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Competitive Balancing Act I, Scene II—The King James Version: An Overview of the Literature
2004-03-02 21:48
by Mike Carminati

Other entries in the series:

Competitive Balancing Act I—The King James Version: An Overview of the Literature, Scenes I, II, and III
Competitive Balancing Act II—This Is Pop: Redefining Large- and Small-Market by Population
Competitive Balancing Act III—C'mon Freddy, Everyone into the Poo-el: Reviewing the Available Player Pool
Competitive Balancing Act IV—Natural Resources: Attendance and Competitive Balance

This morning I opened the morning paper—well, actually the morning paper is reading ESPN online, but you get the nub of my gist—and looky look what issue Giants owner Peter Magowan used to deflect attention from new allegations that Barry Bonds received steroids? Why, it's none other than competitive balance, that bugbear of the egalitarian major league baseball ownership:

"In terms of competitive balance it is not good for baseball," Magowan said Monday in his first appearance at spring training.

"The Rodriguez trade moves us back to where we're escaping. The team with the highest payroll can add the highest-salaried player. It's good that A-Rod is playing in a big market, but it should be another big market," he said.

"I think all of us in baseball would prefer to get a salary cap if we could," he said. "The Yankees are probably the only ballclub that would not want to have one. They have a payroll of $185 million. We'll probably start the season at $80 million. The Yankees could be the only team to have to pay a payroll tax."

Of course, Magowan, who evidently is watching too many reruns of "Escape from New York" on TNT, fails to mention that between the money that the Rangers will kick in to get rid of the best player in the league, the Yankees also dumped Drew Henson, Aaron Boone, and Alfonso Soriano amigo money. In total, A-Rod will cost the Yankees $2.14 M more than they were spending before the Boone injury

(That is, the cost is $21 M for A-Rod's contract. Subtract the $40 M over seven years that the Rangers are paying on his contract, or $5.7 M—the Yanks also get $27 for deferred money. Then subtract $5.75 for Boone, $5.4 for Soriano, and $2 M for Henson in 2004, and you get $2.14 M. You can add in the Henson money, $12 M in total, if you want. You can subtract the contract of whomever they get to replace Enrique Wilson at second if you want as well.)

"[A]ll of us in baseball" want a salary cap? I think the players would disagree. However, is it surprising that the owners want a salary cap? Payroll is a very big expense. Of course the owners want to limit it. What owner doesn't? Just ask Marx.

That's why all of the owners except the Yankees are treating the payroll tax threshold as a cap. That's the reason that A-Rod slipped through the Red Sox fingers in the first place. It was reportedly over $3 M that would have pushed Boston too close to the payroll tax limit.

However, Magowan's blast was just the opening salvo in MLB's new war on the Yankees. It took a few weeks but the doomsayers are coming out in full force. I guess spring training brings out the best in all of us.

The denuded Jayson Stark, who somehow looks odder without his Groucho 'stache than with, reports that "MLB suspects the true value of YES to this club is actually much higher [than the $50 M a year that the Yanks report and]… sources say that MLB is ready to bring in an independent auditor to determine YES's true market value to the team. If that value turns out to be more than $50 million, the Yankees would have to pay another 40 percent of that difference. Not just this year. Every year. Retroactively." (Italics his)

But that certainly would not be the end of it as the Yankees would try to block any such action. Not only that, they may go on the offensive and there are plenty of targets to go after with the Braves, Cubs, and Red Sox all having some ownership over their cable partners. As Doug Pappas found, there is some reason that each is undervaluing their cable deals or using their relationship to hide money some way or another (e.g., the Cubs charge themselves three times the norm for advertising).

However, I can't imagine that the Bud and his boys would actually follow through. I think it's another idle threat, like contraction. Although, it's the typical knee-jerk reaction that we're all used to by now. But the last thing the powers that be in MLB want is to open their books to anyone.
That said, only MLB is shortsighted enough to follow this path. So who knows?
Bob Raissman, whose moustache apparently swallowed Stark's, points out that the nascent YES network may have lost money due to legal wrangling and a very limited audience in the first year or so. And if that's the case, would MLB kick back some money to them? I can't imagine that's the case though: why would the Yankees have reported more revenue than actual, just to pay additional luxury tax money? (Thanks to Charlie Mikolajczak for the link.)
If baseball wants to correct the "Yankee problem", there's a simple and logical solution. Move the Expos to North Jersey. Having a third team in the NY metro area would siphon off a few dollars. Some will say that the Expos could never compete with the two established franchises. However, does anyone remember that the New Jersey Devils were a struggling team from Denver when they moved into an area already inhabited by two well-established teams. The Rangers had legions of devoted fans and the Islanders were still a championship-caliber team (I believe) at the time. And the Devils don't seem to be hurting today. They've won a couple of championships. They may not be as popular team in the area, but they have to outdraw the Columbus Blue Jackets.
A third of the NY metro area would constitute the largest fan base (7,066,622 based on the 2000 census) available in North America. But baseball does not want teams to relocate anymore. I'm not really sure why. Is it so that Peter Angelos doesn't get scared that a team will move into Northern Va? They like to threaten to move, but ever since the Rangers moved to Arlington, they have done everything possible to avoid a team moving. The creation of the Mariners, Devil Rays, Marlins, and Rockies was to either avoid either a lawsuit or congressional action to remove their "antitrust exemption" because a team wasn't allowed to move to the area concerned.
Or why not a third option, let Steinbrenner spend, and live off his welfare money? It's certainly the only goal of the Brewers in 2004. As Stark point out, the funds will not be drying up any time soon. Besides the Yankees have not won a Series since 2001, so it's not like they are building a monopoly. They simply have a business model, as Levine says, that works well. It works because of their large and devoted fanbase and because of a smart and resourceful management team. Baseball should be trying to emulate them but all they can do is carp. They won big-time with the last CBA, have a 29-team salary cap, can run roughshod over one of their teams (Expos), can have their "expenses" (i.e., executive salaries) outpace salaries especially in the last few years, and yet this is what they choose to worry about. It's unbelievable.

Anyway, before we foray into more articles on competitive balance, I just wanted to remind you that the issue has not died since the signing of the last CBA.

An Historic Overview of Independent Studies

Competition has been shown to be useful up to a certain point and no further, but cooperation, which is the thing we must strive for today, begins where competition leaves off.

—"Ryan" Franklin D. Roosevelt

Well, now that we have looked at some introductory articles and fully refuted, hopefully, the Blue Ribbon Panel's report, it's time for a full overview of the studies on competitive balance. Most of the studies have something interesting to offer if you can get past the rather dry, academic manner in which they are presented. However, most have severe limitations because of the definition for and scope of competitive balance that the author chose. But without further ado…

Simon Rottenberg, "The Baseball Players' Market" (Journal of Political Economy, 64, 1956, pp. 242-258)

By 1956, the reserve clause that bound players to their teams had been in effect in some form or another for 77 years. There had been challenges to it, most recently in the early Fifties accompanied by Congressional hearings, but none had been successful. The owners had maintained that the reserve clause was necessary to insure competitive balance. Without it, the richest teams in the largest markets would monopolize all the talent, they claimed, and the result would a lack of fan interest or worse, an economic infeasibility for baseball as a professional sport. As it was, baseball's collective monopsony, i.e., a state in which teams act in congress to ensure that there is a singular buyer for a given player's skills, reduced player competition and, therefore, salaries. What a happy byproduct!

Rottenberg did the seminal work on competitive balance in the sport in 1956. He argued that a player ended up on the team that valued him most if player sales are unrestricted. Whether by free agency or via player sales by poorer teams, the teams with the most means would end up with the players they most desired.

However, extremely one-sided competitions would have diminishing marginal returns (or MRP for marginal revenue product) as fans would lose interest. His "uncertainty of outcome" hypothesis stated that the closer the competition between teams within a professional league, the greater the fan interest in the sport and the greater the attendance. So acquiring more talent becomes less critical if the subsequent competitive imbalance would create fan boredom and a decrease in revenue. Additionally, the dominant team's interest in a player is limited by the number of players it can have on its roster by league rules (though some can be hidden in the minors as well), by the number of players it can field at any given time by the rules of baseball, and by diminishing marginal returns for the additional wins.

It's like the farcical Onion article from last season, that the Yankees had signed every major league player. After you have one All-Star shortstop, you don't need another. Consider that the Yankees did not get involved in the Alex Rodriguez sweepstakes until Rodriguez offered to move to third. With Derek Jeter on the roster, they did not need another shortstop, even if he was the best player in the league.

The marginal revenue generated by the additional talent and the attendant, additional wins would not outweigh what it would take to acquire that talent. All teams, even the Yankees, strike a balance between revenue and cost of talent no matter whether the rules entail free agency or the reserve clause. Teams would limit themselves from getting too dominant or so was Rottenberg's opinion.

Ronald H. Coase, "The Problem of Social Cost" (Journal of Law and Economic, 3, 1960, pp. 1-44)

Coase established an economic theory that buttressed Rottenberg's argument. Coase does not cover baseball specifically, but he seems to have an affinity for the business of baseball: "[T]his paper is concerned with those actions of business firms which have harmful effects on others." Perhaps he understood it better than the lords of the game back in the day: "[I]f we are to discuss the problem in terms of causation, both parties cause the damage. If we are to attain an optimum allocation of resources, it is therefore desirable that both parties should take the harmful effect into account in deciding on their course of action". It sounds like competitive balance to me.

His Invariance Proposition (strong version) held that in the absence of transaction cost, the resulting allocation will be independent of the original property rights. In baseball terms, if a player's MRP is the greatest for a certain team, he will end up on that team.

And that was just about the beginning and the end of the conversation. Just about all academic study is preoccupied with defending or refuting Rottenberg/Coase. The two major points of Rottenberg's hypotheses have been the foundation of all conversation on the topic. Either one studies the effects on fan interest and therefore revenue from the competitive (im)balance within a game or throughout a season or one studies whether free agency has affected competitive balance. Sure, there are independent authors who have struck off in their own direction (James and Zimbalist for two, both of which will be covered later). However, the academic conversation has only served to tweak Rottenberg.

Steven Cheung,. "The Fable of the Bees: An Economic Investigation" (Journal of Law and
Economics, 16, 1973, pp.11-33)

Cheung's article had nothing whatsoever to do with baseball but rather bee farmers, and it is the farthest that I will go afield. However Cheung makes a point that should be remembered while viewing the remaining baseball-related studies.

The "fable of the bees" was an allegory for the theretofore historic economic thought. Cheung used the example of apple growers and beekeepers. The nectar from the apple blossom sustain the bees, and the bees pollinate the apple blossoms. They had one big synergistic system: even if the apple growers and beekeepers did not transact any business with each other, clearly they affected each others business (i.e. via what are called externalities).

Cheung called this fiction, that no business exists in a vacuum. Basically, there's some sort of Seven Degrees of Kevin Bacon that connect all businesses directly or indirectly. For example, beekeepers rent their bees out as a pollination service, and as such the businesses definitely commingle.

What Cheung did is say that businesses have to be fully investigated to determine if these externalities are actually key elements of the business. To understand a business one must understand the transaction costs (payroll and development and player acquisition costs) of doing business and what elements are external and what are not.

This must be kept in mind as we review the studies of free agency's affect on the business of baseball and to competitive balance in the game. If you don't recognize the myriad of other influences on the economy of baseball, your results will be fiction just like the "fable of the bees" (and a lot are).

And the Rest…

The issue of how free agency affects competitive balance became a hot topic even before free agency became a fact in baseball. In 1972, Harold Demsetz ("When Does the Rule of Liability Matter?," Journal of Legal Studies, 1, January 1972, pp. 13 – 28) agreed with the Rottenberg-Coase model:

In the absence of the reserve clause, a player would change clubs only if he found it in his interest to do so. With the reserve clause, a player will change clubs only if the club that owns his contract finds it in its interest. It appears that a different pattern of player migration between clubs might exist with the reserve clause than without it. But the appearance is deceptive. No matter who owns the right to sell the contract for the services of a baseball player, the distribution of the players among teams will remain the same.

However, when free agency started some early studies (Donald J. Cymrot, "Migration Trends and Earnings of Free Agents in Major League Baseball, 1976 - 1979," Economic Inquiry, 33, October 1983, pp. 545-56 and Cymrot and James A. Dunlevy, "Are Free Agents Perspicacious Peregrinators?," Review of Economics and Statistics, 69, February 1987, pp. 50 – 58) found that premier free agents seemed to be going to the highest bidders usually in bigger cities even if they were leaving a successful club.

The studies started to pour out once the free agency data started to mature (about 15 years). Gerald W. Scully (in The Business of Major League Baseball, 1989) is one of the first to measure competitive balance before and after free agency. He used two measures: the standard deviation of the league's team winning percentages and a Spearman Rank Correlation (which attempts to find how well two sets of data correlate by rank) between a team's overall winning percentage rank within a league and the population rank for that team's metropolitan area. His overall findings were that there were some indications of improved competitive balance in the NL for the ten years after the advent of free agency and the AL showed no change. (See also this article.)

I guess this is as good a place as any for me to review the problem of using standard deviation (SDs) in baseball studies. It's a problem that permeates these studies and scuttles many of them.

Let me explain: It’s my experience that SDs are dependent upon the size of your population. When population size changes, the SDs are no longer usable with the previous data from the smaller population. I’ll illustrate using an example:

There is an 8-team league from the pre-expansion era that has the following standings. The leader, the Mammoths, has a 126-28 record. They played 22 games against the other 7 clubs and were 18-4 in each season series. The other teams were all 70-84. They were 4-18 against the Mammoths and 11-11 against each other. Of course, this is a contrived scenario, but I wanted to have a league in which one club is clearly and equally superior to the rest and the remaining clubs are equally average. The average team would be 77-77 with a SD of 19.799.

Now, let’s pretend that the last round of expansion resulted in two 15-team leagues. Also, each team plays 11 games against the rest of the teams in the league (no interleague play). The best team in the league, again the Mammoths, has a 126-28 record after going 9-2 against each of the other teams. The rest of the teams finish at either 74-80 (7 teams) or 73-81 (7 teams). The 74-80 teams are 2-9 against the Mammoths and 6-5 against seven of the teams and 5-6 against the final six teams. The 73-81 teams are 2-9 against the Mammoths and 6-5 against six of the teams and 5-6 against the final seven teams. Again the average is 77-77. The SD is 13.565.

Which Mammoths team is the better one? This is the basis of Neyer’s dynasty book and I think he botched it (I wrote him about it and never got a response). The winning percentage in either case is the same, but the 15-team league is 3.61 SDs better than average whereas the 8-teamer is only 2.47 SDs better than average. I would be hard pressed to pick one as superior. They won the same number of games in the same number of attempts. They were equally superior, one-on-one, to the rest of the league. The rest of the league was (almost) equally average against each other. And yet the SDs say that the 15-teamer is much better.

That's because as you add more teams, your standard deviation gets smaller. It has to. So the teams from the expansion era looked better than the '27 Yankees. The 1986 Mets then look really great. You can't compare standard deviations across populations of different sizes.

The majors have expanded since the beginning of the "modern" era and have yet (Bud notwithstanding) to contract. Therefore, the more modern the data are the better it will score according to SDs. The end result in typical competitive balance tests is that leagues will appear to become more competitive as time goes on. One can employ linear regression (or multiple regression for more complex questions) to circumvent the issues with SDs, but it has its own attendant issues that I'll get to later.

Anyway, there are the SD issues here as well as the fact that the AL expanded by two teams in 1977, the second expansion in the majors in eight years, there were two work stoppages, and the owners colluded to suppress free agency for three of those years. The pre-free agency period (1961-76) included four rounds of expansion (ten teams), significant rules changes (the DH was instituted in the AL, the strike zone was redefined twice, and the mound was lowered), and the then ubiquitous new, multipurpose stadiums with Astroturf.

Actually, a 1985 study by David Besanko and Daniel Simon ("Resources Allocation in Baseball Players Labor Market: An Empirical Investigation", Review of Business and Economic Research, pp. 71-84) predates Scully. They compared the seven years before, 1970-76, and after free agency, 1977-83, again using SDs of team winning percentages. Even though the SDs decreased, indicating more competitive balance (I'm guessing, engendered by the round of expansion in 1977), the findings were not statistically significant and, therefore, inconclusive.

Rodney Fort and James Quirk combined for a few studies in the early Nineties (Pay Dirt: The Business of Professional Team Sports, The Brookings Institute, 1992 and "Cross-subsidization, Incentives, and Outcomes in Professional Team Sports Leagues", Journal of Economic Literature, Vol. 33, No. 3, 1995, pp. 1265-99). They used the same annual winning percent SDs but used multiple regression analysis that accounted for league expansion (by adding number of teams as an independent variable). The also added a dummy variable for the free agent years—basically, an on/off switch for free agency. Looking at data from 1966 to 1985, they found that competitive balance dropped but not significantly.

John Vrooman (1995, "A general theory of professional sports leagues," Southern Economic Journal, 61, pp. 971-990) used an "idealized" SD based on a 50-50% chance for each team to win a given game and found the exact opposite of Fort and Quirk, though also not significantly.

Furthers studies had similar results, that the Rottenberg/Coase hypothesis that free agency would not affect competitive balance could not be disproved. Some found indications that competitive balance was improving. These include Ira Horowitz in 1997 ("The Increasing Competitive Balance in Major League Baseball", Review of Industrial Organization, 12, pp. 373-87), Sumner LaCroix and Akihiko Kawara in 1999 ("Rule Changes and Competitive Balance in Japanese Professional Baseball", , V. 37.2), C.A. Depken in 1999 (Free Agency and the Competitiveness of Major League Basdeball", Review of Industrial Organization, 14, pp. 205-17—though he found against the hypothesis for the AL only), Dunlevy, Even, and Cymrot in 2000 ("Property Rights in Baseball: An Empirical Test of the Coase Theorem", ISNIE Annual Conference), Sherony, Haupert, and Knowles in 2001 ("Competitive Balance in Major League Baseball: Back to the Future", Nine: A Journal of Baseball History and Social Policy Perspective, V. 9, No. 2, pp. 225-236—link may no longer be good), and Lee and Fort in 2002 ("Time Series Analysis of Structural Change: Competitive Balance in Major League Baseball").

These studies have expanded the scope to include seasonal data from as early as 1901 and have controlled for expansion, the number of games played, and the amateur draft.

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