Pay and Performance in Major League Baseball

Pay and Performance in Major League BaseballGERALD W SCULLYTHE AMERICAN ECONOMIC REVIEW VOL 64 ISSUE 6 DEC 1974

BackgroundBaseball bringing in substantial revenue Salaries are the main part of contract negotiations and the reserve clause gives considerable power to teams

First playersrsquo strike over pension fund1972 Threat of strike lockout from issues of minimum salaries salary

cuts benefits and the reserve clause 1973 Reserve clause retained a playerrsquos rights to his team after contractrsquos

expiration Abolished in 1975

Reserve clause system ruled the game It dictated how and where players moved between teams Owner say clause is ldquonecessary for equalization of playing strength among teamsrdquo and insist that player salary demands are unrealistically high Scully disputes these contentions

ldquoPurpose of this paper is to crudely measure the economic loss to the players due to restrictions of the reserve clause Relationships between player performance and salary will be estimated and the predicted salary compared to predicted player marginal revenue productrdquo

Scully p 915

ApproachldquoAside from providing insights into the operation of a particular labor market the approach differs from other studies of the wage determination process in the following ways 1) the individual player is the unit of observation 2) salary functions are estimated within the framework of a labor market characterized by extensive bargaining 3) marginal revenue products of the factors of production are estimated explicitly and 4) rates of monopsonistic exploitation are found by comp-aring salary and marginal revenue product over various performance levels and career lengthsldquoFirst the institutional characteristics of the base-ball players labor market are briefly outlined Next with this institutional framework in mind a model of marginal revenue product and salary determin-ation is formulated Then the results of the empirical investigation into marginal revenue product and salary determination are presented Finally the rate of monopsonistic exploitation is calculated and policy implications discussedrdquo

Scully p 915

The individual player is the unit of observation Players have various performance levels and career lengths

Salary functions are estimated within a monosponistic labor market characterized by extensive bargaining

Marginal revenue factors are estimated explicitly

Exploitation found by comparing salary and MRP

1) Outline characteristics of the labor market2) Formulate an empirical marginal revenue

product and salary determination model3) Present results 4) Calculate monopsonistic exploitation 5) Discuss policy implications

Organization of the Baseball Players Labor Market (more about the reserve clause and MRP)

Player is a free agent until a one year contract is signed Contract is exclusively renewable for the owner (reserve clause) Owner may renew sell or terminate the contract Player make accept the terms or negotiate After ownerrsquos ldquofinal offerrdquo player must accept or withdraw from professional baseball

MRP is ldquothe ability or performance he contributes to the team and the effect of that performance on the gate receipts The effect of a player performance on revenue may be direct or indirectrdquo ldquoAbility contributes to team performance and victories raise gate receiptsmdashand

broadcast revenues this is the substantial effect of the individualrsquos performancerdquo ldquoSome players may attract fans over and above their contribution through the teamrdquo

Scully p 916

A Simple Model of MRP and Salary Determination in Major League BaseballThe MRP and salary determination model should consider 1) revenues are related to individual performance through their effect on team standing 2) the reserve clause reduces player salaries below player MRP

W = Percent wins Ai = Player skills Ii = Nonplayer inputs (managers coaches capital etc)

W = W ( A1 A2hellip An I1 I2hellipIm)

A Simple Model of MRP and Salary Determination (cont)Teams derive revenue from gate receipts and broadcast rights which are directly related to the teamrsquos percent wins and population in the area R = Team revenue p = Ticket price T = Number of tickets sold W = Team performance Pi = Potential broadcast households B = Broadcast revenues

W = Percent wins Ai = Player skills Ii = Nonplayer inputs (managers coaches capital etc)

R = p T [ W ( Ai Ij ) Pa ] + B [ W ( Ai Ij ) Pb ] i = 1hellip n j = 1hellip m)

A Simple Model of MRP and Salary Determination (cont)Costs are determined by the level of skill and nonplayer inputs Because of the monopsonistic labor market costs are related to the level of skill C = Team costs Si (Ai ) = Player supply functions rj = Nonplayer factor remunerations

C = sum Ai Si (Ai ) + sum rj Iji = 1hellip n j = 1hellip m)

A Simple Model of MRP and Salary Determination (cont)

Standard profit model

= Profit R = Team revenue C = Team costs

= R - C

A Simple Model of MRP and Salary Determination (cont)

First-order conditions for a maximum profit are obtained by differentiating with respect to Ai (player skills) and Ii (nonplayer inputs)

ldquoConditions reveal that teams maximize profits by selecting a level of player skills and nonplayer inputs such that players receive a salary equal to their MRP less monopsony rents (Ai Srsquoi )rdquo

Scully p 917

Player MRP Equation1MRP shall be determined by 1) player performance on team wins and 2) the effect of wins on revenue

Estimated with team data for 1968 and 1968

= Team percent wins 1000 TSA = Team slugging average TSW = Team strikeout-to-walk ratio NL = Dummy variable 1 = the team is in the National League CONT = Dummy variable 1 = divisional winners and their closest competitors at the end of the season if

competition was five or fewer games out OUT = Dummy variable 1 = teams which at the end of the season were twenty or more games out of placing

PCTWINt = 3724 + 92 TSAt + 90 TSWt - 3857 NL + 4348 CONTt - 7564 OUTt

(39) (437) (562) (403) (377) (617)

R2 = 88 DF = 38 t = team

Player MRP Equation 2MRP shall be determined by 1) player performance on team wins and 2) the effect of wins on revenue

= Home attendance times average ticket price plus revenue from broadcasting rights SMAS = Population size of the Standard Metropolitan Statistical Area MARGA = Team specific attendance NL = Dummy variable 1 = the team is in the National League STD = Dummy variable 1 = older stadiums in poor neighborhoods and with limited parking

facilities BBPCT = Percentage of black players on the team

REVENUEt = - 1735890 + 10330 PCTWINt + 494585 SMAS70 - 512 MARGA

(169) (664) (461) (428)

+ 580913 NL CONTt - 762248 STDt - 58526 BBPCTt (184) (242)

(313)

R2 = 75 DF = 36 t = team

PCTWIN The coefficient of primary interest in PCTWIN A one pint increase

is estimate to raise REVENUE $10330 A one point increase in TSA (slugging avg) or TSW (strike-to-walk) raises PCTWIN by 92 and 90

However MRP may be overstated Omitted factors may include managerial quality entrepreneurial player drafting and trading abilities and stadium investment

Individual Playerrsquos MRP ldquoTo obtain the individual player MRP

assumptions have to be made about how individual performance affects team averagesrdquo

Scully p 921

Assume individual performance carries no externalities (team performance is simply the linear summation of individual performance)

Gross MRPs show that even mediocre players contribute $200000 to team revenue Star players easily have MRP double that amount

Salary Determination

Is offensive or defense more important Hitting or pitching performance Weight of contributions Star players

Salary Determination (Hitters) SA = Slugging average M = Years experience in the majors DBA = Dummy variable 1 = Players with below average

lifetime Slugging averages but above average lifetime batting averages Controls for excellent hitter who have low slugging averages

AB = Total lifetime at bats number of years in the majors times 5500 (average season at bats for a major league team)

SMSA MARGA and NL to control for monopoly

Salary sample is nonrandom and biased toward the upper tail of the salary distribution There are 148 observations from 1968 and 1969 Salary range is from $10000 to $125000

Salary Determination (Pitchers) SW = Lifetime strikeout-to-walk ratio M = Years experience in the majors IP = lifetime average percentage of inning pitched

out of a total innings SMSA MARGA and NL to control for monopoly

Salary sample is nonrandom and biased toward the upper tail of the salary distribution There are 148 observations from 1968 and 1969 Salary range is from $10000 to $125000

Degree of Monopsonisitic Exploitation of Professional Ball Players Players are generally exploited and to a

large degree Over a career length average players

receive salaries equal to about 11 of their gross MRP and 20 of their net MRP

Star players receive about 15 of MRP Some mediocre players have salaries in

excess of their net MRP

Policy Implications

Place ball players under a contractual arrangement similar to pro football A player can play out his option and become a free agent Player-initiated transfers would still not exist

Long-term contracts Contracts for 5+ years followed by free agency

Completely free labor market will all contracts for a full season negotiated off-season Eliminate economic rents of players

Questions

What is the reserve clause What is a monopsony In the win model what are the two independent variables Player MRP is determined by 1) the effect of A on B and 2) the

effect of B on C What are the variables What two categories of players were evaluated for salary

determination Are professional baseball players exploited