A New Solution to Competitive Balance in Major League Baseball

Is it time for the Diamondbacks and Pirates to start spending some money?

Why MLB Needs a Salary Floor

During the 2002 labor negotiations, baseball owners arrived at the bargaining table with a unified central vision: To improve competitive balance while curbing skyrocketing player salaries. The most obvious way to achieve this goal would have been through a salary cap, a paradigm enjoyed by owners in the other Big Four sports. The MLB Player’s Association, however, vehemently opposed this policy, as it would have limited large-market teams from setting the salary bar indefinitely high during free agency.

So the owners and players compromised. The new Collective Bargaining Agreement (CBA) called for the institution of something of a “soft” salary cap. In comparison to a hard cap, under which teams cannot surpass a certain salary limit, a soft cap simply creates a disincentive system towards such excessive spending.

Two key facets of this soft cap scheme were the luxury tax and revenue sharing. The luxury tax, in essence, punishes the New York Yankees for crossing a certain threshold payroll (I say “punishes the Yankees” because the threshold has been so absurdly high that the Yankees have been the only perennial contributors to this fund). Moreover, given the requisite financial health of teams paying it, the luxury tax has been little more than a slight nuisance, rendering it ineffective as a means of inducing competitive balance and restricting salaries.

Revenue sharing, on the other hand, has had a more complex effect on the economic state of MLB. It is fairly self-explanatory, as teams set aside a portion of their yearly revenue (around 31%), which gets pooled together and then redistributed evenly. To get a sense of how this affects overall competitive balance, the mean revenue for teams in 2009 was $196,600,000, with a standard deviation of $57,308,963. That figure dropped to $39,543,184 after revenue sharing, indicating the variance in revenues decreased quite a bit through this practice. Needless to say, this revenue sharing system can improve competitive balance by providing poorer teams with more cash.

Revenue sharing also serves a means of salary depression. According to economic theory, without revenue sharing, owners simply need to ensure that a player’s value equals his marginal revenue product (MRP). That is, a player is worth the value he returns in the forms of ticket sales, merchandising, etc. With revenue sharing, however, owners now need to ensure that a player’s salary is restricted to just 69% of his MRP, as the owner will need to share 31% of his value with other teams. Owners will therefore be less willing to grant large contracts, or, at least, contracts that respect a player’s true market value.

It appears that this system falls nicely into line with the owners’ aforementioned goals. This is partially true. Granted, revenue sharing boasts a foundationally sound framework for depressing player salaries. With regards to competitive balance, however, the revenue sharing structure is fundamentally flawed. Why? Because the system says nothing about how shared revenue is to be spent. This loophole has created an ironically adverse effect, allowing teams to gain revenue while stagnating salaries and thus doing nothing to improve overall competitive balance.

Let us examine this phenomenon in further depth. The average shared revenue by teams in 2009 was $60,946,000. Ideally, all twenty-two teams generating less than this figure (and thus benefiting from the subsidy) should be using the money gained to increase their payrolls. Thus, for these organizations, we should find that 2010 payroll as a proportion of adjusted revenue should be greater than 2009 payroll as a proportion of initial revenue. For nearly two-thirds of the relevant teams, however, this assumption fails to hold true.

Declines in Payroll as a Proportion of Revenue After Receiving Revenue Sharing, 2009-2010

Team	2009 Payroll/Initial 2009 Revenue	2010 Payroll/ Adjusted 2009 Revenue
Los Angeles Dodgers	51.49%	48.57%
Seattle Mariners	50.98%	50.50%
Atlanta Braves	50.64%	43.80%
Cleveland Indians	43.39%	32.10%
Toronto Blue Jays	43.77%	33.36%
Milwaukee Brewers	43.82%	43.32%
Cincinnati Reds	43.02%	40.45%
Arizona Diamondbacks	42.99%	33.93%
Kansas City Royals	41.48%	40.54%
Texas Rangers	41.07%	31.48%
Oakland Athletics	39.94%	30.64%
Washington Nationals	38.92%	36.59%
Pittsburgh Pirates	31.41%	20.81%
San Diego Padres	30.16%	23.48%

These teams are the “parasites” of MLB, simply reaping the benefits of other teams’ subsidies while not actually doing their part in Bud Selig’s quest for competitive balance. The Pittsburgh Pirates, Arizona Diamondbacks and Cleveland Indians are the worst violators, each exhibiting drops of roughly 11% in payroll as a proportion of revenue after receiving the subsidy. Low and behold, from 2009-2010, the Diamondbacks and Pirates both came in last place in their respective divisions while the Indians finished next to last. It is unclear where the shared revenue is going, but it is clearly not being used for its intended purpose.

So, with the current CBA expiring in December of 2011, here is a revolutionary proposal: What MLB should do in order to increase competitive balance is not introduce a hard salary cap. On the contrary, what baseball needs is a salary floor. A salary floor is the very opposite of a cap. Instead of limiting spending done by large market teams, the new CBA should simply mandate a minimum amount of money each team spends on salary each season.

Consider that in 2009, payroll accounted for 21% of the variance in wins, indicating that teams must spend their money if they wish to win. Winning, in turn, generates more cash, accounting for 22% of the variance in revenue. This figure of 22% indicates that winning is actually more influential than market size (r-squared= 20%) in determining revenue. This revelation leads to an important insight: small market teams have the capacity to succeed, but they must apply more of their funds towards payroll. A salary floor creates a system of self-regulation that fosters competitive balance through mandated spending. As such, it should be considered in the upcoming CBA negotiations.