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Transcript of Eco 383: PPT lecture slides, October 2006 Topics: –Franchise finances –Competitive balance and...
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Eco 383: PPT lecture slides, October 2006
• Topics:– Franchise finances– Competitive balance and market size– Player salaries, MRPL, and exploitation
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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.
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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.
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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…)
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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.
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Breakdown of team revenues (Forbes, 1998)
• 40% tickets & suites• 34% broadcasting• 12% food,
merchandise• 7% ads, sponsorship• 6% other 0
51015202530354045
Tickets…
B'cast…
Food…
Ads…
Other
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Breakdown of team costsIn 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)
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Estimated profitability of MLB teams (source: Forbes)
Year Operating profit% increase in asset value(and return on assets)
1999 $1.0 million(0.5% of assets)
6%(6.5%)
2000 $4.3 million(1.8% of assets)
12%(13.8%)
2001 $2.5 million(1.0% of assets)
10%(11.0%)
2002 -$1.3 million(-0.5% of assets)
3%(2.5%)
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Estimated profitability, cont’d
Year
Operating profit
% increase in asset value (and return on assets)
2003 -$1.9 million (-0.7% of assets)
3% (2.3%)
2004 $4.4 million (1.5% of assets)
15% (16.5%)
2005 $12.1 million (3.7% of assets)
15% (18.7%)
(Note: best measure may be long-term increase in asset value.)
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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.
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To calculate ROA from the Forbes tableROA = (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%
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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.
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What a difference a year makes:Baseball finances in 2003, 2004, & 2005
2003 2004 2005
average operating profit
(as % of assets)
-0.7% +1.5% +3.7%
number of teams with positive operating profit
15 20 25
number of teams whose estimated value rose
17 28 30
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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?
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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).
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What is competitive balance?
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• 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)
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Why is competitive balance an economic issue?
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• The demand for MLB will tend to fall if--– too many teams cannot compete– fans perceive that the richest teams have an
unfair advantage
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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?
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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)
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What is “market size”?
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• 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
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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?), “mid-market,” “small market” (~bottom 5?)?
• Market size perhaps cannot be measured precisely
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Can the small-market teams compete?MAYBE MAYBE NOT
• First 15 years of free agency (1977-91) saw unprecedented parity, several successful small-market teams
• Insignificant correlation between payroll and W-L % through mid-1990s
• Recent success of some small-market teams
• Market size is not static
• 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 small-market team)
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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
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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
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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)
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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.
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Player performance and salaries
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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
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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
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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?
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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
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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
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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)
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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.
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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
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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
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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.
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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, ...
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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?
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For hitters, the one common statistic with the highest correlation with team winning percentages is...
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“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
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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)
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Salary/MRPL, by service category (1986-89)
Year of service CategorySalary/MRPL,on average
1st - 2nd “apprentice” 16 – 25%(highlyexploited)
3rd - 6th “journeyman” 50 – 64%(exploited)
After 6th “master” 140%(overpaid)
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Salary/MRPL: 2003 update(Source: Bill Felber of Total Baseball)
Years of service
Salary/ MRPL
1-2 27%
3-6 49%
7+ 156%
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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?