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Valparaiso Univ. Law School

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Tuesday, January 27, 2009

Pay for Performance: Would It Work in Professional Sports?

BebchukHarvard's Lucien Bebchuk has done great work to advocate that corporate executives' pay be linked to their actual performance. His 2004 book, co-authored with Jesse Fried, Pay Without Performance has had a huge impact in the academy, in the halls of government and even in board rooms. Today, I read a New York Times article that reported that the Yankees' Andy Pettitte is going to return for one season for a measly $5.5 million. His contract is loaded with incentives that could boost his annual salary to $12 million. And this set me to thinking . . . . Why not structure all sports contracts this way, but do so even more aggressively?

After all, we posted earlier about rookies being signed to large contracts so that their teams could avoid having to pay megabucks to keep them later. And one often hears of players working hard in seasons when their contracts are due for renewal and then becoming less focused once the pressure is off. Well, how about paying all players a basic based salary and then giving them huge financial incentives for reaching certain individual and team goals. These goals can vary widely, but there could be standard items on the menu, which would obviously vary from sport to sport. And then there can be some tailor-made incentives. For Alex Rodriguez: clutch hitting. For Shaq: free throw percentage over 55%, over 60%, over 65%, etc. I would advocate paying the Bulls' Ben Gordon not to shoot at the end of quarters or when the game is on the line. It's an opportunity to get creative and also an opportunity to motivate players in very focused ways.

[Jeremy Telman]

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It's a good idea to base athletes salaries on performance. The only problem would be with some of the sports CBA's. For example, in MLB players can only earn incentives based on performance in post-season awards and certain playing benchmarks (i.e. innings pitched, starts, at-bats). In the NBA a player cannot earn any performance based incentives and it makes sense. In your Shaq example, if he needed to have 60% FT to trigger a bonus, he might try to get to the line more often, and be less concerned with the game plan of the team

Posted by: Domenic | Jan 27, 2009 1:27:22 PM

I don't see why getting to the line more often would be in Shaq's interests, unless he somehow had unlocked the secret of actually making his free throws. In any case, the bonus for free throw percentage would only be one of many. Presumably, the biggest incentives would be for winning games, playoff series and championships, so that the player would always subordinate individual goals to team goals.

For tax reasons, corporations rarely permit their officers base salaries above $1 million. The rest of executive compensation is all performance-based, at least theoretically. So, $1 million might not be a bad base for players who might ultimately win multiples of that amount. But you are right, none of this would happen without getting the players' unions on board and I don't know what incentives the players would have to agree to a pay-for-performance model.


Posted by: Kprofs2013 | Jan 27, 2009 5:35:47 PM

Problem with pay-for-performance in the scenarios you outlined is that much of the performance is due to both luck and effort. What happens if the player gets injured? Also, no matter how hard a player works, there are no guarantees because pro sports is high pressure and atheletes have to be pretty mentally tough so you are also getting into psychological issues, not just effort. So when there is both effort and luck involved, then putting an athlete on pay for performance means making their compensation more risky. And we know there is always a trade-off between risk and return. The players' agents would never accept such contracts unless they raised average salary as well. Do teams really want to raise average salaries to implement pay-for-performance? The real question here is do the current contracts already optimally balance risk and incentives? If not, then a case can be made. If so, more pay for performance will result in sub-optimal risk sharing.

Posted by: Steve | Jan 28, 2009 4:36:42 AM

Who now bears the risk of an athlete's injury? If a baseball team signs Roger Clemens, do they have to pay him $10 million if he ruptures his achilles during spring training? If that's the case, the owners are chumps.

As for the rest, Steve, I don't see how the uncertainty inherent in sports should differentiate their pay structure from that of corporate executives. Quite the contrary. If despite an athlete's talents, he (let's face it, this is just an issue for male athletes) lacks the mental toughness to perform in crucial game situations, then pay for performance seems sensible.

I do not think the players' agents should demand an increase in average salaries in response to this suggestion. Rather, overall salaries should remain the same, to the extent the parties can accurately predict the likelihood that the players in aggregate will achieve their targets and win incentives. Each season, some players should make more than they would have been able to bargain for. Others would make less.

However, my idea likely would never fly precisely because I suspect that professional athletes are overpaid. They try to negotiate their salaries after their best years, and their salary expectations are based on the assumption that they will perform near or at that level in future years, and that's just not a realistic assumption. But they will not agree to accept pay for performance because they already are paid as much as the owners think they are worth when they play at their peaks.


Posted by: Kprofs2013 | Jan 28, 2009 2:33:24 PM

I agree with some of the normative aspect of your argument. But as you point out, it may not fly.

At the end of the day, it is a labor market and what types of contracts players and their agents are willing to accept depends on supply/demand conditions and their relative bargaining power. Roger Clemens can get a contract that insures him against injury because if one team doesn't give it to him, another team will. Incidently, there are pay-for-performance contracts, but they tend to go to players coming off of bad years or injury when their bargaining powers are eroded.

Posted by: Steve | Jan 28, 2009 5:03:17 PM

In theory, pay for performance is an excellent idea for a market oriented economy. It ensures that the parties to a contract get the benefit of their bargain. Pay for performance also supports the argument that resources will be maximized thus resulting in greater economic efficieny. I frequently remind my contract students that in its purest sense, pay for performance is alive and well on Broadway. Broadway performers must initially audition to get a role in a musical production, and then must continue to perform exceptionally well to keep that role. I then lead the discussion to employee perfomance in the private sector and then finally, discuss employment in the public sector. We discuss how contracts should be structured and what clauses each side would want to include in the agreement. I close the discussion by asking the question "How about linking law professors' pay to performance?" - an idea whose time has come. I get a few chuckles and then move on.

Posted by: Art Acevedo | Jan 29, 2009 6:26:24 AM

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