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Volume 2, Chapter 8 Salary caps and luxury taxes in professional sports leagues

Volume 2, Chapter 8 Salary caps and luxury taxes in professional sports leagues. Athlete compensation. Economic justification Compensated based on marginal revenue product (MRP), how much employee contribute to eomployer’s revenues, in free and open market

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Volume 2, Chapter 8 Salary caps and luxury taxes in professional sports leagues

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  1. Volume 2, Chapter 8Salary caps and luxury taxes in professional sports leagues

  2. Athlete compensation • Economic justification • Compensated based on marginal revenue product (MRP), how much employee contribute to eomployer’s revenues, in free and open market • Employer retain most MRP, employee compensated at conservative rate, in restricted, uncompetitive market • Marginal win • How much does a win worth?

  3. Athlete compensation • Player’s point of view • The least willing to accept is what could earn in next-best employment opportunity (reservation wage) • Player’s MRP and reservation wage give max and min limits on salary • Most important consideration is bargaining power of player relative to that of owner • More close substitutes there are (easier to be replaced), more bargaining power team has, salary closer to RW than MRP

  4. Athlete compensation • Owners usually said if player salaries increase, they will be forced to raise ticket price • Limit salary increase really in the interest for fans • Makes very little economic sense • Ticket pricing decision by profit-oriented owner completely independent of player salary • Solely on ticket demand by fans • Ticket price rise when fan demand rise, in turn increase player MRP, result in higher salary

  5. Athlete compensation • Beginning of free agency, raise player salary immediately • Fan would not pay more just because player earning more • in 1980 (4 years after free agency) only Red Sox and Yankees ticket prices higher than 1971 • Ticket price prior to free agency were set by owners at levels representing best guesses to maximize revenue • Rising demand by public for major professional team sports, lead to increase in ticket prices and TV contract revenues • In turn, increase value of skilled players to teams, their MRP rises

  6. The winner’s curse • Not easy in determining free agent salaries • Predict how player will perform in future, what his contribution to team, size of crowd will draw… • In ‘sealed-bid’ auction, such as free agent and league TV rights, the winner’s curse may be operative • All bidders have same information • Winner may make mistake in overvaluing • Winning may mean winner bid too much, maybe for too much • Left on the table: difference in bid between the highest and second-highest

  7. Monopsony買主獨家壟斷 • 有很多賣主而只有一個買主的市場情況 • MLB Salary/MRP = 0.15 in reserve clause days • Star players Salary/MRP = 0.29-0.45 in 1987, even in collusion period • Do not control for player’s effect on revenue other than stats effects on winning

  8. Incentives and performance • Better reward/bonus result in better performance? • Free agency increased incidence of long-term contracts • FA ask for, competition in bidding for FA, lock up young players before reaching FA • Performance and disabled time before and after signing long-term contract • May decrease performance and increase disabled time, moral hazard effect • Many players perform better in ‘contract year’ • Players are still playing for next contract

  9. Regulation of salary • 支持：Competitive balance in the league, especially in small markets • 反對：team continually try to limit players’ ability to sell their talents freely

  10. Win-Revenue Relationship • Positive relationship between winning and revenue with 3 stages: flat, steep, & steady stages • Win effects are not equal: a team’s location has dramatic impact on the value of win. • Respectability vs playoff contention • At the extremes, regular season wins have little impact on revenue

  11. Win-Revenue Curve162-game season in MLB Gennaro, Diamond dollars, 2007

  12. Components of Win-Revenue Curve Gennaro, Diamond dollars, 2007

  13. Market Size Matters! Gennaro, Diamond dollars, 2007

  14. Effect of Market Size on Revenue: NBA • Data: NBA 1992-1996 • Increase in population will increase gate revenue • Moving to a city with an additional million persons worth $399,503 • Such increase in revenue would increase the value of a win by $1648 • Additional persons in population enhance the monetary value of on-court performance Berri, et al. Journal of Sports Economics, 5: 33-50, 2004

  15. NBA 1992-1996, 4 seasons Berri, et al. Journal of Sports Economics, 5: 33-50, 2004

  16. Different Team,Different Win-Curve Gennaro, Diamond dollars, 2007

  17. Same Player, Different Value • It is difficult for great players who play on poor teams to create significant value • As a team improves above certain threshold (85 wins), the value of all its players tend to rise • As a team gets worse, the value of all its players tend to decrease • Even a mediocre player in a great team may provide more value in a star player in a poor team

  18. Same Player, Different Value Gennaro, Diamond dollars, 2007

  19. Evaluation of A Player Gennaro, Diamond dollars, 2007

  20. A Player’s Value Depends on Teammates Gennaro, Diamond dollars, 2007

  21. Postseason Effects • Teams increase ticket prices more after making postseason • White Sox win World Series in 2005 • 8.5% increase in baseline revenue (~17 M) in 2005 • Total future value 28 M: 60% realized in 2006 • Diminishing return of consecutive appearances in postseason • 75% in 2nd, 50% in 3rd, 30% afterwards Gennaro, Diamond dollars, 2007

  22. Diminishing Revenue of Consecutive Postseason Appearances Gennaro, Diamond dollars, 2007

  23. Star Power on the Road: NBA • Increase TV broadcast ratings • 1989-90 season: Magic Johnson 31%, Michael Jordan 28%, Larry Bird 27% increase ratings. • 1991-92 season: Bulls opponents received 50% higher ratings than otherwise equivalent games. • Michael Jordan's total value to other NBA teams is estimated to be $53.2 million in 1991-92. Hausman et al. J Labor Econ, 15: 586-624, 1997

  24. Star Power on the Road: NBA Berri and Schmidt. Journal of Sports Economics, 7: 347-358, 2006

  25. Evaluation of Players: NBA Berri and Schmidt. Journal of Sports Economics, 7: 347-358, 2006

  26. Effect of Ace Starting Pitchers on the Road: Attendance Increase by 2.07% MLB 2006-2007 R2=0.194 Tseng and Chang, 2008

  27. Star Power in CPBL 2002-2007:Attendance Increases by 6% per ASG Starter • dependent variable: total attendance of all games in the season R2=0.552

  28. Reserve clause • In 1800s, talented players found ‘contract jumping’ increase salary • Cause financial problem, even collapse of teams • Owners of remaining NL teams reached a secret agreement: each team reserve 5 players who can not be touched by other teams • Very successful in stopping increase in salary • By 1890s every contract include a reserve clause • Reserve clause: contract can be automatically renewed for 1 year upon expiration by team, even without player’s signature • A new contract also include reserve clause

  29. Reserve clause • 1922 Supreme Court gave MLB exemption from antitrust laws • Baseball was a ‘public exhibition’, not commerce  not subject to antitrust laws • Consistently refused to extend exemption to any other sport or industry

  30. Dismantling of reserve clause • Curt Flood sued MLB for damage and free agency in 1970, financially supported by MLBPA • Refused to be traded • Lost in Circuit Court and Supreme Court • Catfish Hunter signed 2-year contract with Charlie Finley of A’s in 1974 • Part of money paid to insurance fund, which Finley did not pay in 1974 • Arbitrator ruled that contract is voided, Hunter signed with Yankees in 1975 for 3-year lucrative contract

  31. Dismantling of reserve clause • Dave McNally (Expos) and Andy Messersmith (Dodgers) unhappy with club offers • Did not sign contract in 1975 • Team renew their contract according to reserve clause • Grievance panel arbitrator ruled in Dec 1975, that contract can be renewed without player’s signature only once, granted free agency • CBA in 1976 • Owners outraged by free agent ruling, preseason lockout • Agreement for all players with 6 years of MLB experience as free agents • Salary arbitration for players with 2-5 years MLB experience (Super Two, top 17% of 2-3 years experience)

  32. End of Reserve clause • 1957 Supreme Court favor George Radovich • NFL  All American Football Conference (AAFC)  NFL, but blacklisted by NFL • Reject NFL’s right to reserve players • Owners agree NOT to pursue others’ players • 1960s ‘Rozelle Rule’: team singing FA should compensate the team that lost the FA • 1992 District Court ruled ‘Rozelle Rule’ violate antitrust laws

  33. End of Reserve clause • 1972 World Hockey Association successfully sued NHL for violations of antitrust laws • NHL prevent players moving to WHA • 1976 NBA settled with Oscar Robertson suit • Robertson: prevent the merge between ABA and NBA, allow players to jump leagues • Agree to phase in FA

  34. Impact of FA on competitive balance • Failure of rich teams to win champ after champ • Coase theorem: players go to the teams that value their services most highly, regardless of the contractual relationship between players and owners • Predict the end of reserve clause should not have affected distribution of talent

  35. Salary cap • First introduced by NBA • Owners regard salary cap as the cure of all worries about competitive balance • MLB: highest correlation between payroll and winning percentage • FA, no salary cap • NFL: lowest correlation between payroll and winning percentage • Smallest variation in payroll • Hard cap • NBA and NHL in between

  36. NFL salary cap 2011-2020 • 120.375 M in 2011 • Guaranteed 99% spend • Guaranteed league-wide spend 95% in 4-year average 2013-16, 2017-20 • Minimum team cash spend 89% cap in 4-year average 2013-16, 2017-20 • Salary cap base on “all revenue” • 55% national media revenue, 45% NFL ventures revenue, 40% local club revenue • Player share must average at least 47% for the 10-year term of the agreement

  37. NFL: 2005: 94.5 M;2006: $102 M; 2007: $109 M; 2008: $116 M, 2009: $123 M; 2010: none; 2011: 120.375 M NBA: 07-08 55.6 M; 08-09: 58.7 M; 09-10 59.7 M; 10-11: 58 M

  38. NBA salary cap 2005(06)-2010(11) • http://www.nbpa.com/cba_articles.php • Players will be guaranteed to receive 57%of league revenues (BRI), the same percentage paid to players the last two seasons. • The Salary Cap will increase from 48% to 51% of BRI • All Cap exceptions will remain unchanged • luxury tax level will be set at 61% of league revenues • the same level as in the 2001-02 – 2003-04 seasons • The maximum length of a player contract reduced from 7 to 6 years for a team’s own players, and from 6 to 5 years for other players

  39. NBA salary cap 2012(13) • The Salary Cap for 2012-13 is $58.044 million • same as the 2011-12 • Future Salary Cap will be calculated by multiplying projected “Basketball Related Income” by 44.74%, subtracting projected player benefits, and then dividing the result by 30. http://www.nba.com/media/CBA101_9.12.pdf

  40. NBA Salary cap • Larry Bird rule: allow teams to keep its own FA • Rookie exception: A team may sign its first-round draft pick for up to 120% of his Rookie Salary Scale amount • Soft cap

  41. Escrow system • Escrow system 信託: league set aside 10% player salary and 1% BRI • 2011-12: 51.15% BRI, later: 50% BRI • If all salaries > 50% BRI  bring salaries to 50% • If all salaries < 50% BRI  money return to players • Guarantee players with certain percentage of league income

  42. NBA salary cap and avg salary http://en.wikipedia.org/wiki/NBA_salary_cap#Luxury_tax

  43. NHL’s CBA 2005(06)-2011(12) • http://www.nhl.com/nhlhq/cba/index.html • Extended by NHLPA from 2010 to 2011 • The players' share of league revenue • 54% in any year league revenue <2.2 billion • 55% if LR 2.2-2.4 billion • 56% if LR 2.4-2.7 billion • 57% if LR > 2.7 billion • Salary cap and salary floor • Penalty for exceeding salary cap: 100% tax • Escrow system

  44. NHL’s CBA 2005(06)-2011(12) • Salary cap • 05-06: 39 M • 06-07: 44 M • 07-08: 50.3 M • 08-09: 56.7 M • 09-10: 56.8 M • 10-11: 59.4 M • 11-12: 64.3 M • Player salary • Maximal: <20% maximal payroll, 7.8 million in 2005-06 • Minimum: 450 K in 2005-07, 475 K in 2007-09, 500 K in 2009-10, 525 K in 2011-12 • Drafted players: contract with limits of salary and length • No CBA after Sep, 2012

  45. Luxury taxes • MLB: 0, 30, 40% tax for the amount of payroll exceeding the threshold • Yankees paid every year • NBA: 100% tax • No tax in NFL • Effective?

  46. MLB luxury tax 2007: $148, 2008: $155 M, 2009: $162 M 2010: $170 M, 2011: $178 M

  47. MLB luxury tax 2003-10 http://bizofbaseball.com/index.php?option=com_content&view=article&id=4971&Itemid=194

  48. MLB luxury tax 1997-99threshold: avg (5th+6th highest payroll) http://bizofbaseball.com/index.php?option=com_content&view=article&id=4971&Itemid=194

  49. NBA individual and team salary, 2010-11 http://hoopshype.com/salaries.htm

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