THE BOOK--Playing The Percentages In Baseball

To followup this thread:
http://www.insidethebook.com/ee/index.php/site/comments/competing_on_payroll/

You can calculate wins paid for as:

(P+1)/(P+3)

where P = payroll, indexed to league average

So, a team payroll of 150 million, where the league average is 75 million has a Payroll Index of 2, giving us an expecting winning percentage of:
(2+1)/(2+3)=.600

If their payroll is one-third the league average, then:
(0.333+1)/(0.333+3)=.400

In the first case, the extra 75 million$ bought then .100x162 wins, or 4.6 million$ per win.  In the second case, saving 50 million$ cost then the same number of wins, or 3.1 million$ per win.

***

Note, this new equation is of the same form as the other one in the link, but it’s been best-fitted to the data in this new thread.

How much impact does your wage slaves (Pujols) factor into this? He distorts your salaries to wins because he is so underpaid his 1st few years. And other than scouting better, teams can’t do anything about it.

What if you factor in how much Pujols guys should have made, and then factor wages per win? Does that make the correlation a lot higher? Isn’t the reason the correlation isn’t higher due to players who are not in the free market?

If 2 players are worth 5 wins, and one costs $10 million, and the other is a slave at $500,000 - I think you should put in a wage support of $9.5 million for the non eligible fa.

We just have to get every player’s total salary, and their “earned” salary, and get a correlation from that.  From that, you can derive what a team correlation would give you.

"So, the relationship between payroll and wins is a little tricky and it depends on exactly what the question is.”

I think that’s exactly right.  One important question is the relationship between payroll and winning championships.  I took Tango’s data, ranked franchises by payroll index, and put them in quintiles.  Here are payroll index, W%, and average # of championships 1992-2005
Pay W% Champs
1.38 .538 6.2
1.12 .510 3.7
1.00 .504 2.7
0.84 .482 2.5
0.64 .459 1.0

I think it’s very hard to look at this data and conclude, as the Wages of Wins authors do, that “you can’t buy wins in baseball.”

To me, this suggests there are 3 tiers.  Very high payroll teams have a huge edge, winning twice the average number of championships.  The bottom feeders are at a huge disadvantage.  The ratio of top to bottom quintiles is 6:1.  But in between is the large middle group, where the link between payroll and championships (or wins) exists but is not overwhelming.

This makes sense to me.  Given the large luck element, the only way to consistently reach the postseason is to amass a very large true talent edge, and it generally takes money to do that.  At the other extreme, a very low payroll team has so little talent that even in their lucky years they can’t reach 88-90 wins.  But most teams are in the middle, where a combination of luck and skill can occasionally deliver a championship.

Let me amend that slightly.  Even in the middle tier of teams, more $$ equals a meaningful edge.  If we regress championships on payroll index, we find that a team at 80% of average payroll would expect to win 1.5 championships (over 13 years), while a 120% team should win 4.5 on average—a three-to-one ratio.

Put another way, the 80% payroll franchise will win a flag about once every 9 years, while the 120% team wins once every three years.  To fans, I think that’s an extremely meaningful difference.

Guy, you have 16 “champs”, in 14 seasons (13 sans 1994).  Can you define championship, and who won it in 1994?

Sorry, should have been more clear. I took all division champs or wild cards, with no champions in 1994.  So that gave me 96 champions over 13 seasons:
1992-1993: 4 per season
1994: 0
1995-2005:  8 per season

The numbers in the table above are the average number of championships per team in each quintile.  For example, the top 6 payroll teams won 6.2 times, or about once every 2 seasons.

Tango: You mention over at Sabernomics that your data, like JCB’s, indicate that a 10% increase in payroll = 1 win.  But your coefficient of .113 means that each 10% is worth about 1.8 wins, almost twice as much.  Right?  So the difference between an 80 payroll team and a 120 team is about 7 wins.

For the single-year regression, what I said at JC’s siteis correct.  But, for the 1992-2005 regression, it’s what I said here.  That’s what happens when you use single year and 14-year data in your sample.  Chances are, you take anything that has an r=.15 to .20 and then give it 14x the size for each sample, and it’s almost a certainty that the r=.65 to .80.

For example, if we use the regression equation for OBP, which is x/(x+PA), where x=200: PA of 50 means that the regression toward the mean is 80% (i.e., r=.20), and that PA of 50x14=700 means that regression toward the mean is 22% (i.e., r=.78).

***

As for your champs, I think you’d be better off:
1 - selecting an equal number of teams each season

2 - not listening to Bbudd Sselligg about 1994 (which played as many games as 1981, and we have no problem giving out division records there)

When low payroll teams need all the division winners they need, and the best team in the league was a low payroll team, and the authors are arguing that payroll matters little, it’s unfair to the authors specifically, and in general, to skew the results so that the Expos don’t get credit for 1994.

Sorry, Tango, forgot you were an Expos fan. (I was just being lazy, not trying to be unfair.) If I add in 1994 and hypothetical wildcards for 1992-1993 (I only gave 1 WC slot to the 12-team 1992 NL), I get the following results.  For each payroll quintile, this is the number of championships won per 10 years per team. 
Top 4.9
2nd 3.0
3rd 2.4
4th 1.8
5th 1.2

So yes, the curve flattens a little.  But I’d say the fundamental story remains the same. 

Moreover, this may be telling us that payroll mattered somewhat less in the early 1990s (it’s really 1992 and 1993 that helps the poor teams’ record; 7 of the 8 1994 ‘champs’ are large or mid-size markets, plus Mtl).  I don’t remember exactly when the concern about large payroll disparities first emerged, but my sense is that it was in the late 1990s, as the Braves’ and Yankees’ dominance became clear.  So I’m not sure that showing things were better in the early 90s (or 1980s for JCB’s data)—if true—would answer the current concern.  In fact, it would demonstrate that payroll had become more important. 

* *

Our best estimate is that 10% of payroll is worth 1.8 wins (perhaps a little more today).  I don’t see how the fact it’s hard to see that in annual data changes that.  So that means a 125% payroll team will win 9 more games than a 75% team (roughly +/- 1 SD) on average.  That seems like a lot to me.  An 86-win true talent team has a good shot of winning enough games to make the post-season.  A 77-win true talent has only a tiny chance—they have to get very lucky and play in a weak division.

Right, it doesn’t.  All the annual data shows is that there’s alot of noise, and therefore, it’s hard to find a strong signal.  It certainly doesn’t mean the true relationship is not strong.  It simply means the relationship found in the single-year data is not strong.

And, more importantly, by looking at multi-year data, you reduce some of the free agent / slave inefficiencies of the market, so that the payroll reflects (more closely) the true talent level.

In any case, it’s a long-way between saying “salaries don’t affect wins” from “true talent doesn’t affect wins”.  In the latter case, we know that’s what affects wins (talent level, plus timing).  And, salaries follows talent level, though not in real-time (there’s a lag), until it finally catches up (and overcompensates, in FA years).

All-in-all, much ado about nothing.  But, then again, what in baseball is not?

Reading the first line:

Greg Maddux salary as a percentage of the average league payroll, has averaged 17.6% per year, for 14 seasons, for a total of 121 million$ of salary.

percent numSeasons player total
17.6% 14 Maddux Greg $121,650,000
16.7% 14 Brown Kevin $130,245,002
16.7% 14 Johnson Randy $127,117,500
16.0% 14 Clemens Roger $110,921,000
15.6% 10 Cone David $62,750,001
14.4% 14 Glavine Tom $101,918,153
13.5% 14 Smoltz John $96,444,446
13.5% 13 Martinez Pedro $105,569,000
12.9% 14 Mussina Mike $103,292,167
12.7% 11 Finley Chuck $61,850,563
12.4% 7 Rijo Jose $30,129,166
12.0% 7 Smiley John $29,300,000
11.1% 4 Viola Frank $14,190,000
11.0% 7 Drabek Doug $26,038,162
10.9% 7 Key Jimmy $26,879,525
10.8% 3 Welch Bob $10,350,000

This list is the top 15 pitchers, from 1992-2005, in percentage of league average.

Pedro and Mussina are the only players in the group where almost their entire careers are covered.  The other guys don’t have their early season low averages to bring down their 1992-2005 average.  Except for Curt Schilling (10%, and late bloomer), the other 9 of the 10 best starters in the league from 1992-2005 are in the top 9 in the list. 

There’s no question that money follows talent.  The real question: does TOO MUCH money follow talent? 

The top 10 averaged 15%, and if we assume a 70 million$ average payroll, that’s an annual salary (pre and post free agency) of 10.5 million$ per year.  The average W/L record earned by the top 9 was .644, or +.144 wins per game, with an average of 201 IP per season (making it +3.2 wins above average).  A team’s starters should get about 30% of payroll and about 1000 IP.  So, an average pitcher who gets 20% of innings should get 20% of the starter allocation of payroll, or 6% of payroll, or 4.2 million$ for an average 200-IP starter.

These guys earned +6.3 million$ for +3.2 wins for an average marginal $ / marginal win of ..... 2 million$ per win.

That’s what we believed it should be, and that’s what they get.  It seems that incredibly inefficient market (slave wages followed by free agent wages) seems to balance out, that MLB teams’ supply/demand is tipped so that it all works out in the end.

Over a long period of time then, money follows talent.  And, there’s no question that over a long period of time, wins follows talent.

Any kind of conclusion that shows a dissociation of wins and talent simply is focusing on some specific question that itself, while relevant, should not be asked without other equally relevant questions.

Here’s the top 30 among non-pitchers.  They averaged 14.4% of league average payroll (total of 10 million$ in salary per player).  60% of league payroll is set aside for nonpitchers, or 42 million$, or about 4.3 million$ per average 140 GP position player. Assuming these guys were also around +3 wins above average, that also works out to 2 million$ / win.

20.7% 14 Bonds Barry $149,489,882
17.0% 14 Griffey Ken $119,211,654
16.5% 14 Sheffield Gary $118,405,002
16.2% 10 McGwire Mark $69,445,354
16.2% 12 Belle Albert $97,061,294
16.1% 6 Puckett Kirby $33,266,667
15.9% 12 Rodriguez Alex $126,027,000
15.8% 7 Carter Joe $38,468,047
15.7% 14 Sosa Sammy $123,250,000
15.6% 8 Fielder Cecil $43,682,500
14.8% 10 Jeter Derek $97,430,000
14.7% 14 Walker Larry $110,178,431
14.5% 13 Piazza Mike $110,426,002
14.5% 10 Ripken Cal $58,500,000
14.4% 14 Bagwell Jeff $108,765,000
13.9% 13 Vaughn Mo $100,305,001
13.8% 12 Williams Matt $77,975,000
13.8% 6 Tartabull Danny $27,500,000
13.5% 9 Clark Will $46,596,863
13.2% 14 Palmeiro Rafael $87,156,496
13.0% 10 Bonilla Bobby $47,500,000
12.9% 7 Dykstra Lenny $32,433,334
12.8% 13 Ramirez Manny $108,032,727
12.8% 13 Larkin Barry $75,050,000
12.7% 11 Delgado Carlos $90,299,000
12.6% 13 Alomar Roberto $74,763,815
12.5% 14 Williams Bernie $101,500,001
12.5% 14 Gonzalez Juan $86,937,500
12.4% 14 Thomas Frank $85,894,000
12.2% 4 Mattingly Don $15,880,000

I posted this on sabernomics:

Since MLB has the opportunity (and they invoke it) to pay much less for pre-arb players than they produce, and since they have the opportunity to play somewhat less for arb players than they produce (and they invoke that), and if MLB was run by economic principles on free agents (to pay what they produce), this must mean then that, overall, MLB gets a great bang for their buck.

Imagine something like half your players are arb or slave players that you get to pay below what they produce!

But, that’s not what happens. Every win adds about 2% to attendance. Extend that to all revenues, and a team that generates 130 million$ in revenue will see an increase of 2.6 million$ per revenue. But, don’t forget about revenue sharing, and it’s something like under 2 million$ per marginal win.

So, free agents should get 2 mill per win, arb players should get between 1 and 1.8 depending on years of service, and pre-arb will get between 0 and 0.5 if they’re lucky.

The overall average should be somewhere around 1 million$ per win.

The reality is at least double that.

Why? Because teams start with a budget, allocate slave and arb money, and then spend the rest on free agents.

I know JC wants to believe that these guys are smart. But, not all smart people always do smart things. When it comes to baseball, through wisdom out the window.

Assuming owners are paying FAs more than their marginal revenue produced (which I think is true), I don’t think that has to mean owners are making a “mistake” (JC) or showing a lack of wisdom (Tango).  Suppose owners decide they won’t pay FAs more than their MRP.  Given the super-profits they make on arb and pre-arb players, that means the payroll/revenue ratio will fall and profits will rise.  But what happens next?  The players go on strike, and refuse to play until teams start paying FAs more or lift restrictions on free agency for younger players. 

Now suppose one owner decides not to pay more that MRP to FAs, which means he can basically only hire near replacement-level FA players.
In that case, his profits rise and players’ share of the revenue falls.  What will happen to that owner?  He will be pilloried in the press for failing to use his revenues to improve the team, especially in the context of revenue sharing.  He will face enormous pressure either to buy more good players, cut ticket prices, or sell the team.  He would be an embarrassment for Selig and the other owners.  I can’t imagine the position could be sustained for long.

What JC is failing to account for is a strong union.  This is not just a series of independent negotiations between individual players and their employer, which would theoretically yield salary=MRP.  The union means the players, collectively, are more like co-owners than employees.  If they don’t get their fair share, they have enough power to grab it.

Guy, well said!

We can even think of it at an extreme level, where there is 100% revenue sharing, including local, cable, playoffs.  In that case, it wouldn’t make sense, economically, to pay anyone more than anyone else.  So, the players would then get a tiny slice of pie.

However, as the great Ted Lindsay (from my memory):

I love hockey.  I’d play for nothing.  But if someone is selling my ass to watch me play, I want my half.

So, in this extreme situation, where you have 100% revenue sharing, then each player would earn exactly 3 million$.  That gives the players their share, of which they divide it equally.

Of course, market forces would make it so that a new league would be created, and all the top stars, who know that 100% revenue sharing is cutting in on their value, will leave MLB for the startup.

So, I think Guy has a great point, that MLB must offer the players, as a group a certain percentage.  (Just as the NHLPA has accepted the 54% or 55% from the NHL.) It would make more economic sense for MLB to construct a model where the revenue sharing is such that the free agents would be paid what they bring, in dollars.  But, the nature as it is, prevents it so.

If a sports economist wants to think about something, show us the ideal model where:
a - players get around 55% of all revenues
b - free agents get paid relative to what they produce

So, how much revenue sharing, and when does free agency start?

BTW, I think the factor that David Gassko emphasizes—that some owners want to win more than maximize profits—is also valid and important.  Combine that, the union’s strength, the likely attendance consequences once fans realized ownership wasn’t really trying to win, and the political need to protect the anti-trust exemption (and thus the importance of public opinion), and it’s clear that pocketing the extra profits from arb and pre-arb players just isn’t a viable option for the owners. 

* * *

Studes has two great articles up at THT related to these issues.  The Free Agent Cycle piece is particularly good.

http://www.hardballtimes.com/main/article/the-free-agent-cycle/

http://www.hardballtimes.com/main/article/how-much-is-that-replacement-player/

I posted this on Sabernomics, where it awaits moderation:

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I think the Picasso theory is the correct explanation. As I wrote here, it seems like every team owner makes a below-market return on the market value of his team. I think that just reflects the market price of the ego boost and prestige of ownership.

Some owners don’t just want to be owners – they want to be *winning* owners. The supply of winning teams is limited, by definition, and so the price gets bid up.

I think you have to think of a franchise not 100% as a firm, but partly as a firm and partly as a consumer good (consumed by the owner). $2 million might be the marginal value of a win *to the fans*. But if the marginal value *to the owner* is (say) $3 million, he’ll wind up willing to pay $5 million per win.

It seems to me that the value of the player to a team is his MRP plus the consumer surplus reaped by the owner. This would explain high salaries without having to assume that owners are irrational.

I just want to say, great points.  I think Guy has nailed it.  I’ve always felt that anyone who says owners are acting irrationally (as a group, anyway) are missing the larger point, and Guy has expressed the phenomenon well.

Guy writes that owners *have* to pay free agents more than their MRPs, because, otherwise, because of slaves and arbs, the players’ share of revenue will be so low that the players will strike.

But what is the *mechanism* by which this happens?  It would have to be collusion, wouldn’t it?  Because no team has a specific incentive to be the first to overpay and lose money. 

More likely is that cause and effect are reversed—the union agreed to the current deal *because* the owners tend to overspend on free agents. 

I agree with Guy that if the owners stopped spending more than MRP, the players would want a better deal.  But I disagree that that’s *why* the owners are spending more.

Phil:  I’m sure the history of this is complex.  But clearly the owners have been paying above-MRP prices for FAs for a while.  Once that is the pattern, the question becomes not “why should any team be first to overpay,” but “why doesn’t an owner break ranks and increase his profits?” I answered that question above:  pressure from the media, Selig/MLB, and politicians, and eventually the very real threat that fans will stop watching and buying tix for a team that isn’t trying hard to win.  Also, such an owner would be destroying the case for revenue sharing, from which he likely benefits.

But I also agree on the Picasso factor.  If all 30 owners were only in this for the money, the union would have to fight a lot harder for its share.  And maybe they would have to settle for 50% of revenue, or something like that. 

My point is that this is a story involving important legal/political, organizational, and collective bargaining dynamics, none of which are accounted for by a simple theory of salary=MRP.

Guy: That makes sense; I agree with you on why an owner won’t break ranks and immediately start paying only MRP.  But why wouldn’t it *gradually* happen?  I agree with you on the pressures teams will face—but they will face them only with respect to how their spending compares to other teams’ spending.

That is, suppose you and I started paying $20 for ten-dollar bills.  If I said, “this is nuts,” and dropped my bid to $9.99, I’d get shellacked by Selig and the players and the press.  But if I decided that I could pay $19.50 and nobody would notice, I would.  Then you would.  Then you might go $19, and I’d follow.  And, eventually, we’d be at $10.

Even if both of us knew, for a fact, that the chance of a strike increased as the price of twenties dropped, it would still happen (unless we colluded).  Neither of us would have an incentive to unilaterally pay more than the other.

Having said that, it could be that a win means more money for the big-market teams, so MRP is higher for their signings.  That would force smaller markets to match the higher salaries, even at less than MRP, because of the pressure you describe.

However, the evidence shows that the Yankees are losing the most money of every team, so they are the worst offenders in paying more than MRP, even though MRP for their players is the highest in the league.

Could it be that a very few rich teams are having an irrational arms race ("irrational" from a purely financial standpoint), and the poorer teams are having to pay up for the reasons you describe?  That might be possible ...

Guy: agree with you on #22.  There is definitely something going on that’s much more complex than MRP.

(BTW, my previous comment was a response to #21.)

Phil:  Not sure we disagree that much.  But here’s the problem I see with your post 23 scenario:  If you bid $19.50 and the going price is $20, you don’t get the player.  If you bid $9 for $10 players, you don’t get the player.  So if you refuse to pay market rates, you can only buy $1 players. And THAT gets noticed in a hurry.....

I don’t know if I’d call it collusion, but I suspect there a variety of subtle and perhaps not-so-subtle signals that Selig and co-owners would send you if your payroll/revenue ratio started to get very far out of line (up or down).

Guy: fair point about my scenario.  But in real life, any kind of mutual inclination to pay less will escalate.  I think.

Suppose we each need one player.  There’s a $5 player expected to go for $10, an $8 player expected to go for $16, and a $10 player expected to go for $20.  Both of us don’t want to waste money, so both of us prefer to placate Selig by paying $10 for the $5 guy.  But only one of us can have him.  What happens is that you pay $13 for the $5 guy, and I pay $16 for the $8 guy.  Neither of us bids on the $10 guy, so he goes for less than $20 ($18.01 to a third team).

That means next year, all expectations are lower, and we get a downward spiral.

That’s one example.  The exact mechanics are irrelevant—the thing is that it’s supply and demand, and if a few teams decide they have less demand now, the prices will drop, even if there’s *some* outside pressure to spend.

I don’t think we disagree that much either ... my point is that it can’t be ALL teams that are trapped by outside pressures.  There have to be at least a few teams that are doing it willingly, or prices would drop.

There have to be at least a few teams that are doing it willingly, or prices would drop.

I agree that some teams are doing it willingly, but I still think this can be viewed as rational by including the impact on franchise valuation.  Plus, the teams that actually do it rotate a bit from year to year.  You only need a few teams at a time to keep prices high.

Hi, Studes,

Sure, it could be rational in the “Picasso” sense rather than in the financial sense.  The more pennants the Yankees win, the more prestigious the franchise, and higher the team’s value as a trophy purchase.  I can’t deny that that’s possible.

My argument is just that while there can be a certain amount of being “trapped” into having to spend much more than MRP on players (by pressure from Selig and the fans), there also has to be a substantial amount of willingness, too, otherwise you start a death spiral of lower spending.

As long as teams feel pressure to spend *only relative to each other*, a bunch of teams deciding to get off the merry-go-round should cause salaries to start dropping.  One drops a bit, and the next one now has a bit more leeway to follow, and the next one, and the next one ... over time, payroll has to settle down, it seems to me.

But I could be wrong.

Hi Phil,

I guess I’m struggling in delineating between the “Picasso” sense and the “financial” sense.  It seems to me that franchises are valued by a market of potential buyers and those buyers look at a number of factors, including but not only the current financial bottom line.  That’s true in virutally every industry.

You know, the current bottom line isn’t that big a deal in baseball.  Player contracts come and go, and the profit of a team is very manageable from year to year.  Just ask the Marlins.

I’ll bet most potential buyers will look beyond the immediate bottom line and ask what the underlying value of the franchise is (i.e. the revenue potential).  And the underlying value will be driven by a number of things, including the team’s standing in the community.  Winning teams with high-profile marketable players will have the highest franchise valuation.  So teams will bid for players beyond their “marginal revenue product” because it drives up the value of the franchise beyond what a simple MRP analysis would indicate is prudent (if I understand MRP).

Anyway, my main point was that you don’t need that many teams on the merry go round at any point in time.  You just need a few to keep player salaries high.  Sure, there are a lot of teams that step off the thing, but there are just enough teams and also enough ballast to keep salaries afloat.

But maybe I’m missing your point.

Hi, Studes,

My point is that teams are valued differently than other companies—say, Ford.  Ford is valued strictly on its ability to earn profits and pay them out as dividends.  If the value of Ford stock goes up 10%, it’s because investors believe it will be (adjusting for the time value of money) 10% more profitable than they believed previously.

Sports teams, on the other hand (I argue) are valued like Picassos—not just for the cash profits they will earn, but for the joy of ownership.  When a Picasso goes up 10%, it’s not because its future has become more profitable, but because someone has come along for whom the joy of ownership is 10% higher.

With Ford stock, even if you never sold it, you would make money.  With the Picasso, and the sports team, the only way to make money is to sell it.

Ford may invest $10 million in a new plant because they think it will return more than $10 million in profits from the business over the long term.  But it looks like when teams pay $10 million for a free agent, they know it will return only $5 million in profits.  So why do they do it?  One theory (which I will ascribe to you for now) is that they believe it will attract another $5 million worth of “bigger fool” money for when they sell the team.  Another theory (Guy) is that they really don’t want to buy the player, but are facing pressure from Bud Selig and the union to spend money.  A third theory is that they just don’t realize that free agent money is a bad investment.  A fourth theory (me, I guess) is that the owners know they’re losing money on each player, but just don’t care, because that’s just the cost of admission to their big public game of fantasy baseball, and they gotta spend their wealth on *something*.

My guess is actually a combination—a bit of “bigger fool,” a fair amount of what Guy says, and a big chunk of blowing money on high-dollar fantasy baseball.

Having said that ... I may have mischaracterized your argument.  What you may be saying is that free agents drive up the price of the franchise for *business reasons*—that there’s a revenue stream to come, in the future, that makes the team more valuable.  If so, what’s that revenue stream?  How does winning (say) five more games this year improve revenue down the road?

Hope this explanation made sense.

Thanks, Phil.  That makes sense, and I’m sure the real answer is a combination of all factors.

I agree that individual investors value Ford based on its bottom line, but the bottom line is only part of what drives the acquisition/merger process for most companies.  Virtually all acquisitions occur significantly above a company’s stock price.  One reason is that the market demands it, but the other is that the acquiring company sees more value in the target company than just the bottom line.  Brand value, customer base, inherent assets, dreaded “synergies” are all examples.  So I think you’re referring to how an individual investor might value a company, but I’m referring to how an acquirer might value it.

I’m suggesting that, since most baseball operations are bought and sold on the private market and don’t pay dividends (I don’t think), their investors primarily value the eventual sale price of the franchise.  Valuation is the key measure for them, not year-to-year profit.  This isn’t true of all teams, obviously.  I’m sure the Braves and Cubs are more bottom-line oriented.

But when, as an investor, franchise worth is most important to you and yes, there certainly is a “Picasso” element to your potential buyers, then doing things that you think will drive up the value of the franchise is very rational indeed.

I think a lot of closely-held businesses maximize something other than just profits ... usually some combination of profits and ego and fun.

I own shares of a company called Magna, a successful manufacturer of automotive components.  Most of the voting shares are controlled by the family of the founder, Frank Stronach.  Stronach loves horse racing.  A few years back, he got Magna to buy a bunch of racetracks.  There was an outcry from common shareholders, that Stronach was doing it for his own pleasure, and it was going to be a moneyloser—but we had only subordinate voting shares, so Stronach got to do what he wanted.  Because of the pressure, though, he did eventually spin off the company so the dissenting shareholders could divest.  As it turns out, the racing business has not done very well.  But I don’t think Stronach cares very much.

Don’t the Fords have special voting rights?  That would explain why the CEO is always named Ford.  It would be quite a coincidence if the person best qualified to maximize Ford profits just happened always to be a member of the family.  (Although, didn’t they hire an outsider recently?)

Anyway, it seems to me that family-controlled businesses are more likely to be run partly as a hobby, to carry on pride of ownership, while widely-held public companies more strictly value the bottom line.

JC has this to say over at Sabernomics:

“If owners are maximizing something other than profits, then I guess we just have to throw our hands up in the air. If you to develop a model that predicts salaries in a different manner, I have no objection. But once we depart from using money to proxy utility, all decisions become tautological. And that’s just not very interesting to me. Furthermore, if owners are such altruists why do they lobby for stadium subsidies, seek corporate sponsors for their stadiums, charge $7 for a beer, etc. I will grant that owners do care about more than just profits, but I just don’t buy these other motivations as large determinants of their behavior.”

To me, this completely misstates the choices.  Phil, Studes, David G. and Tango have offered various theories for why owners overpay for FAs, but none of them involved “altruism.” Instead, they suggest that utility for owners is not limited to short-term profits (and restraints on owners’ freedom to maximize profits). If sports economics can’t handle that kind of complexity, I don’t know that it will be able to offer a lot of useful insights.

It’s also not true that the only alternative to MRP is a ‘tautological’ explanation, or that it prevents us from modeling salary.  The common denominator to every theory here is that owners are seeking to buy wins, and will use a (roughly) fixed share of revenue to do that.  Based on Studes’ work, it looks like the going FA price of a win is now about $4M.  With that information, we can predict future contracts and assess the quality of signings.  It’s not like the alternative to MRP pricing is owners’ writing large checks to randomly-selected players.  Again, JCB poses a false dichotomy.

Well, that’s too bad.  I’m certainly learning a lot from this conversation.

Phil, I have no doubt that what you’re suggesting occurs.  However, I keep pushing back because I think many fans believe that these free agent deals are all the result of quirky owners and that there is no underlying financial rationale for what we see.  I think we can explain what’s going on, add nuance to JC’s model and maintain economic rationale without forcing him to throw up his arms.

Here’s one other personal story.  The company I worked for was publicly traded, making a lot of money and keeping it in cash and investments.  When stock market analysts came to visit us, they started giving us a hard time about all the cash and investments we were holding.  They didn’t want us to pay out dividends; they wanted us to reinvest that money in the company.  Their rationale was that a company with a high rate of return should be reinvesting their profit in the company, for the good of the shareholders.

I think this is what owners (majority and minority) holders of many major league teams feel.  Because their primary return is going to be the eventual sale of the franchise, they don’t really want cash on hand.  They want to reinvest it in the franchise.  If you will, this is the “mechanism” by which Guy’s economic theory is played out.

As we’ve said here before, the value of major league franchises has risen about 10% over the last couple of decades, and salaries have increased about 10% over the last couple of decades.  I’m sure the actual story behind this is very complex, but franchise value and salaries are in sync, bound together at the money belt.

I’m probably focusing on the Cubs too much as an example, but while they were held under corporate ownership they took a fairly responsible approach to player salaries.  Now that they’re up for sale, they are signing eight-year deals. I’m not saying the Soriano deal was good or rational, but I’m very struck by the obvious change in strategy and its timing.

That’s my theory, anyway.  It may still be too “tautological” for JC, but I think it explains behavior pretty well.

Hi, Studes,

I do like your theory better than the others—all things being equal, the most satisfying theory would be one that shows that a $5 million player is indeed worth $5 million.  Any theory that insists that economic actors are irrational is (and should be) suspect.

But I just don’t get *why* the franchise values keep going up, or, specifically, why signing Soriano to an expensive 8-year deal would make the Cubs worth more.  That’s where I’m stuck.

BTW, I replied to J.C.’s post there.

Good question, Phil.  If my theory has any usefulness, I think you could use it to list those things that a prospective buyer would want.  For instance, in theory they’d be more inclined to focus on potential future profit instead of past profit.  So I would think they’d value:

- Strong brand (which supports higher ticket prices and media contracts).
- Winning record (see brand)
- Great stadium deal and strong relations with local government
- Strong player development expertise
- Good players locked in at relatively low prices (compared to market).  Include minor leaguers and factor in the cost of salary inflation when evaluating future salaries.

Things they wouldn’t value would be the opposite, specifically:

- Poor brand
- Bad stadium deal
- Contentious relationship with local government
- Poor player development expertise
- Bare minor league system
- Bad players locked in at relatively high prices (compared to market).

So, exorbitant, long-term contracts make sense for the superstars if they’re truly superstars, projectable and young.  Given that salaries will probably increase 8% to 10% a year, I think that contracts like Carlos Beltran’s are an asset to their team’s valuation.

If the Cubs put Soriano on Beltran’s level, they obviously missed the boat.  But their thinking makes sense.

Of course, I’m just thinking out loud here.

Post from sabernomics:

I think the majority of the increase in price valuation is the supply/demand.  Teams were selling for 10 million$ 30-40 years ago, which means something like a 16x multiple in valuation (i.e., doubled in valuation 4 times, meaning doubles every 7 to 10 years).  That’s a 7-10% increase in valuation, which is also the increase in payroll and the increase in revenue.

But actual profits have never even approached anything where a DCF would justify such a jump in valuation.  And certainly future profits won’t justify it either, if teams keep spending like this.

The modus operandi is to spend 50-65% of your revenue, and be one of the 30 collectors of an MLB team (or one of the 120 collectors of a major sports team).

You also try to leverage that into cable deals (MSG, YES, NESN, TBS, WGN, etc).  But mostly, you are buying a Picasso, or as Phil said, a vintage car.

If you can squeeze the players, like the NFL, you get the bonus of also turning profits, and thereby increasing you valuation (i.e., MLB would be 2x revenue, while NFL would be 4x revenue, or whathaveyou).

Agree, Tango.  The major league owners just plain blew it in the beginning years of free agency and they’ll never be able to get it back.  The union is too strong now to turn back the clock.

I don’t think that’s a bad thing, by the way.  Why shouldn’t the players get most of the money in this business?  Particularly since owners can still make their money when they sell to the next collector.

Keep in mind that the number of hugely wealthy families in the U.S. has increased a lot over the past 10-20 years, the combined result of economic growth and a huge increase in inequality.  Twenty years ago the Forbes 400 had only a handful of billionaires; now, virtually the whole list has $1B+ in assets.  So the potential market for these ‘Picassos’ has greatly expanded.

Not to mention that attendance has skyrocketed from a few decades ago, even though ticket prices has way overtaken inflation.  Sports was simply not anywhere near as popular as it is today, making ownership of a team that much more prestigious.