Forbes estimates throughout this book, but we acknowledge the possible errors in their calculations.

Fig. 1.1

MLB average team payroll , average team revenue and payroll share of revenue, 1980–2018

(Source https://​sites.​google.​com/​site/​rodswebpages/​codes taken on December 20, 2019. These figures are taken from Financial World and Forbes magazine)

Team values have increased from a median value of $102.5 million in 1990 to $1.58 billion in 2019, yielding an average annual growth rate of 48.0% (without compounding). New expansion clubs have appeared in Miami, Tampa Bay, Denver, Phoenix, and one club relocated from Montreal to Washington, DC. A new, more extensive revenue sharing system was adopted in 2002 that is even more extensive today, and in the late 1990s a competitive balance tax on payrolls above a given threshold level was phased in. Increased attendance resulted in the construction of 21 new ballparks at a total estimated cost to clubs and taxpayers of $7.8 billion.⁵ Even after general inflation (the all items Consumer Price Index increased by 85.6% between 1990 and 2016), MLB operates on a much larger dollar scale that it did in the 1980s.⁶

The impressive growth in player salaries in MLB begs the question of whether players are being paid what they are worth. Economics suggests that player salaries are proportional to the revenue a player generates for the team owner, more specifically, the player’s marginal revenue product (MRP). Players do not generate revenue directly for their owners, rather their talent contributes to a team production function that generates winning results. These wins then translate into a greater demand for the team’s product (tickets, television and media subscriptions, etc.) that result in greater revenue for the owner. The owner pays the player for his skills on the field and keeps a share of the revenue generated by these skills: what we term the surplus from talent. Owners and players determine the relative shares when negotiating salary contracts in MLB. Player salaries in the National Football League (NFL), National Basketball Association (NBA), and National Hockey League (NHL) have definite ceilings due to salary caps agreed to in their collective bargaining agreements (CBAs), however MLB has no salary caps, so players are better able to capture the full value of their MRPs.

Our task in this monograph is to suggest an answer to the apparent anomaly in MLB that many players are paid well above the MRPs. This evidence is supported by a number of studies that we discuss later. An early study by Scully (1974) found convincing evidence that players were paid well below their MRPs in the reserve clause period (defined in the next section). This is understandable since the reserve clause prevented the movement of players to new teams by limiting free agency. The standard monopsony model of industry structure predicts that the wage rate paid to players will be well below their MRPs when there is only a single buyer of talent. We do not refute Scully’s results. However, subsequent analyses using more recent salary and performance data after the abolition of the reserve clause suggest that the situation has become reversed for many players, but in particular, for highly talented players. One can justify this anomaly by pointing to the greatly increased bargaining power of these players after the fall of the reserve clause, however it is not clear what this bargaining power actually is.

We attempt to clarify the process of bargaining by introducing the concept of real options. A player and an owner who wish to agree on a multi-year contract each give up valuable options in comparison to a series of one-year contracts. Players give up the option to move to another team if more attractive ones become available. Owners give up the option to leave the player un-signed in future years if the player’s performance diminishes and his MRP falls. Salary negotiations then involve each party placing values on these options and agreeing on their net value. If the net value favors the player, such as a younger player moving into the prime of his career, the player ...

Índice

• Cover
• Front Matter
• 1. On the Rise: Player Compensation and Multi-year Contracts
• 2. The Puzzle of Overpaid and Underpaid Players
• 3. Contract Options for Buyers and Sellers of Talent
• 4. Extensions to the Put Option Model
• 5. Concluding Remarks
• Back Matter