Competitive Balance

Competitive Balance • The distribution of wins in professional team sports most consistent with the maximization of league profits. • Outline of Discussion • The Reserve Clause • Rottenberg (1956) • The Importance of Outcome Uncertainty • Perfect Competitive Balance? • Measures of Competitive Balance • Berri (forthcoming) • Review of league policy

The Reserve Clause • The Reserve Clause - A renewal clause in each uniform player contract, which permits the team to renew the contract for the following year at a price the team may fix.

Early History of the Reserve Clause • The National Association of Professional Baseball Players (organized 1871) established a rule that you could not sign a player from another team during the regular season. • This rule was broke by William Hulburt, owner of the Chicago team (who raided the championship Boston team during the 1875 season) and the National League was formed in 1876. • Initially, the player’s market was unrestricted. • In 1878, players could not be signed to a new team until after the season ended. • In 1879, a limited reserve clause (applicable to five players) was enacted. • In 1889 the reserve clause was added to the standard player contract.

Purpose of the Reserve Clause • The reserve clause reduces player salaries, hence increasing profits. We will discuss this point when we discuss labor economics. • The reserve clause promotes competitive balance.

Rottenberg, Simon. 1956. “The Baseball Player’s Labor Market.” “ What if there is a free market? “At first sight, it may appear that the high-revenue teams will contract all the stars, leaving the others only the dregs of the supply; that the distribution of players among teams will become very unequal; that contests will become less uncertain; and that consumer interest will flag and attendance will fall off. On closer examination, however, it can be seen that this process is checked by the law of diminishing returns...” [Rottenberg (1956): 254]

Rottenberg (1956), cont. “Beyond some point-say, when a team already has three .350 hitters-it will not pay to employ another .350 hitter. If a team goes on increasing the quantity of the factor, players, by hiring additional stars, it will find the total output, that is admission receipts-of the combined firms (and, therefore, of its own) will rise at a less rapid rate and finally will fall absolutely. At some point, therefore, a first star player is worth more to poor team B than, say, a third star to rich Team A.” [Rottenberg (1956): 255]

The Coase Theorem • The Coase Theorem: “When there are no transaction costs the assignment of legal rights have no effect upon the allocation of resources among economic enterprises.” [Stigler (1988)] • Note: Ronald Coase published his work in 1960, after Rottenberg made essentially the same argument. Coase, though, talked about cattle, not baseball.

Rottenberg (1956), cont. “The position of organized baseball that a free market, given the unequal distribution of revenue, will result in the engrossment of the most competent players by the wealthy teams is open to some question. It seems, indeed, to be true that a market in which freedom is limited by a reserve rule such as that which now governs the baseball labor market distributes players among teams about as a free market would.” [Rottenberg (1956): 255]

Rottenberg (1956), cont. “Players under contract to a team may be used by that team itself, or they may be sold to another team. Each team determines whether to use a player’s services itself or to sell him, according to the relative returns on him in the two uses. .... It follows that players will be distributed among teams so that they are put to their most ‘productive’ use; each will play for the team that is able to get the highest return for his services.” [Rottenberg (1956): 256]

Uncertainty of Outcome • Why is balance important? Uncertainty of outcome is crucial to the demand for sporting events. The works of Knowles, Sherony and Haupert (1992), and Rascher (1999) found that Major League Baseball attendance was maximized when the probability of the home team winning was approximately 0.6. These studies suggest that consumers prefer to see the home team win, but do not wish to be completely certain this will occur prior to the game being played. • Knowles, Glenn, Keith Sherony, and Mike Haupert. 1992. “The Demand for Major League Baseball: A Test of the Uncertainty of Outcome Hypothesis.” The American Economist, 36, n2, Fall: 72-80. • Rascher, Daniel. 1999. “A Test of the Optimal Positive Production Network Externality in Major League Baseball.” Sports Economics: Current Research, Edited by John Fizel, Elizabeth Gustafson and Lawrence Hadley. Praeger: 27-45.

Perfect Competitive Balance • Teams in larger markets generate greater revenue from an additional win than teams in smaller markets. If marginal cost is the same for all teams, then teams in larger markets would maximize profits at a higher winning percentage than teams in smaller markets. • Review Figure 7.11

Measures of Competitive Balance • Range of winning percentages • Gini Coefficient • Standard deviation • Excess tail frequency • Concentration of league championships • Life-time team winning percentages • NOTE: There are several others that we will not be discussing.

Range of Winning Percentages& Gini Coefficient Range of winning percentages: Team with highest winning percentage - Team with lowest. • Easy to understand and calculate • Only measures the extremes. Gini Coefficient: See Handout

Standard Deviation • Standard deviation = [[(PCT actual - PCT mean)2]/number of teams]0.5 • Idealized standard deviation (if every team was equal) = (.500)/ N0.5 Where N = number of games each team plays in a season • With a normal bell shaped distribution: • 2/3 of league will be within one standard deviation • 95% will be within two standard deviations • 99% will be within three standard deviations

Berri, David J. “Is There a Short Supply of Tall People in the College Game?”in Economics of Collegiate Sports; eds. John Fizel and Rodney Fort; Praeger Publishing; forthcoming in 2003. • Competitive balance is within the control of league policy. Hence the need for a reserve clause and reverse-order draft. • The work of Rottenberg (1956), along with the writing of Stephen Jay Gould and Andrew Zimbalist (1992), suggest competitive balance is not primarily determined by league policy. Rather the underlying population of athletic talent dictates the level of competitive balance a league achieves. • REVIEW TABLES

Additional Competitive Balance Measures • Excess tail frequency (two and three standard deviation tails) • For two standard deviations: Excess Frequency = Actual frequency - Idealized Frequency (4.6) • For three standard deviations the Ideal Frequency is 0.3. • Refer to Figures 7.12 and 7.13a-d. of Quirk and Fort (1992) • Concentration of league championships Gini coefficients for each league: data pre-1990 NBA .419 NHL .386 AL .377 NFL .350 NL .334 • Life time team W/L Percentages • Most successful teams (1901-1990) Review Table 7.5 in Quirk and Fort (1992) • Who has the most competitive balance by this measure? The NBA • What does this mean? The NBA has the most inequality in any given year. However, the NBA has the most mobility in the rankings over time.

Review of League Policy • Note: The work of Rottenberg, Gould, Zimbalist, and Berri suggest that competitive balance is primarily a function of underlying population. • Despite this research, leagues do enact policies designed to impact competitive balance. These include • the Reserve Clause • the Reverse-Order Draft • Revenue Sharing • Payroll and Salary Caps

Competitive Balance