JSE: Zimbalist on salaries and revenues

The second article in the February, 2010 issue of "Journal of Sports Economics" is "Reflections on Salary Shares and Salary Caps," by Andrew Zimbalist.

It's an overview of the recent history of revenues and salaries in the four major sports. I say "overview" because Zimbalist implies there's a lot of detail that went into the numbers that wouldn't fit in the article. Zimbalist starts off by quoting some incorrect numbers that appeared in the press, and says,

"... it helps to get the numbers right before plowing ahead. ... Special knowledge of the real world, even though it may sometimes be proprietary or may entail diligent digging, can help sharpen and deepen research by sports economists ..."

The main question in the paper is: what percentage of revenues is paid to the players in salaries? Zimbalist touches on some of the issues involved in figuring that out. In three of the sports (MLB is the exception), there's a salary cap that's based on a percentage of revenues. You'd think it would be as simple as looking at the union agreements to see what the percentages are. But what counts as revenue? The details are different for the different leagues, as defined in their respective contracts. For instance, the New York Knicks and the MSG network that broadcasts their games are both owned by the same company (Cablevision). In order to avoid having MSG pay a too-low price for the broadcast rights (thus artificially lowering the Knicks revenues), the contract contains a clause that values the TV contract at the same price as the Lakers' contract (which is a transaction between unrelated parties).

Also, NHL revenues are defined to include the value of complimentary tickets; NBA revenues are not. And so forth.

Anyway, here are the numbers, as Zimbalist calculates them:

In the NFL, salaries from 2001-2006 fluctuated in the range of 54 to 60 percent of total revenues. Before that, from 1994 to 2000, they were higher, between 60 and 65% all seasons but one.

In the NBA, salaries from 2001 to 2006 were 57% of "basketball-related income" in all seasons but one (60% in 2002-03). In the six preceding years, they ranged from 53% to 65%.

Zimbalist doesn't give data for the NHL, perhaps because the salary cap is so recent. But the agreement calls for salaries to comprise 54% to 57% of revenues, with the higher numbers applying when revenues are high.

Finally, for MLB, Zimbalist's numbers fluctuate a fair bit. Here they are from 1990 to 2007:

1990-94: 42%, 47%, 54%, 54%, 63%
1995-99: 62%, 58%, 59%, 56%, 59%
2000-04: 56%, 61%, 67%, 63%, 55%
2005-07: 53%, 51%, 51%

Those numbers don't include minor-league salaries. If you add those in, the 2007 figure rises from 51% to 57% (since MLB pays minor league salaries but doesn't participate in minor-league revenues). The same principle holds for the NHL, but to a much lesser degree (since there are fewer minor-league players, and some NHL teams own their affiliates outright). With minor leagues included, the NHL ratio rises to 58%.

If you're interested in some of the issues behind these estimates, I definitely recommend Zimbalist's article. There aren't a lot of hardcore details, but there is a discussion of some of the many issues that have to be considered to get accurate numbers.

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Generally, it looks like all four sports have about the same ratios, between 55 and 60 percent. Zimbalist expresses a bit of surprise at this, since MLB doesn't have a salary cap, while the other three leagues do. You might have expected the MLB ratio to be higher, because of that, but it doesn't work out that way.

I guess it shouldn't be that much of a surprise -- if the MLB ratio was too much higher, the teams would be demanding a cap, and that doesn't seem to be the case. To me, logic seems to suggest that MLB should be the healthiest of the four leagues: it spends the same ratio of revenues on player compensation, but the big-market teams pay more, and the small-market teams pay less. This lets all the teams make a decent profit, and puts the best teams where there are the most fans.

With a cap, the Yankees would have to spend the same as everyone else. They'd be an average team, and, since the Yankees are the biggest market, their revenues would drop more than the revenues of other teams would rise. And so the league as a whole would be worse off -- they Yankees would make less, and, with a salary floor like in the NHL, lots of small-market teams might start losing money.

Except ... well, as I wrote before, I wonder if, in the long term, the fans will be willing to put up with a system that virtually guarantees the Yankees and Red Sox so many more pennants than the Royals and Marlins. I guess time will tell. For my part, I much prefer the long-term competitive balance promised by the other three leagues.

Does it matter that the Yankees keep buying pennants?

As most baseball fans are aware, the New York Yankees have been spending more money on payroll than any other team in the major leagues, by a long shot. In 2009, for instance, the Yanks spent $201 million, about two-and-a-half times the average, and $76 million more than the next highest team (the Mets).

And so, as you would expect, the lavish-spending Yankees have been very successful. The Yankees made the post-season every year but one since 1995. That's 14 out of 15.

In an excellent post in November, Joe Posnanski wondered why fans are willing to put up with this. He gave two reasons:

1. In baseball, unlike football and basketball, a truly dominant team still wins only about 60% of its games. This tends to hide the extent of the dominance:

"I would bet if the Indianapolis Colts played the Cleveland Browns 100 times, and the Colts were motivated, they would probably 95 of them — maybe even more than that. But if the New York Yankees played the Kansas City Royals 100 times, and the Yankees were motivated, I suspect the Royals would still win 25 or 30 times. That’s baseball.

"So you have this sport that tends to equalize teams. That helps blur the dominance of the Yankees. If the New England Patriots were allowed to spend $50 million more on players than any other team, they would go 15-1 or 16-0 every single year. And people would not stand for it. But in baseball, a great and dominant team might only win 95 out of 160, and it doesn’t seem so bad."

And, given that the Yankees should only be expected to win 97 games or so, there will likely be other teams that come close to them, so it winds up looking like the Yankees are one of many quality teams. Of course (and now this is me, not Posnanski), the Yankees are expected to do it every year, whereas whatever team challenges them is probably just a random team that got lucky. But you can't tell that just by watching, so that Yankees don't look all that special in any given season.

2. Under the new, post-1995 playoff system, a team has to win three rounds to win the World Series. But in a short series, anything can happen, and the better team will lose with pretty high frequency.

A team with a 60% chance of winning each game will only win a best-of-five series about 68 percent of the time, and a best-of-seven series 71 percent of the time. (If I've got the numbers right.) So the chance of winning three consecutive rounds, and the World Series, is .68 * .71 * .71, which is about 34 percent.

So even if the Yankees are 60% favorites every game of the post-season -- the equivalent of 97-65 against three of the best other teams in baseball -- they'll win the World Series only about one year out of three. Posnanski:

"And in that way the expanded playoffs have been genius for baseball — not only because they are milking television for every dime but because the short series have been baseball’s one Yankee-proofing defense against the ludicrous unfairness of the New York Yankees. ... They are the best team with the best players every year — that sort of big money virtually guarantees it.

"So, you create a system where the best team doesn’t always win. In fact, you create a system where the best team often doesn’t win. For years the Yankees didn’t win. They lost to Florida. They lost Anaheim. They blew a 3-0 series lead against Boston. They lost to Anaheim again and Detroit and Cleveland — and how could you say that baseball is unfair? Look, the Yankees can’t win the World Series! See? Sure they spend $50 million more than any other team and $100 million more than most. But they haven’t won the World Series! Doesn’t that make you feel better?"

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Last week, at the Sports Economist blog, Brian Goff agreed and disagreed with Posnanski's analysis. His agreement was that Posnanski got it right in terms of understanding why MLB did what it did with the expanded playoffs. His disagreement was that, while Posnanski thinks it's a bad thing for the fans, Goff thinks it's a *good* thing.

Why? Because Yankee-haters get a lot of satisfaction out of seeing the Yankees lose. And so MLB's strategy is win-win. Yankee fans get to see their team in contention every year, which creates a lot more revenue for the league and utility for fans (since the Yankees have the largest fan base in MLB). And then, Yankee-haters get to see their least-favorite team defeated two years out of three, which makes *them* feel good and open their wallets. MLB deliberately designed the system this way to squeeze more money out of its fans.

That may be true, but I'm not so sure the strategy is still in baseball's long-term interest. The sports economists I've read note that fans spend more money when their team is successful, and, from that, they conclude that it maximizes profit for the league to ensure the cities with the most fans win the most often.

I'm not convinced. That may work in the short run, when the fans still have memories of when payrolls were more even, and playoff berths were earned more by other means than money. But what happens longer term, when the Yankees make the playoffs for 28 of the next 30 years, and it becomes more and more obvious that the Pirates and Royals will seldom (if ever) be able to compete? And what happens when even Yankees fans start to get uncomfortable noticing that there's a lot less to be proud of when your management is just buying all the best players, and a playoff berth is just being purchased every year?

Maybe it's just me, that it's my personal taste that I'd rather all teams have an equal payroll, and that success on the field be "bought" with intelligence, strategy, and luck, rather than money. I've been a fan of the Toronto Maple Leafs all my life, but if the Leafs finally won the Stanley Cup again, but by spending three times as much as any other team ... well, I don't think I'd really care that much. And I'm sure there are many more like me. And so I wonder if a "we make more money when we rig the system so the Yankees win more often" strategy might backfire.

If you asked me a few months ago, I'd say for sure it would backfire, and fans would never put up with years and years of the Yankees buying pennants. But, after reading "Soccernomics," I'm not so sure. What I learned (pp. 48-49) was that, in the English Premier and Championship Leagues, there is a huge tendency to purchase wins. From 1998 to 2007, Manchester United had three times the average team payroll, and finished second, on average. That's second out of 58 teams, not second out of five teams in the AL East. Moreover, that's not second one year and then tenth the next -- it's an *average* of second, over ten years. They finished first five times, second twice, and third three times.

And they weren't even the highest-spending club ... that was Chelsea, who spent 3.5 times as much as the league mean, and had finished third on average.

The flip side of Man U is a club called "Brighton & Hove Albion," which spent 1/7 the average payroll (and finished 42nd, on average). So, in English soccer, you have the biggest team spending 23 times as much as the smallest team. Compare that to MLB, where the ratio was only 6 times for 2009, and is probably a lot smaller than that when you average out 10 seasons.

Moreover: in baseball, the Yankees stand alone in payroll: last year, they spent almost 50% more than the second-highest paid Mets. In English soccer, there were four teams at double the average (compared to one in MLB), and 13 teams at less than a quarter of the average (compared to none in MLB). And, again, these are ten-year trends in soccer, compared to a single year in baseball, which makes then even more shocking.

(One disclaimer: the soccer teams are, technically, divided into two leagues: the (first-tier) Premier League, and the (second-tier) Championship League. You'd expect that teams in the lower league would pay less. However, every season, as I understand it, the three best teams in the second tier swap places with the three worst teams in the first tier. So, theoretically, even the lowest paid second-tier team has a hope of being the overall champion two years from now. In that sense, it's really one league.)

But, despite the payroll and standings disparities, Man Utd still has a rabid fan base, and, as a result, the club is valued at $1.87 billion, even more than Forbes' appraisal of the Yankees at $1.5 billion.

So, what I'm thinking is: if British soccer fans can tolerate huge pay differences, and accept the fact that it's almost always going to be one of the richest teams that win ... well, maybe baseball fans can accept that too, especially since it's on a much smaller scale. Maybe the New York Yankees can become baseball's Manchester United, the Red Sox can become Chelsea, and fans of the Marlins and Padres can hope to fluke into the postseason and engineer an upset.

Major League Baseball might very well lose me as a fan if they do that, but if they can make it up in revenues from everyone else, who am I to say they're wrong?

Stacey Brook on salary caps and competitive balance

You'd think that when a sport introduces a salary cap, it would lead to greater competitive balance in the league. That would make sense; with a cap, you won't have teams like the Yankees, who spend two-and-a-half times as much on players as the average team, and about five times as much as the Marlins. If you forced the Yankees to spend only the league average, they would have to get rid of many of their expensive star players, and they'd win fewer games.

In theory, if every team had to spend the same amount, they'd all start the year with equal expectations. I say "in theory" because, in practice, different teams would have different philosophies, some of which might work better than others. Certain teams might spend more on scouting, wind up drafting better, and win more games with the same payroll (at least until the draftees reach free agency). But, generally, you'd expect more balance among teams.

It seems that Stacey Brook, co-author of "The Wages of Wins," doesn't think that's true. He thinks that the salary cap (and floor) the NHL instituted in 2005 has had no effect on competitive balance.

Here are Brook's "Noll-Scully" measures of competitive balance for the last few years of the NHL (lower numbers = more balance):

2000-01 1.858
2001-02 1.581
2002-03 1.592
2003-04 1.633
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salary cap begins
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2005-06 1.637
2006-07 1.600
2007-08 1.037
2008-09 1.369

It does seem, Brook acknowledges, that competitive balance has improved the last couple of years. But, he says, that's part of a trend that's been going on for a long time. For one thing, there was virtually no change in the Noll-Scully the first two years after the cap. For another, balance has been improving since at least the 1970s:

1970s 2.557
1980s 1.969
1990s 1.796
2000s 1.538

Since competitive balance has been increasing even through most of hockey history that had no salary cap, he argues, it's just a continuation of the trend, and the salary cap doesn't have anything to do with the recent decline. He writes,

"As we argue in The Wages of Wins, and detail in our paper - The Short Supply of Tall People - competitive balance is declining not because of changes in league institutional rules - such as payroll caps - but rather due to the increasing pool of talent to play sports, such as hockey."

But that doesn't make logical sense. Sure, there's already a decreasing trend, for whatever reason, but that doesn't mean a change to the rules can't contribute to the trend. Does having the ability to send text messages lead to people using their phone more? Of course it does! But if you apply the same argument, you get something like, "well, cell phones were becoming more and more popular even before text messaging, so text messaging can't have anything to do with it." That's not right.

And, indeed, it contradicts their own findings in "The Wages of Wins" itself. The authors found that there was an r-squared of .16 between salary and performance in MLB. Which means that if you were to flatten out salaries, so that each team paid an equal amount, it would reduce the variance of wins by 16%. So, absent any compensating factors, "The Wages of Wins" is argues a salary cap MUST reduce the Noll-Scully measure!

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By the way, take a look at the value of 1.037 for 2007-08. That's really, really low; the lowest you can expect Noll-Scully to be is 1.000, and that's when every team is of exactly equal talent. A value so close to 1 suggests a combination of (a) the league being really balanced that year, and (b) teams, by luck, playing closer to .500 than their talent suggested.

If you look at the standings, you see the usual suspects at the top of the conferences, so it doesn't really seem like all the teams were equal that year. Could it be that Brook used a formula for Noll-Scully that didn't consider the extra point for an overtime loss?

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But what about Brook's (and Berri's) argument that balance has increased because players' skills are becoming more equal? Well, sure, that's been part of it, no question. But effects often have more than one cause. You may be earning more money because you're working overtime, but that doesn't mean winning the office hockey pool will *also* make you richer. Whatever was causing the levelling of team talent before might still be there ... but, now, there's an additional effect, the salary cap effect.

Now, maybe I'm not interpreting Brook's argument correctly. Maybe he's thinking that the salary cap does contribute to balance, but so much less than the other effect (players getting more equally talented) that it's not worth considering. But I think it's the other way around. With a salary cap, it doesn't matter much how the players' talent is distributed.

Suppose players vary a lot in talent, 100 players equally spaced from 0 to 100, with an average of 50. A team that has lots of money might buy players with an average of 70, and a team owned by Harold Ballard might buy players with an average of 30. Big difference.

Now, suppose the talent pool gets bigger, and competition gets tougher, and now the players are all spaced between 40 and 60. Now, no matter how much you want to spend, you can't get above 60. And no matter how cheap you are, you can't get below 40. But the league average is still 50.

So, yes, Brook is correct, a narrower range of talent leads to more competitive balance.

But, now, suppose that every team has a salary cap and a floor: they all have to spend exactly the same amount of money. Now, it doesn't matter how the talent is distributed: assuming every team is equally good at evaluating players, they'll all sign a team with an average of 50. Even if the distribution of talent is like it was in the 1970s, with lots of spread, it doesn't matter -- because even if there are lots of players in the 90s and 100s, no team can afford to sign more than one or two. The more talented the player, the more likely a team who signs him will have to sign *less* talented players to stay within the cap.

Even if you have the Babe Ruth of hockey, a player who's (say) a 500 when the other players top out at 100, it won't matter, because the teams will bid up the price of his services until they pay him what he's worth. The team who gets him will have less money to spend on other players, and it all evens out in the end.

What's happening is this: in the past decades, competitive balance decreased steadily for many reasons, including the increase of the talent pool that Brook cites. But, now, with a salary cap and floor, most of that stuff doesn't matter much any more!

It matters a bit, because not everyone is a free agent. The distribution of talent does matter for draft choices, because the top draft choice doesn't cost that much more than the others (but can be a whole lot better, as in Sidney Crosby).

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Of course, NHL hockey teams are more than collections of free agents priced at market value, so we shouldn't expect competitive balance to be perfectly level. There are some factors that might cause the Noll-Scully to actually rise a bit from the theoretical bottom created by the salary cap.

For instance: the first draft choice goes to a team near the bottom of the standings. Back in the days of less competitive balance, that went to a team that was probably legitimately awful. Now, with teams closer in talent, it could go to a team that was just unlucky. If the team that gets the next Sidney Crosby is an average team, rather than a bad team, that won't reduce competitive balance the way it used to.

Also, scouting: an investment in scouting now pays off more than it used to. Before, if you were a low-spending team, maybe a better draft choice might move you from .400 to .450. Now, if all teams are medium-spending, maybe it'll move you from .500 to .550, and give you a legitimate shot at the Stanley Cup. So more teams should be willing to spend the money to improve their drafting. And so, the rich teams could "buy" better players, not by spending to pay them, but by spending to identify them better.

And there are probably other ways to get around the cap: didn't companies introduce employee health plans to get around wage controls in World War II? If a superstar free agent has knee problems, and I wanted to sign that player, I'd offer to hire the best knee doctor in the business and keep him on staff. Whatever he costs, it's not going to count against my cap. That may not actually be practical, but I'm sure rich teams will figure out ways to buy better teams, one way or another.

My point is not to say that these factors will push inequality back to where it was when teams could sign all the free agents they were willing to pay for, just that there may be other theoretical reasons that Noll-Scully may bounce back up a little bit. I think all those factors will be minor, and as long as the salary cap and floor stay within roughly the same range of each other, we'll continue to see a balanced league, regardless of how the talent pool changes.



Hat tip: The Wages of Wins

Tom Benjamin on NHL salary cap "loopholes"

I recently wrote about a loophole in the NHL's collective bargaining agreement that may allow teams to skirt the salary cap by front-loading contracts.

Tom Benjamin points out that the CBA actually limits the amount of trickery teams can do. For instance, no contract can specify a salary more than 50% less than the previous season. Also, poorer teams who back-load contracts also get an advantage; towards the end of the contract, when the player makes much more than his cap amount, he can be profitably traded to a rich team that's short of cap space.

Very good stuff; read Tom's entire post.

Update: James Mirtle comments on the 50% restriction here.

Massive loophole in the NHL salary cap?

The NHL's labor agreement has a loophole that allows teams to skirt the salary cap almost at will. That is, if I correctly understand Michael Farber's article in the July 16 Sports Illustrated (which I couldn't find online – maybe it's not up yet?).

According to Farber, when a player is given a multi-year contract that doesn't pay the same amount each year, the team's salary cap is debited the average annual amount. For instance, Daniel Brière signed with the Flyers for $52 million over eight years. That's an average of $6.5MM, which will be charged each season against the Flyers' cap. But for the eight years, Brière is actually being paid $10, $8, $8, $7, $7, $7, $3, and $2 million, respectively.

While this contract does add up to $52 million, its present value is obviously much higher than if it were eight equal payments. At an discount rate of 10%, the present value of Brière's contract is about $39.1 million. If the payments were equal, the PV would be only about $36.4 million. So the Flyers are effectively handing Brière a bonus of $2.7 million, right now, without it affecting the salary cap.

Obviously, the Flyers could game the system even worse, by paying Brière $51,999,993 this season, but only $1 for each of the last seven seasons. It still adds up to $52 million, and $6.5 million on the cap each year. But now the present value is $49.6 million, for a salary-cap-free bonus of $13.2 million.

That might be a bit obvious, though, and Gary Bettman would probably take notice.

Now, suppose the Flyers are so rolling in money that they're willing to pay Brière something completely unreasonable, like $50 million a year for 20 years. Technically, they can sign him to a billion year contract, at $1 per year, and front load all the money into the first twenty years. The cap gets charged $1 per year, for a billion years – and the Flyers barely notice. Brière gets rich, and the cap (in spirit, if not in letter) is blown away.

Of course, even if Gary Bettman could ignore the front loading, he couldn't let a billion year contract slip by. So here's another trick. According to Farber,

"Under the collective bargaining agreement, if a player signs a multi-year deal before the age of 35, and retires before it finishes, there is no salary-cap charge for the unplayed seasons."

So, suppose you want to sign a 34-year-old free agent to a six-year, $120 million contract, and the player plans to retire at 40. You'd normally take a $20 million hit to the salary cap each of the six years. But what if you sign him to a twelve-year, $120 million contract, instead, but front-load the contract onto the first six years? Now, his salary cap charge is only $10 million a year. And, when he retires at 40, the last six years of cap charge disappear completely. So you've doubled his salary over the cap charge, and gotten away with it!

If I understand this right, front-loading has the potential to undermine the intent of the salary cap, and allow the rich teams to continue to outspend the poor teams. Maybe in negotiating the agreement that ended the lockout, the NHLPA was a lot smarter than everybody thought?