Multiyear Contracts

Before the demise of the reserve clause, there was no need for multiyear contracts because players never became free agents. Now, however, many athletes and coaches have multiyear employment contracts. The terms of these contracts may vary widely. Some contracts are guaranteed, which means that the club must pay the player regardless of his or her performance, or even if the player is injured and cannot perform at all. In the case of losing coaches, they must be paid or bought out in order to hire a new coach. Other contracts are not guaranteed. Some contracts have buyout provisions, some have option years, some have incentive provisions, and so on. One thing is certain about multiyear contracts, however: none of them are valued correctly in newspaper and TV reports. For example, Rick DiPietro, the New York Islanders goaltender, recently agreed to a 15-year contract extension that was reported to be worth $67.5 million. National Hockey League (NHL) star Patrick Elias signed a seven-year deal with the New Jersey Devils that the New York Times reported as a $42 million contract. Carmelo Anthony, when he was a Denver Nuggets star, signed a five-year contract extension in 2006 that was estimated to be worth $80 million. Alfonso Soriano signed an eight-year contract with the Chicago Cubs reportedly worth $136 million. In November 2010, Donovan McNabb signed a five-year contract extension with the Washington Redskins that could be worth more than $80 million according to some reports. All of these reports are misleading because they report the total nominal dollars in the contract.

The mistake that is invariably made by the news media is that they simply add up all of the future payments without regard to when, or even if, those payments will be received. The news reports would only be correct if all of the payments were received at the time the contract was signed. This, of course, is never the case, and therefore, these reports are always misleading. DiPietro's contract calls for annual payments of $4.5 million, which add up to $67.5 million over 15 years. However, the last payment of $4.5 million will not be received until the 15th year of the contract. The last payment is worth far less than $4.5 million on signing day.

Introduction

We encountered two kinds of misconduct in the preceding chapters – gambling and cheating. In this chapter, we turn our attention to an array of misconduct on and off the field. Misconduct on the field can be relatively minor – excessive celebration, taunting opponents, and arguing with game officials are common examples. It can also be more serious and far more dangerous – helmet-to-helmet hits, stick-wielding incidents, kicking opponents, and starting brawls. Off the field, misconduct has taken many forms – dog fighting, domestic violence, DUIs by the dozen, weapons charges, drug dealing, and assaults. These forms of misconduct can have an adverse impact on the image and popularity of professional sports. If fans begin to think that athletes are thugs and criminals, the stars will no longer shine so brightly and no longer be heroes in fans’ eyes. When fans begin to turn away, the turnstile stops clicking, and the money stops flowing. As a result, sports leagues and organizations as well as the athletes themselves have an economic interest in controlling such behavior for the good of the game.

In this chapter, we begin with the personal conduct policy of the NFL, which is representative of the other major sports leagues and organizations. Once again, we analyze the economics of deterring undesirable conduct. Following that, we examine several examples – fighting, excessive violence, off-field legal problems, and even some relatively minor forms of misconduct that may draw the ire of the league officials. In all of these examples, our focus is on punishment that is designed to deter others from misdeeds.

Introduction

There is a wide array of sports facilities: bowling alleys, golf courses, tennis courts, multiuse athletic fields, parks, public school facilities, and, of course, the professional venues. Some of these facilities are privately financed, and many others are publicly financed. In the vast majority of cases, privately owned facilities are privately funded. For example, privately owned bowling alleys, golf courses, racquetball courts, health and fitness centers, and tennis clubs are financed by the owners of those facilities with private debt and equity. Similarly, governmentally owned facilities are publicly funded. For example, municipal golf courses, community swimming pools, high school athletic facilities, and parks are publicly financed through bonds and taxes. This, of course, makes perfect sense: facilities for private use are privately owned and privately financed, and those for public use are governmentally owned and publicly financed. When it comes to professional team sports, however, we often have public ownership and private use. For the most part, the stadium, ballpark, or arena is at least partially funded by local and/or state government, which then leases the facility to the professional club on very favorable terms. These “sweetheart” deals are designed to attract pro teams to a city and to keep them there.

In this chapter, we begin with some principles of sound investment decisions. We examine the case for public subsidies of privately owned facilities and explore some political realities. Then we turn our attention to the nature and extent of public funding for the benefit of professional clubs. We also examine some issues of fairness as they relate to paying for sports facilities that are used by few people in the community that is paying for them. Along the way, we analyze the ways in which state and local governments can raise the money necessary to pay for sports facilities. As we will see, local governments often use eminent domain to acquire the needed land, and that imposes added costs on some members of the community.

Introduction

The major sports leagues and organizations own the broadcast rights to their athletic contests. Given the enormous popularity of sports in the United States, these broadcast rights can be worth considerable sums of money. The National Football League's (NFL's) broadcast rights provide an excellent (although admittedly extreme) example. In 2010, the NFL's broadcast rights brought in more than $3.8 billion. Such numbers are driven by other numbers – the Nielsen ratings and the audience demographics. The hugely popular NFL can command billions of dollars for its broadcast rights because of its high Nielsen ratings. Broadcasters want sports programming largely for one reason: to sell advertising slots. The price of those ad slots is determined by the number and demographic characteristics of the viewers that the programming delivers. As a result, the broadcast license fees for less popular sports are more modest than those for the NFL. In 2010, for example, the United States Tennis Association received some $43.3 to 48.3 million for broadcast, cable, and international TV rights to the U.S. Open. Similarly in 2007, Major League Soccer (MLS) signed its first TV contracts with ESPN, Univision, Fox Soccer Channel, and HDNet for only $20 million. This may seem like a meager beginning, but until MLS gains popularity in the United States, it will not command a high price for its broadcast rights.

Broadcast license fees are an important source of revenue to large and small alike. The billions of dollars generated by the NFL are just about enough to cover the player payroll. For the U.S. Figure Skating Association, its contract with ABC/ESPN provided only $12 million per year. For the association, however, this was significant because the rights fees accounted for more than 65 percent of its budget.

Introduction

At least in team sports, demand by the fans is driven by the uncertainty of the game's outcome. Close games between evenly matched teams are more fun to watch (especially if your team wins) than lopsided games in which one team has no real chance of winning. If one is not a fan of either team, Ohio State versus Wisconsin is far more appealing entertainment than Ohio State versus Toledo. In addition to their being traditional rivalries, Oklahoma versus Texas, Oregon versus Oregon State, and Florida versus Tennessee are popular games because the teams are usually pretty good in an absolute sense and evenly matched. The outcome is uncertain, and therefore, the game has an element of suspense that adds to the fun of watching. As a result, it is important to achieve some semblance of equality of talent, which we may refer to as competitive balance.

All major sports leagues are concerned about competitive balance. This term refers to the ability of teams within a league or conference to hold their own on the field. The league recognizes that the demand for tickets would suffer if the Cowboys always beat the Redskins who always beat the Giants. In that event, the games would not be contests – they would be exhibitions. The need for competitive balance – or at least some semblance of competitive balance – leads to league rules that limit competition off the field to improve competition on the field. These rules include (1) revenue sharing, (2) salary caps and luxury taxes, and (3) reverse-order player drafts.

Introduction

Workers in many occupations and industries have felt the need to band together in unions so that they could bargain collectively with management. In this way, the workers sought to level the playing field in negotiating wages, hours, benefits, and working conditions with large, powerful employers. Much the same has been true in professional sports: the players have formed unions to offset the collective monopsony power of the team owners. These players’ unions, however, are somewhat different from the traditional craft unions or industrial unions. We explore some of the differences here.

We begin this chapter by introducing the players’ unions in the four major sports leagues. We then turn our attention to the economics of unions. Successful unions are labor cartels, which would ordinarily be illegal under the antitrust laws. There is, however, an explicit antitrust exemption for organized labor, which we outline briefly. When the union meets the league management negotiators, we have a market structure known as bilateral monopoly. We develop a simple model of bilateral monopoly and relate it to professional sports. We then examine minimum salaries in the major professional sports leagues, salary caps and luxury taxes, revenue sharing, and free agency. All of these issues are subject to collective bargaining and are largely protected from antitrust scrutiny.

Introduction

Following the University of Florida's (UF's) 2006 National Collegiate Athletic Association (NCAA) Championship in men's basketball, Gator fans held their collective breath. Four of UF's starters could have declared for the National Basketball Association (NBA) draft even though they had college eligibility remaining. To the great relief of the Gator Nation, they all decided to return for another season. Whether this was a wise decision ex post, only time will tell, but the relevant issue is whether it was wise ex ante; after all, we all have 20-20 hindsight.

Every year, there are hundreds of athletes with college eligibility remaining who must decide whether to stay in school – or even to go to school in the first place. Star athletes – and even some who are not stars – agonize over whether they should take a shot at fame and fortune in professional sports before they have exhausted their college eligibility. No doubt, this is a difficult decision with many risks whether the athlete stays or leaves. There are some prominent examples of those who made the wrong choice.

Introduction

Drug use has long been a serious problem in the sports world. For many years, the central concern was over the use of illegal “street” drugs such as marijuana, cocaine, and heroin. More recently, however, attention has shifted to performance-enhancing drugs: anabolic steroids, human growth hormone, stimulants, and erythropoietin (EPO). There are almost daily allegations and revelations regarding the use of performance-enhancing drugs across all sports – amateur as well as professional. These reports appear so often we are hardly surprised to find that one of our heroes – Marion Jones, Justin Gatlin, Shawne Merriman, Alex Rodriguez – has feet of clay. Some athletes have been temporarily suspended, and others have been banned for life. Suppliers have gone to prison, paid heavy fines, or both. Surveillance is increasing, and sanctions are becoming more severe. In this chapter, we examine the health risks associated with using performance-enhancing drugs. We also review the policies of several sports leagues and organizations and the sanctions they impose for using banned substances. We then employ the expected utility model to identify the potential for deterrence.

Prevalence of Abuse

No one can be quite sure just how prevalent the use of steroids has become in the sports world. Athletes do not want to admit to steroid use. In fact, several prominent athletes have lied about it. Some have persistently and vehemently denied using steroids when, in fact, they did use them.

Talent: A Risky Asset

Player talent is a valuable asset that is put at risk every time athletes play or practice. Some injuries – even if relatively severe – can be overcome. There are numerous examples of football players who have overcome serious knee and shoulder injuries. Willis McGahee, for example, suffered a devastating knee injury during the 2003 Fiesta Bowl game while playing for the University of Miami. The Buffalo Bills took a huge chance by drafting him in the first round of that year's National Football League (NFL) draft. McGahee sat out his entire rookie year rehabbing his knee, while earning $1.8 million. He recovered from the injury and rushed for 1,128 yards and 13 touchdowns in 2004. Dan Marino, the great Miami Dolphins quarterback, played for years after having torn his Achilles tendon. Tommy John was an ace of the Los Angeles Dodgers pitching staff for years after elbow surgery. Sometimes, however, injuries can end a career. In some sports – golf, tennis, cycling, track, and professional football – the athlete is out of luck if he or she suffers a career-ending injury because incomes are not guaranteed. In other sports, notably baseball and basketball, professional contracts are guaranteed, which means that the athlete gets paid even if he or she cannot perform. A career-ending injury does not void the contract or lead to a financial disaster for the player, but the financial loss does fall on the team, which must pay both the athlete who can no longer play and his replacement.

The value of athletic talent is a risky asset. Who bears that risk depends on the contract. For example, Carl Pavano signed a four-year contract with the New York Yankees in 2005. The contract was reported to be worth $39.95 million. Pavano developed shoulder problems in his first year (2005) and could not pitch after June 27. Pavano worked to rehab his shoulder but developed back, buttocks, and elbow problems. To make matters worse, he was in a car accident and cracked some ribs. He did not pitch at all for the Yankees in 2006 but remained optimistic about his health in 2007. In 2007, Pavano developed further problems. After just two starts, he went on the disabled list and was scheduled for Tommy John surgery. This ended 2007 for him as well as most of 2008 because of the prolonged rehab that such surgery requires. Before his injury in 2005, Pavano won four games while pitching 100 innings. The Yankees paid him some $17 million for the 2005 and 2006 seasons, which works out to $4.3 million per win or $170,000 per inning. If Pavano had not regained his physical abilities, the Yankees would still have had to pay for the remaining two years on his contract. That is, the risk of a career-ending injury falls squarely on the team in Major League Baseball (MLB). When contracts are not guaranteed, as is generally the case in the NFL, the risk of a career-ending injury falls on the player's shoulders. This, of course, is true for all amateur athletes as well. If a college player is injured, the expected value of his future professional compensation is lost.

Introduction

When star players are free agents, several teams may bid for their services in a kind of auction. Barry Zito is a good example of this. Several Major League Baseball (MLB) teams were interested in signing Zito when he became a free agent after the 2006 season. In the end, the San Francisco Giants and the New York Mets battled down to the wire over Zito. The Giants ultimately won the battle and Zito's services by outbidding everyone else. Zito, of course, was the real winner: $126 million over seven years. In this instance, Zito's salary was determined through competitive bidding. In other cases, however, salaries are determined through bilateral bargaining between one team and one player (or his agent). Top NFL draft choices for example, bargain over the terms of their initial contracts with the teams that selected them in the draft. Some players who are currently under contract bargain over multiyear contract extensions. At the end of the 2010 season, for example, Derek Jeter and the New York Yankees engaged in a very public bargaining struggle. Jeter wanted more than his market value, and the Yankees wanted to pay less than his market value. In the end, they settled on a three-year contract for $51 million. Some National Football League (NFL) players bargain over restructuring their current contract because of salary cap constraints.

In this chapter, we develop the simple economics of bidding at auctions and how it applies to professional sports. We also develop the basics of bargaining. Several examples illustrate the applicability of bargaining theory. Finally, we examine the posting system that applies to players under contract with professional baseball teams in Japan. As it applies in the United States, the posting system combines bidding at one stage with bargaining at the next stage.

Introduction

Advertising is part of the landscape in both professional and amateur sports. It comes in all shapes and sizes. In 2006, Anheuser-Busch spent more than a quarter of a billion dollars on sports advertising. American Express was a corporate sponsor of the 2006 National Basketball Association (NBA) draft. Sony sponsored the Hawaiian Open golf tournament on the Professional Golf Association (PGA) Tour. The Pittsburgh Steelers play their home games at Heinz Field. We now have “Bears football presented by Bank One,” and the White Sox start their home games at 7:11pm because of 7-Eleven's support. Phil Mickelson and Annika Sorenstam tout Callaway Golf, and Tiger Woods is a Nike man. Gatorade is the “official” sports drink of the National Football League (NFL). All of these are examples of advertising in sports, which is a multibillion dollar business.

The reason for all this activity is simple: profit. Advertising (and other forms of promotion) is designed to increase demand for the advertiser's product. Some advertising does this by being informative, whereas other forms do this by being persuasive. In either event, the idea is to increase the quantity demanded at the same price or, viewed differently, to increase the price at the same quantity. Teams advertise their games to increase attendance, whereas leagues and organizations advertise the athletic competition that their members produce. Of course, producers of a wide array of goods and services advertise to sports fans on television and radio as well as at the venue. All of the billions of dollars that are spent on advertising are geared toward improving the advertiser's profit. To be successful, the ads must increase the advertiser's total revenue by more than they increase its total cost.

This textbook grew out of my dissatisfaction with other textbooks on sports economics that were available. As my own course evolved over time, these books became increasingly unsuitable for my class in part because of coverage and in part because of level and organization. This book reflects my interests and those of my students at the University of Florida. Unlike other books on this subject, this one includes extensive use of present values, choice under uncertainty, pricing models, and numerical examples. The content includes multiyear contracts, insurance, sports gambling, misconduct (and its discipline), the steroid scandal, and many other topics that are not standard fare in the existing sports economics textbooks.

An important pedagogical feature of this book is the involvement of students in the learning process through problem solving. At the end of each chapter, there are Problems and Questions that are intended to help students learn the concepts in the text. There are also some Research Questions that will help students learn how to find information and present it.

Introduction

Many cities have an unmet demand for a professional sports franchise in their midst. Whenever an existing franchise expresses an interest in relocating to greener pastures, there is no apparent shortage of willing hosts. The same is true when one of the major sports leagues contemplates expansion. For strategic reasons, the major sports leagues make sure that there are a few viable locations that go unserved. In this way, they ensure the presence of excess demand and thereby improve the credibility of threats by existing franchises to move. This excess demand also provides leverage when either a new or existing franchise is bargaining with a city for benefits.

Cities also compete for major sports events. Major cities around the world compete with one another to host the Olympics or the World Cup. On a somewhat smaller scale, Omaha pursued the College World Series. Some U.S. cities compete to host the NFL player draft, which has turned into a media event. Cities compete in the only way they can by providing benefits to the organizers. Usually these are legitimate, but there have been instances of corruption.