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Professional team sports have a peculiar economic dimension. One of the main differences between the organization of professional team sport and the market is that in a competitive market firm chooses its level of output to maximize profit. In contrast, sport clubs are limited in their output by the league, which determines the membership and number of clubs and the number of games played in a season. Another peculiar fact is that team owners in US professional team sports have a more profit-maximization goal and European club owners are more interested in win maximization, which results in big financial losses. This results in a different approach and use of measurements. In the closed leagues of the US is uncertainty of outcome (UOO) and competitive balance, the solid fundament of sport economic analyses, which resulted in the introduction of cross-subsidizations such as revenue sharing, salary caps, and drafting systems. In historical times was there also a reserve clause for transferring players between clubs, but this was forbidden by law in both continents and free agency was introduced. In the open leagues of Europe is UOO less important and are most of the fans focused on some major teams who have to compete for the championship. Cross-subsidization is not a main issue and in most countries is their only a collective sale of broadcasting rights.
- The Peculiar Economics of Professional Team Sports
- US Profit-Maximizing Objectives versus European Win-Maximizing Objectives
- Uncertainty of Outcome and Competitive Balance
- Methods of Cross-Subsidization
- The Sport Labor Market
- Revenue Sharing
Sport economics is an exponential growing study topic in the academic world. It started in North America with a central and neoclassical focus on professional team sports and diffused first to the UK and then to the rest of Europe and finally to the world. The increasing cash flow in the sector combined with leisure time and purchasing power resulted in the emergence of a new economic industry. Sport as a leisure industry became a hot item and besides the organization of professional sport leagues came topics as the economic impact or feasibility of sport events, financing sport infrastructure, measuring return on investment, and more European items namely, innovation in sports industry, public funding of sport, sport participation in relation to health economics, and social impact of sport, a central topic in academic research.
We notice in American handbooks on sport economics such as Sports Economics of Fort (third edition in 2011) and in The Economics of Sport (fifth edition in 2014) by Leeds and von Allmen a total absence of recreational sport. On the other hand, we have the European-oriented handbook Sports Economics: Theory, Evidence and Policy of Downward et al. (2009) and Sport en economie: samen in de spits of Dejonghe, T. (2012) that has as much chapters on participation sport than on professional sport leagues and also contributes on the economics of sports events and infrastructure. The book of Downward et al. (2009) was more or less a successor of The Economics of Professional Team Sports by Downward and Dawson (2000), a more European approach of professional team sports. A neoclassical theoretical framework of European and American professional league models is Késenne’s The Economic Theory of Professional Team Sports: An Analytical Treatment (2007).
In this research paper, we will only discuss the economics of professional team sports. The ‘planned’ organization of leagues in North America will be compared with the less rigid organization of Europe.
The Peculiar Economics of Professional Team Sports
Professional team sports can be analyzed from an economic perspective in which labor (mainly players), capital, and land (stadiums and other facilities) are combined by clubs that supply teams to produce a saleable product – the game or contest. To obtain revenue to pay for inputs it is necessary to exclude nonpaying spectators, hence the universal use of stadiums and a traditional suspicion of live broadcasting of sports. For teams to cover their costs each must be guaranteed a minimum number of home games for which tickets can be sold, which suggests ‘league’ or round-robin tournaments rather than knock-out competitions. As an organizational structure leagues comprise sets of individual clubs, which fall within the broader governance structures. Another difference between the organization of professional team sport and the market is that in a competitive market firm chooses its level of output to maximize profit. In contrast, sport clubs are limited in their output by the league, which determines the membership and number of clubs and the number of games played in a season. The league is a cartel with clubs acting as firms and can be seen as a violation of antitrust laws (Sherman Act (1890) and Clayton Act (1914)). Despite these legal frameworks, there has been little government intervention in sport markets.
There is potential division of interests between league and club because of the existence of the externalities in production. The first publication about economics of professional team sport were articles of Rottenberg (1956) and Neale (1964) about the players’ labor market in baseball and the peculiar economics of professional sport in the US. In Europe, came a reaction of Sloane (1971) who noticed the existence of a different professional team sport model in Europe. Those articles created a massive spin-off of research and publication to understand and optimize the professional team sports and their leagues. In the US are most of the interesting questions on the economics of sport related to professional team sport. This results in a focus on the industrial organization of sports in the major leagues (National Football League (NFL), Major League Baseball (MLB), National Basketball Association (NBA), and National Hockey League (NHL)) and government subsidies on professional sport.
US Profit-Maximizing Objectives versus European Win-Maximizing Objectives
Drawing upon the historical development of professional sports in Europe and the US, most US writers assume that profit maximization is the goal of team owners. In contrast, Sloane (1971) argued that European club owners might more accurately be viewed as utility maximizers (later on referred to as win maximization) where a major determinant of utility is playing success (winning), although profit is important for the club’s long-run financial stability. Forgoing profits, and even underwriting losses, therefore suggests that club ownership is an act of consumption more than investment. The impetus to this assumption was the relegation and promotion of hierarchical sports systems in Europe, coupled with the historic desire in European football for success in international competition.
Sloane’s (1971) proposed team utility function is
where ‘U’ is the utility level attained, which depends upon performance on the field ‘P,’ home attendance ‘A,’ health of the league ‘X,’ and on the excess of posttax profit ‘P’ over a minimumacceptable level of posttax profit ‘PMIN.’ The notion of an acceptable minimum profit reflects factors such as the club’s need to secure its long-run future. Any club that has outstanding debt has to display the ability to service that debt. Over and above servicing debt, the club may need to generate an acceptable level of profit; if it is a publicly quoted limited liability company, the directors need to produce enough dividends to keep the shareholders happy. If they cannot, the share price will fall and the company may become the subject of a hostile takeover. In contrast, if a club has access to a sympathetic and wealthy owner (Chelsea with Roman Abramovich, Manchester City with Sheikh Mansour, AS Monaco with Dimitry Rybolovlev, Paris Saint Germain with Nasser Al- Khelaifi, Juventus with the Agnelli (FIAT) family, AC Milan with Silvio Berlusconi, Shakthar Donetsk with Rinat Akhmetov, etc.) or to favorable treatment from local or national government (Real Madrid, Barcelona, AS Monaco) the minimum acceptable level could actually be negative.
Theoretically, one can expect that other things equal an increase inanyone of the four factorswillmake the supporters, the owners, and themanagement happier. As Sloane notes, themore closely the four explanatory variables are correlated with each other the more probable it is that the predictions of the profitmaximizing and utility-maximizing models will resemble one another. Unless the predictions differ in some readily identifiable manner attempts to distinguish the objectives of teams will fail.
Uncertainty of Outcome and Competitive Balance
The first contributions to the economics of professional team sports stressed the importance of a key externality in professional team sport known as the uncertainty of outcome (UOO) hypothesis. This implies a more or less equal distribution of talent if there has to be UOO and that gate receipts and broadcasting rights depend crucially on UOO of the games played in the league and on the competitive balance in the league. The North American profit-maximization approach defines the UOO as the solid fundament of sport economic analyses and makes competitive balance as the most important item of sport leagues. If the top club always beats the next ranked club, and so on, the games would be exhibitions, not contests, and they would have little market value. Some degree of UOO is necessary in sports, and this uncertainty is greater the more equal the playing strengths of the competitors. Greater equality of playing strengths among the clubs is wealth maximizing. Attendance at games and viewership on television is higher the closer the standings of the clubs are over a season. The acceptance of UOO and competitive balance implies that the market of professional team sports differs significantly from most industries. Competitive balance depends mainly on the comparative financial strengths of the clubs. Teams earn revenue primarily from ticket sales and broadcast fees. The main cost is player payroll. Attendance is determined chiefly by market (city) size and the club’s historical reputation. Since teams are located in cities of markedly different size, the prospect of fielding a competitive team depends in part on where the club is located, but also on how revenues are divided up among the clubs. This resulted in a system of cross-subsidization between the clubs in American leagues. In the US, leagues have intervened in sporting labor market or regulated the distribution of club revenues from broadcasting and in some cases of gate receipts. The arguments in the US are that with a distribution of clubs in unequal size markets and with a ban on unilateral relocation of clubs to the more lucrative markets, the more unequal the division of revenue among clubs the less will be the competitive balance within a league. The desire to promote long-run UOO or competitive balance is due to the fear that domination by a few teams may result in a loss of consumer interest, revenue, and profit. The problem is that there is no convincing body of evidence that sports leagues do evolve toward perfect balance. Clearly, if the bigger members of an industry systematically grow more rapidly than smaller ones, and if the process continues, the industry will become more concentrated. If the small firms grow faster, and if the process continues, the industry will tend to become less concentrated. Given enough time, the sizes of all firms (as measured by, say, revenue or assets) would converge on an ‘equilibrium’ value, although whether this occurs also depends on random factors. This means that convergence or divergence in the relative distribution of revenues would have an impact on competitive balance and could be a support for cross-subsidization.
In Europe, noticed Dobson et al. (2001) for the English Premier League that from the 1920s until the late 1950s there was a period of steady adjustment toward equilibrium. From the late 1950s until the late 1970s it is suggested that there was no tendency to revenue convergence but this occurred from the late 1970s until about 1990 and convergence seems also to have broken down in the 1990s. The authors conclude there may have been two periods of relative equilibrium, followed by two of major change. The causes of these major changes occurred during a period of marked social change. In the period 1950–1970s, population drift toward southern England and also from the inner city, and increased access to private transport may have been important, as well as the media in the creation of national support for some teams. It also starts about the time that the maximum wage was abolished, forcing clubs to increase admission charges that had been virtually unaltered since the 1920s. The 1990s breakdown of convergence took place against the simultaneous effects of the Bosman Ruling (see The Sport Labor Market) that enhanced players’ bargaining power, the influx of money from broadcasters, and the setting up of the Premier League. Add the transition to all-seat stadiums and the necessary rise in ticket prices and there are plenty of factors that would be expected to shake up the industry structure. However, in summary it seems is that the UOO hypothesis seems to be rather overworked as a phenomenon that affects attendances in as much that it not ubiquitously important despite the ingenuity with which it has been measured.
Methods of Cross-Subsidization
Another remarkable characteristic of American leagues is the limitation of the number of teams and the absence of promotion and relegation from or toward a hierarchal lower league. These closed leagues in US sport create, with exception of some major metropolitans, spatial monopolies and a latent demand for enlargements of number of clubs in the league. An advantage of this scarcity of supply is that it has been used to leverage public investments for sport facilities. The combination of the US acceptance of cartelization of the closed sport leagues and the ‘need’ for UOO and competitive balance results in the creation of specific peculiar measurements known as cross-subsidization. An economic rationale for cross-subsidization lies in the market structure of sporting leagues that can be viewed as a producer cartel within which clubs need to compete in sporting terms, but also to cooperate to ensure that the sports are managed effectively. To attain these ends, leagues have traditionally set the terms of sporting competition and have directly influenced the economic aspects of competition, influencing admission price structures, negotiating television deals and sponsorship arrangements, and last, but not least, controlling the terms upon which players may move between clubs.
The Sport Labor Market
While different in detail, leagues have intervened in sporting labor market or regulated the distribution of club revenues. Leagues have attempted to influence the distribution of talent by applying three major types of labor market policy instruments: drafting systems, salary caps, and reservation option arrangements.
The best-known example of a drafting system is the ‘Rookie draft,’ where the weakest teams have in some degree the first pick of the new playing talent at a price that is discounted on the player’s market value. The intention of this measurement is that talent will be allocated between the clubs to improve competitive balance. For example, the source of recruitment to the NFL is college football, which comprises amateur players. The reverse draft ensures that every year the professional teams obtain bargaining access to the new crop of graduates in reverse order of how they finish in the professional league. The intention is to give last year’s least successful outfits the first option to pick new recruits. Consequently, the weaker teams have the opportunity to enhance their stock of playing talent at a price, that is, probably discounted on the player’s genuine market value. Over time the intention is that such a system reallocates talent between the teams to promote competitive balance. Of course, in hierarchical leagues, with promotion and relegation, the replacement of weaker teams with stronger teams reallocates talent in a similar way. There is, however, one potentially major flaw in the thinking behind drafts, or for that matter how promotion and relegation affects talent distribution. For example, in the draft system, despite the opportunity for weak teams to initially sign new, higher quality talent, there remains an economic incentive for the stronger teams to buy them from the weak ones and the weak teams to sell them to the stronger teams. Leaving aside the personal ambitions of players to wish to play for stronger teams, the clubs would have incentives to trade because the players will probably be offered a contract with a wage below their market value by the team allocated first pick in the draft. Consequently, the gap between what the player can earn from the weaker team and the true market value of the player becomes an economic rent over which teams can bargain. The stronger team can offer the weaker team more than they have paid for the player, while not paying the player their market value. It follows that both clubs can make a relative financial gain through the trade. The player may or may not receive some of this gain. This depends upon the contract of the player.
Over their histories, in some leagues, players have been restricted from moving between clubs within a league, the so-called reserve clause. Club owners have claimed that reservation of players or the imposition of transfer fees was necessary to maintain financial soundness of small clubs and to preserve competitive balance within leagues. Economists, since Rottenberg (1956) have been very skeptical of this claim and there is no empirical evidence to support it. While it is true that there is a tendency for the best players to migrate to the largercity franchises, freedom of player movement or restrictions on player-initiated movement have no bearing on the distribution of playing talent within a league (El-Hodiri and Quirk, 1971). Under free agency, players will migrate to the best-paying clubs. The franchises that pay the most are those that expect the largest incremental revenue from those players’ performances. Since an increment in the win percent raises revenue more in a large city than in a small city, the best players tend to migrate to the big-city franchises. At issue is whether in a market where player-initiated movement is forbidden (player reservation, transfer fees), would a small-city club keep a star player that it had acquired through a draft or an assignment? On the roster of that club, the player is worth, say, $1 million in incremental revenue. On a large-city franchise, that player’s performance is worth, say, $3 million. Without a scrupulously enforced league ban on cash sales of player contracts, the franchise in the small city has an incentive to sell the player’s contract to the big-city club and capture some portion of that $2 million difference in incremental value. Therefore, players are allocated across clubs based on their highest incremental revenue. Whether the player or the club owns the contract (property right) is irrelevant to the allocation of playing talent within a league. That the efficient allocation of a resource is independent of who owns the property right is, of course, the famous Coase (1960) invariance theorem, but the essence of that theorem was discovered independently by Rottenberg (1956) in his earlier paper on the baseball players’ market. While the distribution of playing talent is independent of the degree of freedom in the market for players, the distribution of the rents between owners and players is not. The players obtain a much higher share of the rents arising from their scarce talent under free agency than would be so under league restrictions on player-initiated transfers. Under player reservation, player pay is less than the players’ contribution to club incremental revenue. Under free agency, the players, ultimately, receive all of the incremental revenue. It is shown that the intrateam salary structure, with its wide pay differential between starting and backup players is rational and wealth maximizing. Competitive balance is value maximizing, also in part, the appeal of professional team sport is the extraordinary playing ability of the athletes. This is demonstrated repeatedly on television and commented on widely. Such feats are value maximizing for the leagues, since they promote interest in the sport. Prior to the mid-1970s, baseball and basketball players could not negotiate freely with more than one team, and this restriction applied in football and in hockey, until more recent times. In European football (soccer), until the Bosman Ruling in 1995, player movement was restricted by the substantial transfer fee that had to be paid to the club owning the player’s contract. The result of player reservation in professional team sport was that players were exploited economically by the owners, in the sense that they were paid less than the incremental revenue that their performance brought to the club (Scully, 1974). It is not the case that the athletes in professional sports were poor by any means, since they were paid on average several times a working man’s wage. But, their pay was not equal to what they could have earned, if they were free to offer their talent to the highest bidding club. Free agency has led to an enormous explosion in player salaries and in the share of club revenue captured by the players. Concern about the heavy spending of a number of professional clubs across Europe resulted in the introduction in 2009 of UEFA Financial Fair Play measurements. It was hoped that the regulation would lead to a more ‘level playing field’ by preventing clubs with wealthy owners who make substantial cash gifts to their club from gaining an unfair advantage over other clubs that are run on a more substantial business model. The full implementation of Financial Fair Play was delayed until 2015 by the European Club Association, an independent body representing football clubs at European level.
In Europe, a general principle of EU law, better known as the Bosman Ruling, that discrimination on grounds of nationality regarding EU citizens was illegal and that all citizens are allowed to work in other EU countries under the same conditions, was the start of free agency in sport. The consequence of the Bosman Ruling was that all players at the end of their contract became agents who were free to move at an international labor market. This resulted consequently in the fact that clubs lost their monopsony power over players. On the contrary, market power went to those players who could sell their talents to the team that offered the highest wages. In combination with this power shift, European football faced the elimination of the limitation of the number of foreign players, which resulted in a substantial migration of player talent. The Bosman Ruling made factor mobility of labor possible and resulted in a reallocation of player talent. The arguments of the football federations and UEFA to defend the existing transfer system were that transfer fees are a form of revenue sharing and remuneration of assets and that without these financial compensations clubs would eradicate youth development. Parrish and McArdle (2004) notice that the European Court of Justice foresaw in its verdict alternative possibilities such as ‘revenue sharing’ and ‘salary cap’ to maintain or even increase competitive balance. The problem was that this kind of cross-subsidization would be difficult to implement in the structures of European football. This is because open league structures are historically embedded in European team sports. Moreover, UEFA and the national federations never took these alternatives into concern. The academic world, however, countered arguments on the probability of concentration of player talent and decreasing competitive balance. Késenne (1998), for example, indicated that North American sports economists, such as Scully (1989) and Quirk and Fort (1992), analyzed the elimination of the ‘reserve clause’ in the US, a system comparable to the transfer system before Bosman, in the MLB. Their conclusion, based on existing theoretical and empirical studies, was that professional leagues in the US would benefit if limitations on freedom of players movement were eliminated. Their central argument came from Rottenberg’s (1956) article that anticipated on the already mentioned Coase theorem. Rottenberg argued that a limitation through a reserve clause would not prevent migration of talent toward major teams. In Coase’s terms the distribution of resources, in this case player talent, would not be affected by the distribution of ownership rights. Translation of these theoretical findings to professional sports means that free movement of players will have no effect on their distribution and was defined as ‘the invariance principle’ (El-Hodiri and Quirk, 1971). This North American approach was used as an argument to demonstrate that the Bosman Ruling would have no impact on the distribution of talent in Europe. The problem was that the European professional team sports environment did not fulfill the main criteria of Rottenberg namely, that all firms had to be nearly equal if each is to prosper. A fundamental fact that the European court did not consider, at least not explicitly, is that football players do not move around in a common market as long as there are independent leagues. This implies that smaller national leagues in particular cannot afford to keep their most talented players in a free-agency market. Consequently, the transfer fee can be motivated as an instrument to stimulate development of talent in small-market teams. Haan et al. (2007) warned that free movement of players could be the death penalty for many European leagues. According to them, international differences will increase and international competition will become less exciting. Changing structures toward an open labor market in separated product markets resulted in a competitive disadvantage for smaller market leagues and their teams. The introduction of an open labor market resulted in a concentration of talent into the Big 5 (England, Spain, Italy, Germany, and France) as well as more recently in Eastern European leagues with ‘new money’ (Russia and Ukraine). The main reason for this divergence is the opening of the labor market with migrating players in separated win-maximizing product markets with almost no revenue sharing. Some sports economists see a solution in a further Americanization of European football, resulting in a European Major League Football that resembles an American Major league, with one of more semiclosed divisions and forms of cross-subsidization such as salary cap and revenue sharing. From an economic viewpoint, creating a European Major League Football would be the natural outcome of the transformation of locally embedded football into a more business- and media-oriented entertainment. This idea, however, stands in opposite of European football culture with its strong relations with local communities, called ‘topophilia,’ and the existence of historical traditions and rivalries in every country. Dobson and Goddard (2011) also notice that those in favor of a total withdrawal of major teams from their domestic league underestimate the importance of domestic history and tradition as typical characteristics of football identity in Europe. Arnaud (2006) refers also to the tradition of the football fan who wants a ‘twin-pillar’ structure consistent of a national competition and a European competition. In sum, local embedment and identity are defining characteristics of European professional football. The EU recognized the specificity of sport in its 2007 voted White Paper on Sport where it takes account on the specific characteristics of sport. Hereby, they recognize the specificity of sporting activities, sporting rules, and sport structures. One of these specificities is the need to ensure uncertainty concerning outcomes and to preserve a competitive balance between clubs taken part in the same competition.
On the whole, the introduction of free agency has eliminated monopsonistic exploitation of players in professional team sports. Nevertheless, in the US leagues, pockets of exploitation exist, particularly among promising rookies, journeymen players, and first-round draft choices from the amateur ranks. This is so because there is not complete freedom in the players’ market, such as would occur with teams competing for all players by offering 1year or multiyear contracts for their services. New entrants into the professional ranks, if they survive the intense competition for their positions, must wait several years before they are free to negotiate with other clubs.
Salary caps unlike drafting systems directly target the financial cost of talent. Salary caps can either involve fixing the cost of individual and thereby aggregate player costs by establishing a maximum wage or represent a maximum absolute amount that clubs can spend on players in total, or expressed as a percentage of team (or league) turnover. In the US, the NBA, hoping to strengthen weaker teams’ finances, adopted a salary cap, after the alternative of gate-revenue sharing was blocked by the combined efforts of the strongest drawing teams. The frequently offered justification for the control of wages and/or wage bills is that, in principle, it makes the best talent affordable to all teams and which will help to produce competitive balance. A salary cap can be hard or soft. A hard cap means that the total wages in a team may not exceed a maximum amount. In a soft cap system may a certain maximum be exceeded in some circumstances but a luxury tax must be paid. On the other hand, there exists a salary floor. That is a minimum amount that must be spend by a team on wages. One mechanism, invented by basketball is the team salary cap, a device that in theory imposes a maximum salary as a percent of gross revenue (and, a minimum percentage that applies to small-city clubs). American football has a team salary cap, and baseball wants one, but has been blocked in its ambition by the players’ union who only allowed a luxury tax. Can a salary cap equalize playing strengths within a league? Suppose that a binding salary cap is imposed that fixes player salaries at a certain percentage of league revenues. The marginal cost of playing talent falls under the salary cap from its level under free agency. If scrupulously enforced, all clubs have the same team salary costs, and if there are no information asymmetries about expected playing talent and no differences in coaching quality, all clubs will have 0.500 records. Like the solution of player reservation with a ban on cash sales of player contracts, the distribution of win percents brought about by a hard salary cap is stable, but it is not profit maximizing nor does it maximize league revenue. A large-city team can earn more profit by acquiring better playing talent and a small-market club can earn more by lowering, its level of playing talent.
In basketball, the team salary constraint is relaxed significantly by the so-called Larry Bird exemption. Under the exemption, a team may re-sign a veteran free agent at whatever cost, and not have that player’s salary count in the salary cap. This has led to most clubs having player payrolls well in excess of the cap, and this transforms the team salary limit concept into a soft or nonbinding constraint. The Larry Bird exemption was the main point of dispute between the basketball players and the owners, prior to the 1998–99 season. Salary caps have led, also, to creative financial arrangements such as large player signing bonuses relative to annual salary, back-end-loaded long-term player salary contracts, deferred player compensation, and the shifting of revenue from team operations to other, nonteam entities. Sufficient erosion in the constraint of the salary cap, as with a player reservation system with player transfers for cash, can lead to the same distribution of playing talent as is attained with unrestricted free agency.
In Europe is a salary cap in soccer absent and occurs only in the more recent formed professional leagues in rugby and hockey.
If the degree of competitiveness in the players’ market does not affect competitive balance, will it be affected by the division of revenue among the clubs? Traditionally, of course, this has concerned the gate revenue – monies paid by spectators at the turnstiles. Because imbalance is created by teams with different revenue bases, which are then spent on playing talent, to redistribute some home-team revenue implies that a greater absolute amount of income is transferred from the larger club to the smaller club, than the other way around. This means that the larger club experiences a net reduction in revenue, while the smaller team a net gain in revenue. As in many other team sports, away-team shares of gate revenue have fallen steadily over the years, and, currently, a variety of arrangements exist in the US ensuring that the home team receives the largest share of revenue. The NFL operates an unusually generous 60/40 split in favor of the home club, while the NBA and NHL have no gate sharing. In European soccer exists currently only gate sharing arrangements in cup competitions.
As far as TV revenue is concerned, in the US local TV coverage provided no revenue for visiting teams although national TV revenue was shared. In European football exists in most leagues a collective bargaining of broadcasting rights and a part of the total sum is been distributed equally among teams. The other part is divided according to recent and/or historical performances and in Italy is a part divided according to the number of attendances and the inhabitants of the local market.
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