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The long-standing issue of payroll disparity in Major League Baseball (MLB), its impact on team performance, and potential solutions such as revenue sharing and salary caps. The document also discusses the historical context of the issue, including the era of free agency, the formation of the MLB Players’ Association, and the implementation of the luxury tax.
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Running head: PAYROLL DISPARITY AMONG MAJOR LEAGUE BASEBALL 1 Payroll Disparity Among Major League Baseball Teams: Building a Competitive Team Despite Limited Resources Sarah Holtschneider A Senior Thesis submitted in partial fulfillment of the requirements for graduation in the Honors Program Liberty University Spring 2020
Acceptance of Senior Honors Thesis This Senior Honors Thesis is accepted in partial fulfillment of the requirements for graduation from the Honors Program of Liberty University.
Scott Ehrhorn, Ph.D. Thesis Chair
Tammy Brown, DBA Committee Member
David Schweitzer, Ph.D. Assistant Honors Director
Date
Payroll Disparity Among Major League Baseball Teams: Building a Competitive Team Despite Limited Resources Introduction There has been an inequality in payroll among Major League Baseball teams for many years. Not only is there a disparity in payroll between separate teams, but there is also pay variation among players on individual teams. The inequality in payroll among MLB teams and players became increasingly apparent after the era of free agency, the formation of the Major League Baseball Players’ Association (MLBPA), the strike of 1994, and the Curt Flood Act of 1998 (Grow, 2016; Krissoff, 2013). Studies have shown, as one would expect, that an individual team’s payroll has a significant impact on that team’s success (Lu, Matthews, Wang, & Zhuang, 2018). In effect, this decreases the chances of small-market teams reaching and succeeding in the postseason compared to larger-market teams and, therefore, causes a competitive imbalance within the league. Relatively few fans want to see the same teams win the World Series year after year, and no fans want to see their favorite team lose year after year, so MLB implemented a revenue sharing program in an attempt to lessen the pay disparity among teams and improve the competitive balance. While the plan does not make all teams equal, Rockerbie & Easton (2018) found that revenue sharing produces significant utility gains at little cost. The agreement intended to alleviate the growing inequalities found among large- and small-market teams and improve the competitive balance within the league. Despite MLB’s implementation of revenue sharing, payroll disparity and competitive imbalance are still present throughout the league. While a team’s payroll has a significant impact on their performance relative to other teams, it is
not the only contributing factor to a team’s success. There are a number of ways that small- market teams can build a competitive team despite their low budget. Payroll Inequality Among Teams The payroll inequality among teams has not always been as evident as it is today. The valuation of MLB teams today ranges from $1 billion to $4.6 billion dollars, with twenty-two out of thirty teams being valued at less than $2 billion, five teams being valued at $3 billion or more, and only one team being valued at more than $4 billion: the New York Yankees at $4.6 billion (“The Business of Baseball,” 2020). Four main occurrences contributed to the rise of player salaries and the increasing disparity among team payrolls: the era of free agency, the formation of the Major League Baseball Players’ Association (MLBPA), the strike of 1994, and the Curt Flood Act of 1998. Lu et al. (2018) confirmed that when a team pays more to its players, it enhances the team’s winning percentage. Similarly, organizations that compensate their employees at higher levels than their competitors should expect to enjoy superior performance (Hill, Aime, & Ridge, 2016). Having a higher payroll allows teams to offer star players higher salaries, persuading them to sign with them rather than with a small-market team. Free Agency The minimum salary for MLB players in 2020 is $555,0 00 (MLB, n.d.). This means that every MLB player is in the top one percent of American households (Krissoff, 2013). However, this has not always been the case. It took lengthy and extended labor negotiations and the emergence of new revenue sources for players to be able to make what they make today. In 1887, professional baseball owners added the reserve clause to contracts restricting their players from signing contracts with new teams which limited players’ options to negotiate salaries in an
Curt Flood Act Three Supreme Court decisions led to MLB’s exemption from antitrust laws with the Court originally upholding in 1922 that professional baseball did not constitute interstate commerce (Grow, 2016). This immunity to antitrust laws meant that players could not file lawsuits against the league under antitrust laws. However, after the 1996 collective bargaining agreement was approved, both sides agreed to jointly petition Congress to repeal baseball’s antitrust exemption solely for purposes of allowing Major League players to file antitrust suits against the league (Grow, 2016). The Curt Flood Act of 1998 allowed this and, therefore, equalized the power between players and owners. Though the Curt Flood Act passed in 1998, it started developing in the 1970s when Curt Flood lost his case for free agency. Shortly after his case, in 1975, a ruling by arbitrator Peter Seitz granted Major League players the right to move from one team to another for the first time (Krissoff, 2016). Knowing this ruling would soon be granted, Andy Messersmith and Dave McNally opted to play the 1975 season without agreeing to terms on a new contract with their teams for upcoming years. After the season, the two claimed that the reserve clauses in their 1974 contracts only allowed their teams to claim their services for one additional year (the 1975 season) and that they should be granted free agency so they may sign with whichever club they choose (Grow, 2016). MLB attempted to dispute their interpretation, but a panel of arbitrators ruled in favor of the players, and they were granted free agency for the 1976 season (Grow, 2016). However, owners tried to take this right away from them at every chance they could. In the 1985, 1986, and 1987 off-seasons, owners collectively agreed amongst themselves that they would not bid on each other’s free agents. The MLBPA then filed grievances charging the owners with collusion, and the owners settled these claims by
agreeing to pay the affected players $280 million in restitution (Grow, 2016). Over the next few years, owners and the MLBPA continued to disagree and could not come to terms on a new collective bargaining agreement before 1993. This is what triggered the strike of 1994 and caused the league to cancel the World Series for the first time in 90 years (Grow, 2016). The two sides finally reached an agreement in November of 1996 which included a provision explaining that the Clubs and the MLBPA would work together to pass a law that would cover MLB players under the antitrust laws giving them the same rights as other professional athletes while the passage of the bill would not affect the antitrust laws in any other way (Grow, 2016). This agreement is what eventually resulted in the passage of the Curt Flood Act in 1998. Within Team Pay Inequality While payroll inequality among teams seems to be the most evident factor in a team’s performance, there have also been studies analyzing the correlation between intra-team payroll and the team’s success. Today, player salaries range from the league minimum of $555,000 up to $38.3 million (MLB, n.d.; Langs, 2019). Breunig, Garrett-Rumba, Jardin, & Rocaboy (2013) found that there is a negative relationship between wage dispersion and overall team performance. They concluded that increased wage dispersion leads to lower individual effort, and consequently, lower team performance (Breunig et al., 2013). Their findings support the theory that a small-market team with lower wage dispersion could perform better than a large- market team with a high wage dispersion. Tao, Chuang, & Lin (2016), tested whether the tournament theory or the cohesiveness hypothesis is supported by the relation between salary dispersion and team performance. The tournament theory suggests that employees’ efforts are dictated by the spread between the
Success of Small Market Teams versus Large Market Teams The growing revenue and payroll inequities as well as the competitive imbalance between teams became increasingly evident in the mid to late 1990s. In 1999, Commissioner Allan “Bud” Selig assembled the Blue Ribbon Panel to study the effects this inequality had on outcomes in MLB games, specifically postseason games (Hill & Jolly, 2015). The Panel divided all teams into four quartiles based on the club’s payroll, with Quartile 1 consisting of the teams with the highest payroll and Quartile 4 consisting of the teams with the lowest payroll. There were 158 post-season games played during the 1995-1999 seasons, and no teams from the bottom two quartiles won a post-season game during this period (Hill & Jolly, 2015). Additionally, every team that won the World Series during each of those five seasons had a payroll that fell into Quartile 1 (Hill & Jolly, 2015). Between 2000 and 2019, this trend seemed to continue, though not as extreme. Many more small-market teams made it to the postseason and won games, but the World Series champions continued to be teams with high payrolls. Two out of the last twenty World Series champions had the highest payroll in the league as of opening day (the 2000 New York Yankees and the 2009 New York Yankees). Three more champions had the second highest payroll (the Boston Red Sox in 2004, 2007 and 2018), and two more had the third highest payroll the year they won it all (the 2013 Boston Red Sox and the 2019 Washington Nationals). Nineteen out of these twenty champions had an opening day payroll that ranked in the top 50% of teams for that season. Only one World Series champion between 2000 and 2019 had an opening day payroll in the bottom 50% of payrolls: the 2003 Florida Marlins, whose payroll was ranked 25th^ out of 30 teams (USA Today, 2020).
MLB’s Attempt to Reduce Pay Inequality As the payroll disparity became more and more evident within the league, MLB attempted to lessen the disparity in two ways. The first, and more impactful, is the revenue sharing program first implemented in 1996 that redistributes a percentage of local and national revenues from large-market teams to small-market teams. The second is the competitive balance tax, more commonly known as the luxury tax, which is similar to a salary cap such that it penalizes teams for spending more than a certain amount on payroll for one year. Revenue Sharing Program The revenue sharing program used in MLB was first instituted in 1996 (Rockerbie & Easton, 2018). Motivations for implementing a revenue sharing plan included supporting small market teams, affecting league parity, suppressing player salaries, and improving team profitability (Rockerbie & Easton, 2018). Small market teams struggle to compete with large market teams when it comes to signing star players and winning championships. Revenue sharing can also help suppress player salaries, and this is especially useful in MLB because the league does not have a hard salary cap for its players or its teams. The revenue sharing plan negotiated in the 2003-2006 collective bargaining agreement increased the marginal tax rates associated with teams’ revenues from the 1997 collective bargaining agreement levels which resulted in rates of 40% for high-revenue teams and 47% for low-revenue teams (Hill & Jolly, 2015). Under the 1997 collective bargaining agreement, the rates were 20% and 41% for high and low revenue teams, respectively (Hill & Jolly, 2015). Owners and players agreed to these changes because they hoped it would increase competitive balance on the field, but the changes did not have the intended effects. Some teams lowered
or more offenses. It is estimated that the New York Yankees paid $304 million in tax over the 2002 - 2016 seasons (Rockerbie & Easton, 2018). The competitive balance tax certainly discourages teams from utilizing high payrolls, but as seen with the Yankees, it does not prevent it completely. The tax assists in keeping team payrolls within a certain range, but the tax revenue is not redistributed to any MLB teams and, therefore, lacks the redistributive component that the revenue sharing program implements. Salary Cap and Salary Floor While MLB does not have a salary cap, the competitive balance tax is viewed as a type of salary cap by many baseball professionals, owners, and fans. There are two types of salary caps: hard salary caps and soft salary caps. A hard salary cap prohibits teams from going over that salary under any and all circumstances, such as in the NFL. A soft salary cap, which is what the NBA has in place, allows teams to go over the set threshold but will penalize them in other ways such as fines or a luxury tax. Even though the competitive balance tax in MLB is not called a salary cap, it is very similar to a soft salary cap. Implementing a hard salary cap is one way MLB could lessen the disparity among team payrolls. The salary cap for NFL teams in 2019 was $188.2 million (Shook, 2019). The luxury tax threshold in 2019 was $206 million and will increase to $208 million in 2020 (MLB, n.d.). It is hard to imagine the league implementing a hard salary cap that is below the current luxury tax threshold, but even if they set a hard cap at the current luxury tax threshold, it would prevent teams from going over the threshold. However, with the MLB’s historic opposition to having a salary cap, and with the soaring revenues that the league is seeing today, the league as well as the MLBPA would likely reject implementing one now. Because of this, an alternative route that the
league could choose to go would be to implement a salary floor. A salary floor would require teams to spend a minimum amount on payroll every year. As discussed earlier, every team received over $200 million in 2018 from the revenue sharing redistribution system (Baseball Reference, 2020c). Still, there are teams that have a payroll of far less than these amounts. While not all of this can go straight toward player payroll for every team, much of it can. Team payrolls for 2019 ranged from $53.5 million to $211.5 million; a difference of $158 million (USA Today, 2020). Implementing a salary floor of $75 million or even $100 million would decrease the payroll disparity and improve competitive balance. A salary floor, and what it should be set at, could be discussed for the next collective bargaining agreement that will need to be renewed in 2022. Seeing inequality in payrolls within MLB seems to be inevitable today and will most likely continue to be a problem for many years to come. Factors that contributed to growing the disparity in the league included the era of free agency, the formation of the MLBPA, the strike of 1994, and the Curt Flood Act of 1998. The affect pay inequality had on the competitive balance within the league became increasingly evident in the 1990s when no lower payroll team won a single postseason matchup during the 1995-1999 seasons, and this competitive imbalance due to payroll inequality has still been apparent over the last twenty years and today. MLB has recognized this disparity and has taken steps towards diminishing the payroll inequality and competitive imbalance within the league by implementing a revenue sharing program and a competitive balance tax threshold. Though these undertakings have had a positive affect for the league as a whole, pay inequality still seems to be the main factor that contributes to the competitive imbalance we continue to see in the league. Small market teams must learn how to
performance. This approach, first used by Oakland Athletics’ GM Billy Beane and his assistant Paul DePodesta led the Oakland Athletics to high winning percentages despite the team’s low payroll by analyzing statistics about a player’s walks and on-base average, rather than what traditional baseball scouts could see with their own eyes. Small-market teams can only afford one-tool players. According to the moneyball approach, the most efficient way to spend money on baseball players is to spend it on hitters (Lewis, 2003). Eric Walker (as cited in Lewis, 2003), a former aerospace engineer turned baseball writer, wrote that fielding was “at most five percent of the game” (Lewis, 2003, p. 58). The rest was pitching and offense (Lewis, 2003). At the time, good pitchers were usually valued properly while good batters were not. Lewis (2003) cited Walker as having stated, “[The] most critical number in all of baseball is 3: the three outs that define an inning. Until the third out, anything is possible; after it, nothing is” (p. 58). He went on to explain that the goal of an offense is to decrease its chances of making an out and that on- base percentage is an isolated, one-dimensional offensive statistic that measures exactly that: the probability that the batter will not make an out and will not put the team closer to the end of the inning (Lewis, 2003). This simple observation was overlooked by almost all general managers in MLB at this time. GM’s also tended to overvalue RBIs, the runs batted in statistic. RBIs were treated as an individual achievement. However, in order to hit runners in, there must be runners on base when a player comes to bat. A player’s ability to hit base runners in and receive credit for an RBI, is heavily based on the achievement of others and/or luck. Bill James, an American baseball writer and statistician, explained that the RBI statistic, among other baseball statistics, “are not pure accomplishments of men against other men,” but “they are accomplishments of men in combination with their circumstances” (Lewis, 2003, p. 71). General managers in MLB
during this time overvalued a player’s batting average and RBIs and undervalued a player’s on- base percentage and slugging percentage. According to Lewis (2003), James also observed that a hitter should be measured by his success in creating runs. James disputed the belief that the purpose of an offense is to compile a high batting average by stating that the purpose of an offense is actually to score runs. He explained that the number of runs a player creates cannot be directly measured, but the number of runs a team creates can be. James built a model to predict how many runs a team would score given its number of hits, walks, stolen bases, etc. He achieved this essentially by predicting the past. Using the statistics of the 1975 Red Sox, he determined the relative importance of what players did at the plate and on the base paths to the team’s scoring patterns and assigning weights to outs, walks, steals, singles, doubles, etc. The first version of what James called the Runs Created formula is as follows: Runs Created = (Hits + Walks) Total Bases / (At Bats + Walks) The accuracy of this equation revealed that baseball professionals, owners, and general managers did not place enough value on walks and extra base hits, which are featured prominently in the Runs Created model, and placed too much value on batting average and stolen bases, which are not even included in the model (Lewis, 2003). The essence of the moneyball hypothesis is that the ability to get on base was undervalued in the baseball labor market. Hakes and Sauer (2006) used linear regression analysis to demonstrate that on-base percentage is a powerful indicator of how much a batter contributes to winning games. The results of their analysis confirmed that there is a high correlation between runs scored and linear combinations of on-base and slugging percentage.
was higher than it was in the 1980s and early 1990s, it was much lower in the 2000s than it was in the late 1990s (Baumer & Zimbalist, 2014). Farrar and Bruggink (2011) also used the moneyball approach to show that MLB general managers do not reward hitters in a manner reflecting the relative importance of on-base percentage and slugging percentage. The two developed a team run production model and a player salary model to determine how an increase in on-base percentage and slugging percentage increases salary (Farrar & Bruggink, 2011). They found that a 10 unit increase in team on-base percentage brings in an additional 28.5 runs, and a 10 unit increase in team slugging percentage results in an additional 17.4 runs (Farrar & Bruggink, 2011). The player salary model shows that the 10 unit increase in individual on-base percentage costs $370,500 while the 10 unit increase in individual slugging percentage costs $369,800 (Farrar & Bruggink, 2011). These results show that for approximately the same increase in salary, an increase in on-base percentage brings in 11.1 more runs than the same increase in slugging percentage (Farrar & Bruggink, 2011). Even years after the publication of Moneyball , on-base percentage continues to be undervalued, and slugging percentage is overvalued. The moneyball hypothesis seems to have been accepted by teams, baseball professionals, and fans throughout all of baseball. However, as these two studies reveal, it is not fully implemented and utilized to its full potential. Today, employing only the moneyball hypothesis does not give a team much of an edge over other teams as it did for the Oakland Athletics in the late 1990s. There are many other strategies that small-market teams can apply in order to compete with large-market teams with much higher payrolls.
Utilizing the Farm System An additional way small-market teams can build a competitive team despite their low budget is to utilize the farm system and the annual draft. Every MLB team has minor league team affiliates, typically consisting of at least a Class A team, a Class A-Advanced team, a Double-A team, and a Triple-A Team. Select MLB teams also have Class-A Short Season teams. Additionally, every team has at least two rookie teams (many teams have more than two). The MLB First-Year Player Draft is held every year in June and all thirty Major League Clubs participate. The teams take turns selecting players in reverse order of their win-loss records at the close of the previous regular season. In other words, the team with the worst record from the previous regular season selects the first player in the draft in the following year. Additionally, the order is based off regular season records; the postseason has no effect on the draft. Just because a team wins the World Series, it does not necessarily mean they pick last in the draft. When a team drafts a player, that club has full control over the player for at least three full seasons. After these three seasons, a team must decide to place the player on the team’s 40- man roster, meaning that the player has a major league contract, or the player becomes eligible for the Rule 5 Draft^1. Once a player signs a major league contract with a club, he does not become eligible for free agency until he has at least six years of service time on a major league team. Specifically, the player must have six years of service time on a major league 25-man (^1) The Rule 5 Draft, held every December at the annual Winter Meetings, allows teams without a full 40-man roster to select non- 40 - man roster players from other clubs (Major League Baseball, 2020 b). It is organized similarly to the First-Year Player Draft as clubs draft in reverse order of the standings from the previous regular season.
