Eco 383: PPT lecture slides,
October 2006
• Topics:
– Franchise finances
– Competitive balance and market size
– Player salaries, MRPL, and exploitation
Franchise finances: An introduction
• Why we care:
– (1) To draw a conclusion about the health of the
industry (MLB), we need to know about the
health of individual firms (teams).
– (2) Issue of whether the small-market teams can
afford to field competitive teams.
• If too many teams cannot compete, then demand for
MLB will tend to fall.
MLB’s 2000 report concluded that...
• (1) 27 of the 30 MLB teams had cumulative
operating losses in 1995-99.
• (2) Small- and mid-market teams can’t
compete, because they can’t afford to field
very good teams.
Computing team profits
• OPERATING PROFIT
• = total revenues total costs
• same as “operating
income”
• what we focus on
• reported in Forbes
(1997-), Financial
World (1990-96)
• PRE-TAX PROFIT
• = operating profit interest costs* “player depreciation”
• < operating profit
• declared to IRS
• (* interest costs could
be from purchase of
team, stadium debt…)
Ways to hide a team’s profits
• Claim “depreciation” of your players as a loss (over 5
years, up to 50% of what you paid for the team; legal
under U.S. tax law).
• Deduct the interest paid on team-related loans.
• Related-party transactions: If you own another
company that does business with the team, overcharge
your team (or pay it too little) in those deals.
• Featherbedding: Pay yourself (and friends and
relatives) an excessive salary and claim it as a cost.
Breakdown of team revenues
(Forbes, 1998)
• 40% tickets & suites
• 34% broadcasting
• 12% food,
merchandise
• 7% ads, sponsorship
• 6% other
Other
Ads…
Food…
B'cast…
Tickets…
45
40
35
30
25
20
15
10
5
0
Breakdown of team costs
In rough descending order of importance
• Player salaries (~55% in 1992-2001)
• Scouting & player development (farm teams…)
• “General and administrative” / Team operations
– (front office, manager, coaches…)
•
•
•
•
Marketing, publicity, ticket operations
Stadium operations
Contributions to MLB central fund
(MLB revenue-sharing; sums to $0)
Estimated profitability of MLB teams
(source: Forbes)
Year
% increase in asset value
Operating profit (and return on assets)
1999 $1.0 million
6%
(0.5% of assets) (6.5%)
2000 $4.3 million
12%
(1.8% of assets) (13.8%)
2001 $2.5 million
10%
(1.0% of assets) (11.0%)
2002 -$1.3 million
3%
(-0.5% of assets) (2.5%)
Estimated profitability, cont’d
Year
% increase in asset value
Operating profit (and return on assets)
2003 -$1.9 million
3%
(-0.7% of assets) (2.3%)
2004 $4.4 million
15%
(1.5% of assets) (16.5%)
2005 $12.1 million
15%
(3.7% of assets) (18.7%)
(Note: best measure may be long-term
increase in asset value.)
Calculating a team’s (one-year)
return on assets (ROA)
ROA =
% increase in estimated team value
+ (operating profit as % of previous year’s team
value)
Note well: Because operating profit is usually a very small
fraction of team value, ROA will usually be very close to
the one-year percent change in team value.
To calculate ROA from the Forbes table
ROA =
(Operating income)
(1 year change in value) + -------------------| (Current value) |
| ---------------- |
| 1+(1 year change)|
(Tip: Compute in decimal form, then convert to %.)
Ex.: NY Yankees: Value: Current value (May 2006) = $1026 M
Value: 1 year change = 8% (or .08)
Operating income = -$50.0 M
– --> ROA = .08 + (-50.0)/[(1026/1.08)]
–
= .08 + (-50)/(950)
–
= .08 + (-.053)
–
= .027, or 2.7%
Is the sky falling on MLB financially?
• YES, say owners and
commissioner (most notably in
2000-02)
• Selig: for 2001, a $232 M
operating loss & a $519 M book
loss
• 2000 report said 5 of 13
franchise sales in 1992-2000
were at a loss
– Selig: “We’ve run out of
‘greater fools’ ”
– weak resale market in 2001-02
• Lately, Selig and owners are
less negative, thanks in part to
current CBA
• NO, say most independent
researchers
• Forbes: for 2001, a $75 M
operating profit
• Franchises normally sell at big
profits; high rates of asset
appreciation
– Weak resale market in 2001-02
was temporary and due to sluggish
economy.
What a difference a year makes:
Baseball finances in 2003, 2004, & 2005
2003
2004
2005
average operating profit
(as % of assets)
number of teams with
positive operating profit
-0.7% +1.5% +3.7%
15
20
25
number of teams whose
estimated value rose
17
28
30
Media ownership of teams
• Ownership of teams by media companies, esp. TV
stations, complicates the profit picture.
– Media companies often buy teams as programming
content, not as separate investments; synergy strategy.
– Large operating losses may be OK if media company’s
own profits go up.
• Two media companies recently sold their teams.
– (Fox) News Corp. sold Dodgers, Disney sold Angels
– Time Warner looking to sell Braves?
– MLB teams as unprofitable corporate divisions?
Criteria for investments,
and how MLB teams stack up
• Rate of return (appreciation of asset value)
–
–
–
–
12.4% in 1960-2002 (John Moag)
8% in 1950-2000 (Rodney Fort)
9% from time of purchase to 2004; average of 23 teams (Forbes)
stocks (benchmark): 6.9% in 1960-2002
• Safety (lack of risk)
– Forbes, April 2004: 16 of 23 teams had long-term gains of 9% or more; 4
had gains of 5-7%; 2 had gains of 2-3%; one had loss of 2%
– Operating losses are usually small but not uncommon.
– stocks: returns are highly variable and often negative; but, can diversify.
• Liquidity (convertibility into cash; resellability)
– poor; selling a team takes many months if not years
– stocks: very liquid, easy to resell
• Cash flow
– Minimal in relation to size of investment (ditto for stock dividends).
– But, can be negative (whereas stockholders have limited liability).
What is competitive balance?
• Blue Ribbon Panel report (2000):
competitive balance exists when
– “there are no chronically weak clubs because of
MLB’s financial structural features”
– a well-managed club has a reasonable hope of
reaching postseason play and winning
• (implies that finances and market size should have
minimal effect)
Why is competitive balance an
economic issue?
• The demand for MLB will tend to fall if-– too many teams cannot compete
– fans perceive that the richest teams have an
unfair advantage
Simple measures of competitive
balance
• Standard deviation of team winning percentages
• Number of WS or pennant winners, in comparison
with-– number of teams in league
– previous years or intervals
• Average number of games out of first place?
MLB’s competitive balance, then & now
•
•
•
•
1903-1950s: not much, but gradually improving
1965-1976: improved more; amateur draft helped
1977-early 1990s: peak of competitive balance
1995-2001: competitive imbalance?
– Regular season: strong correlation between payroll and
W-L %
– Postseason:
• all WS winners were from top 25% of payrolls
• only 4 teams from bottom 50% made postseason, won 5 games
• 2002-2006 WS winners and payroll rank:
– Angels (15th-highest), Marlins (26th)
– Red Sox (2nd)
– White Sox (13th), Cardinals (11th) or Tigers (14th)
What is “market size”?
• Market size is based on REVENUES (both
actual and potential).
• Revenues are very dependent on the quality
of the team’s product (wins, players,
stadium, etc.), but also on local factors like
– area population
– area per-capita income
– area level of interest in baseball (hard to
measure)
• Hard to separate team factors from local
factors, actual from potential market size
Two crude measures of market size
• TOTAL REVENUES, as compared with the other
MLB teams
• ESTIMATED TEAM VALUE, as compared with
the other MLB teams
– more forward-looking, e.g., higher if team is about to
move into new stadium
• Which teams are “large market” (~top 4?), “midmarket,” “small market” (~bottom 5?)?
• Market size perhaps cannot be measured precisely
Can the small-market teams compete?
MAYBE
• First 15 years of free
agency (1977-91) saw
unprecedented parity,
several successful smallmarket teams
• Insignificant correlation
between payroll and W-L %
through mid-1990s
• Recent success of some
small-market teams
• Market size is not static
MAYBE NOT
• Yankees: 4 WS titles in 5
years (1996-2000)
• 1997-2006: statistically
significant correlation
between payroll, W-L %
• 1992-2006: Only one
small-market, low-payroll
team has won WS
• Collapse of Montreal
Expos (well-run smallmarket team)
Competitive balance in recent decades
• Recall:
– 1977-early 1990s: peak of competitive balance
– 1995-2001: some pattern of competitive imbalance
• Explanations:
– Free agency (post-1976) helped comp. balance
• Easier for also-rans to improve themselves with new talent
• Rising salaries --> harder to keep championship teams intact
– Growing revenue and wealth imbalance in 1990s
• Growing importance of local media and stadium revenues
– Value of MLB’s national TV deal fell 60% in 1994
• Increasing corporate (esp. media) ownership of teams
Competitive balance in other pro sports
• (NFL) National Football League: highest comp. balance
– low concentration of championships (but MLB’s is lower now)
– policies: ~70% of revenues are shared; hard salary cap;
“unbalanced” schedule
– lowest correlation between payroll and performance
• (NHL) National Hockey League: ??????
– Pre-2004: in the middle:
• low concentration of championships (1991-2002: 8 different teams)
• little revenue sharing, no luxury tax, no salary cap
• lower payroll-performance correlation than MLB or NBA
– 2004-05: season-long lockout by owners, who got a salary cap
• (NBA) National Basketball Association: least balanced
– high concentration of championships (1991-2002: just 4 teams)
– increasing standard deviation of win percentages since 1980
The English Premier League (PL; soccer)
• League membership not fixed (non-monopolistic)
– no territorial rights
• London: 9 PL teams since 1990
• Within the league, a hierarchy of divisions
– bad high-division teams are relegated (demoted)
– good low-division teams are promoted to higher ones
• Comp. balance is mixed
– good in terms of standard deviation of win percentages,
upward mobility of teams
– high championship concentration (Manchester United)
How can be MLB’s competitive balance
be increased?
• Payroll cap / luxury tax?
– Payroll cap might work, but is not feasible
• Players’ union willing to strike to prevent one.
• Owners have not asked for one since 1995.
– MLB has a luxury tax on large payrolls, but threshold is
too high to be binding for most teams
• Increased revenue sharing?
– Could work, but details are key:
• What if teams use accounting tricks to hide revenues?
• Incentive for low-revenue teams to improve themselves?
– Part of current (2002-2006) Collective Bargaining
Agreement.
Player performance and salaries
News flash:
MLB players are highly paid
• Average MLB salary = $2.87 M (April 2006)
– Up 8.9% from previous year
– About 10 times as high as in 1983
– Less than NBA ($4.5 M in 2003)
– More than NHL ($1.6 M), NFL ($1.3 M) (in 2003)
• Median MLB salary = $1,000,000
– Fluctuates a lot more than the average
• Was $975,000 in 2000, fell to $800,000 in 2003
– 409 players making $1 M+, fewer than in 2000-2002
marginal revenue product of labor
(MRPL)
• = the amount of revenue that an employee
generates for his employer
• standard economic answer to “How much is
that employee worth?”
• can be measured in yearly terms (salary), or in
hourly terms (hourly wage)
• marginal product of labor (MPL) = how much
OUTPUT an employee produces
MRP theory & player pay
• First, note that athletes are not the only very
highly-paid people in U.S. society
• VOLUNTARY EXCHANGE = market
transactions, including free-agent contracts,
are agreed-upon by buyer and seller
• Fort: “talent is hired to produce [wins] in the
long run.”
– perhaps more than just wins...
– Mark McGwire, 1998: extra MRPL of $15M?
A labor market under perfect competition:
Assumptions
• Many buyers, many sellers -- nobody has
market power
• No restrictions on pay or employment
• No cartels among employers, no unions
• Diminishing returns --> downward-sloping
demand curve for labor
• Upward-sloping supply curve for labor
Notation (goes with blackboard notes):
•
•
•
•
•
L = # of workers ( = QL = quantity of labor)
w = wage ( = PL = price of labor)
SL = supply of labor
DL = demand for labor
MRPL = marginal revenue product of labor
– MRPL = the amount of revenue that an
additional worker generates for the firm
Economic exploitation
• MONOPSONY: a labor market with just one buyer
• ECONOMIC EXPLOITATION
• = difference between a worker’s marginal
revenue product and his wage
• = MRPL - w
• In a monopsonistic labor market:
• w < MRPL
• w < w* (competitive wage)
When the baseball players’
labor market was a monopsony
• Until 1976, when all players were under the
reserve clause.
• RESERVE CLAUSE: a provision in baseball’s
rules that allowed owners to renew a player’s
contract automatically for one year.
– Players either re-signed with their teams after each
season or retired (or were traded or released).
– No free agency; no competitive bidding for players.
– Held salaries down; average salary = $25,000 in 1969.
Independence Day
• July 1976: new Basic Agreement gives all players
free agency after 6 years of service.
– Salaries surged after 1976; up 42% in 1976-77
– Can use monopsony diagram to illustrate
Baseball’s current system
Year of
ML service Eligible for…
1st - 2nd
Rookie minimum ($327,000 in 2006)
3rd - 6th
Salary arbitration
After 6th
Free agency
The amateur draft
• MLB’s annual selection of the top amateur talent in
the U.S.
–
–
–
–
Conducted each June. Worst teams draft first.
A player can deal only with the team that drafts him
Monopsonistic market.
In effect since 1965.
• Before 1965, teams just signed amateur players as
free agents.
– Competitive market
– Signing bonuses were often quite high.
– Once the draft began in 1965, signing bonuses dropped
dramatically.
Baseball’s salary explosion,
1976-present
• “Freedom and prosperity”
• Shift from monopsony to competitive bidding was
less sudden than it seems
– Over time, more and more teams played the FA market
– Collusion against FA’s held salaries down in mid-1980s
• Salary arbitration (1973-) allowed 3rd-to-6th-year
players to piggyback on FA salary scale
• MLB revenues surged -- attendance rose, TV
revenues soared, stadium revenues soared, ...
Comparison of performance
(MRPL) and salaries:
• “Exploitation index” (EXPL) =
MRPL/salary
– Alternatively, “pay-for-performance index,”
salary/MRPL
• Zimbalist estimated this with 1986-89 data
– How to measure MRPL?
For hitters, the one common statistic
with the highest correlation with
team winning percentages is...
“OPS”
(On-base Plus Slugging pcts.)
• = On-base percentage (OBP) + Slugging
percentage (SLG)
• = what Zimbalist uses a measure of hitters’
productivity, in computing MRPL’s
– --> next steps:
• estimate the player’s contribution to team winning
percentage, based on wins as a function of OPS
• estimate contribution of additional wins to team
revenues
Comparison of performance
(MRPL) and salaries:
• Younger players tend to be “exploited”
(pay<MRPL)
• Players with 6+ years of experience tend to
be “overpaid” (pay>MRPL)
Salary/MRPL, by service category
(1986-89)
Salary/MRPL,
Year of service Category
on average
1st - 2nd
“apprentice” 16 – 25%
(highly
exploited)
3rd - 6th
“journeyman” 50 – 64%
(exploited)
th
After 6
“master”
140%
(overpaid)
Salary/MRPL: 2003 update
(Source: Bill Felber of Total Baseball)
Years of
service
Salary/
MRPL
1-2
27%
3-6
49%
7+
156%
How do we explain those systematically
“overpaid” veterans?
• Supply and demand: Even though most free
agents are past their prime, teams still have holes
to fill and supply of free agents is limited 
mediocre free agents can command top dollar
• Also of note:
– Stats-based MRPL measure may be too narrow -doesn’t count leadership, reputation, marquee value
– Free-agent contracts are often long term  reduced
incentive to work hard?