Player salaries, MRPL, and exploitation

(revised 13 Nov. 2008)

News flash:MLB players are highly paid

• Average MLB salary = $3.2 M (April 2008)– More than 2 times as high as in 1998– More than 10 times as high as in 1983– Less than NBA ($5.4 M in 2007)– More than NHL (~$2 M in 2007) and NFL ($1.4 M in

2006)• Median MLB salary = $1 M in 2006, 2007, and 2008

– Highest ever; previous peak was $975,000 in 2000– 85 players made $10 M or more in 2008

• Up from 66 in 2007

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

• Also, free-agent contracts are examples of VOLUNTARY EXCHANGE (market transactions agreed upon by buyer and seller)– Nobody forces the owners to pay such high salaries.

• Rodney 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 or workers

• Diminishing returns --> downward-sloping demand curve for labor

• Upward-sloping supply curve for labor

Notation (for diagram drawn on board):

• 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

• [See link on course website, “MLB’s Labor Economic History, 1945 - Present,” for details on the Messersmith-McNally case that ended the reserve clause and brought free agency to MLB.]

Baseball’s current system

Years of ML service

Eligible for…

0 – 2

Rookie minimum ($400,000 in 2009)

(Team can pay more if it wants.)

3 – 5

Salary arbitration

(A handful of “Super Twos” also can go to arbitration.)

6 or more

Free agency

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

• First, how to measure MRPL for baseball players? The standard, simplified way is a two-step process:– (1) Using player statistics, estimate each

player’s contribution to team wins;– (2) Estimate the contribution of more wins to

team revenues.

For hitters, the one statistic that has the highest correlation with team winning percentages is...

“OPS”

• = On-base percentage (OBP)

+ Slugging percentage (SLG)

• OPS * (player’s plate appearances as % of team’s) = what Zimbalist and Bradbury use to measure hitters’ productivity, in computing MRPL’s

For pitchers

• Earned run average (ERA) is the standard measure– Bradbury prefers “Defense-Independent

Pitching Statistics” (DIPS), which is like ERA minus the contributions of the team’s fielders

• Includes walks, strikeouts, and home runs allowed

– Then compare a pitcher’s DIPS with the league average, and multiply by his innings pitched as a % of his team’s total.

Next steps toward estimating MRPL

• Estimate the player’s contribution to team winning percentage, based on wins as a function of OPS or ERA/DIPS

• Estimate contribution of additional wins to team revenues

Comparison of performance (MRPL) and salaries:

• Exploitation = MRPL – salary

• Zimbalist (1992):– Younger players tend to be exploited (pay<MRPL)

– Veteran players (6+ years in majors) tend to be “overpaid” (pay>MRPL)

• MRPL calculations by Bill Felber (The Book on the Book, 2005) echo Zimbalist’s conclusion.

• MRPL calculations by Bradbury (p. 195) find pay<MRPL (i.e., “exploitation”) but a much smaller gap for veterans.– But Bradbury doesn’t “think this is exploitive” if you take development

costs into account.

MRPL - salary, by service category

Salary as percentage of MRPL

Years of service

Category

(1986-89, Zimbalist)

(2005, Bradbury; hitters, pitchers)

0 – 2 reserved 16 – 25% (highly exploited)

11%, 10%

3 – 5 arbitration- eligible

50 – 64% (exploited)

23%, 22%

6 or more

free-agent-eligible

140% (overpaid)

92%, 64%

How do we explain those systematically “overpaid”* veterans?

• (* overpaid by Zimbalist’s and Felber’s estimates, not Bradbury’s)

• Nature of the (seniority) system– Most free agents are past their prime (age 30+), which reduces their MRPL, but as

free agents they’re in a position to earn the most money– Limited supply of free agent players– Many free-agent contracts are long term (less risky for player)

• --> Reduced incentive to work hard?• Statistical MRPL measure (based on stats and wins) may be too narrow

– Doesn’t count leadership, experience, consistency, marquee value– Also doesn’t count expected value of playoff or World Series success, or of extra

offseason ticket sales due to a free-agent signing.• Back to supply and demand

– Limited supply of free agents, high demand for players who can help a team– Concept of value above replacement – A player’s value is not just relative to the rest

of the league, but also to his team’s next best option.• Ex.: A team that has no MLB-caliber catcher in its organization may be rational

to “overpay” for a catcher.

Salary arbitration• A mechanism for players with 3 to 5 years of service to avoid being

underpaid relative to their peers• Established in 1973, implemented in 1974• How it works:

– If a player and his team cannot agree on his salary for the next season, then, separately:

• The player submits a salary figure • The team submits a salary figure• An arbitrator decides which figure is more reasonable and awards it.

– “Final offer” arbitration: The arbitrator must pick one figure or the other, cannot split the difference.

– The player and team, however, can always settle on a compromise figure before the arbitration hearing.

– The vast majority of arbitration-eligible players reach an agreement with their team before filing for arbitration or going to arbitration.

» Salary arbitration is an acrimonious, risky process that players and teams generally seek to avoid.

Effects of salary arbitration system

• Higher salaries (for players with 3-5 years of MLB service)– “I was going to be rich or richer”

– Salary arbitration and free agency a potent combination

– Ironically, this is true even though owners have won the majority of salary arbitration cases.

• More multi-year contracts for young players– Multi-year contracts are a way to avoid arbitration and

yearly salary spiral.