Like most baseball fans, I am shocked by the money going to free agents this off-season. I expected this to be a big year, but these numbers are off-the-chart huge, far higher than I anticipated. Because many of these contracts are long-term deals—Soriano got 8 freakin’ years, which is a totally different problem—I wondered if some anticipated revenue growth would be enough to explain these salaries. Maybe, by the time the contracts expire, the players will have generated value equivalent to the higher revenues the league will generate in the coming years. So, I decided to take a quick look.
I took the 2006 performances of Carlos Lee, Gary Matthews, Juan Pierre, Aramis Ramirez, and Alfonso Soriano, and assumed that these players would perform at the same level for the duration of their contracts (an upwardly biased assumption). I then determined the annual revenue growth rate needed to generate a value equal to the 2006 performance of each player over the course of the contract. For example, I estimate that Soriano generated over $12 million for the Nationals in 2006, far below the $17 million/year average of his contract. But, as revenue rises player performances will grow more valuable. Maybe by the time 2014 rolls around, $17 million won’t seem so expensive.
It turns out that the annual revenue growth needed to justify these contracts is about 10% for all of the players. TEN PERCENT! Heck, even if you assume modest inflation that’s a high growth rate. Now, I can easily buy a year or two of such growth—in fact, revenue did increase by about that much from 2004 to 2005—but this type of growth is
not sustainable very high for a large established business over a long period of time. At that rate MLB will be doubling its revenues in about 7 years. So, what is going on?
Hypothesis 1: All teams are plain nuts. (very unlikely)
Hypothesis 2: All teams are estimating on recent high growth as sustainable. (possible, but doubtful)
Hypothesis 3: A few teams are plain nuts or confused by recent growth. (likely, but not the full explanation)
Hypothesis 4: MLB has been making a lot more money than we thought, and for some reason teams are not restraining themselves the way that they have in the past. (hmm…)
I’ve been wondering about some language in the labor deal that settled some past collusion allegations, which occurred in 2002. Supposedly, this is no big deal, just patching up some minor disagreements. The settlement was small, but I wonder if the players gave up their fight because they had reached some agreement that would prevent future collusion, if it did exist. After all, A-Rod and Manny got big contracts in 2001 because owners thought they’d generate enough revenue to cover them. If the owners then figured out a way to shut off the tap, then these deals would stop. And that’s when the black helicopters swoop in…
Hey, this is way over-the-top conspiracy reasoning, but I am really curious as to what is going on here.
Addendum: Other suggested reasons are welcome.
Further Addendum: In the comments, Tangotiger points out that 10% growth in salaries is the historical norm over the past 20 years.