MLB’S ROOKIE SALARY STRUCTURE AND FREE AGENCY: EFFICIENT AND EQUITABLE?

Rui Xu

MLB DRAFT

Draft was formally established in 1964 Prior to the draft, amateur players were free

to sign with any team that offered them a contract

Effectiveness on suppressing signing bonuses? In 1964, year before draft, highest bonus was

$205,000 In 1965, highest bonus was $104,000

DRAFT PROCESS

Players are selected in a standard 30 team draft, with compensation picks added after pick #30

Players drafted with a certain pick are expected to sign for “slot value”

If/When a player signs with his team, he is then assigned to the minor leagues, with the opportunity to work his way up

EFFICIENCY AND EQUITABILITY OF DRAFT

The draft is obviously inefficient, as simple economics dictates a free market (Like the International Amateur Free Agent system) would be ideal 2009 top international FA: Aroldis Chapman, 6

years $30 million 2009 top domestic draftee: Stephen Strasburg, 4

years $14.5 million This system, however, is equitable in that it

allows smaller market teams to sign top-tier amateur talent

ROOKIE SALARY STRUCTURE

Once a player has joined his MLB team (ignoring options), he is under team control for 6 years until he hits free agency

These 6 years are the most important years for any team because they represent the highest value per dollar they will receive for any given player 2009 Justin Upton: .300 BA/26HR/86RBI: $400K 2009 Alfonso Soriano: .241/20HR/55RBI: $16 Mil.

MLB PLAYER FIRST 6 YEARS

Year 1: Major League Minimum ($400K in 2009) 2009: Colby Rasmus, Cardinals, $400K

Year 2: Major League Minimum + pay raise 2009: Clay Buchholz, Red Sox, $413,500

Year 3: Major League Minimum + pay raise 2009: James Loney, Dodgers, $465,000

Year 4: First Arbitration (~40% FA value) 2009: Andre Ethier, Dodgers, $3.1 Mil

Year 5: Second Arbitration (~60% FA value) 2009: Joe Blanton, Phillies, $5.475 Mil

Year 6: Final Arbitration (~80% FA value)

EFFICIENCY AND EQUITABILITY?

Again, like with the draft, this system is not efficient, but is equitable (from the owner’s perspective)

By drafting well and taking advantage of the marginal value of pre-arbitration players, teams like the Florida Marlins (2009 salary: $35 Mil. 2009 wins: 87) are able to compete with high salaried teams like the Phillies (2009 salary: $111 Mil. 2009 wins: 93)

FREE AGENCY

After a player has played with his team for 6 years (or is denied arbitration by his team), he becomes a free agent, where other teams may bid for his services.

Examples of 2009 FA Contracts: Matt Holliday, Cardinals, 7 Years, $120 Mil Jason Bay, Mets, 4 Years, $66 Mil John Lackey, Red Sox, 5 Years, $82.5 Mil

FLOOD VS. KUHN In 1969, Curt Flood found out that he had been traded from

the Cardinals to the Phillies. He refused to report to Philadelphia, citing “racist fans.”

In 1970, he brought the issue of the reserve clause, which limited a player’s free agency, to trial. It was heard by the Supreme Court in 1972, and MLB’s system was upheld. However, the judges stated that the antitrust exemption that the MLB was given for the reserve clause was tenuous at best, that players represented interstate commerce, and that system was an anomaly among other forms of entertainment.

In 1975, the Seitz Decision nullified the reserve clause, opening up free agency

EFFICIENCY AND EQUITABILITY: PART 3!

Unlike the draft and the rookie salary structure, the free agent system is essentially a free market, with players signing for their market value. Therefore, it is, indeed, efficient.

However, LIKE, the draft and rookie salary structure, efficiency and equitability are diametrically opposed: rich teams (like the Yankees and Red Sox) are able to sign the best players with least variance in performance, while poorer teams, by the nature of the system, rely on the pre-arbitration players with higher variance to sustain their organization.

ANALYSIS ON EQUITABILITY

In the time period (2002-2009), ~25% of the variation on wins were explained by variation in payroll.

In the time period 1977-1991, however, there was an insignificant correlation between wins and payroll

What does this mean? In the earlier period, the competitive balance was

equalized. It is possible that the smaller-market teams had better evaluation methods of players

The later period represents the “Internet age,” where information is freely available. Competitive balance is lost, so large payroll teams again dominate

CONCLUSIONS

1) The amateur draft and rookie salary structure are inefficient yet equitable, which helps poorer teams compete

2) The free agent system is efficient yet inequitable, which helps richer teams compete

3) In the 15 years after free agency, there was a competitive balance between rich and poor teams. Now, that balance has been lost

CONCLUSIONS (CONT.)

4) Ways a small market team can compete with a large market team Have better information/market inefficiency

(Read Michael Lewis’ Moneyball) Invest money forgone in the free agent market

(opportunity cost) into player evaluation and drafting to obtain several great, young, $400K a year players at the same time

Hope to get lucky with veteran players having aberrant years.