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Tuesday, May 22, 2001

Going to Bat for Fair Play Pay: Bringing Pay-for-Performance to Baseball

Some pay-for-performance experts apply their knowledge to MLB.

Pay-for-performance may be a foreign concept to major league baseball players,
  but it has existed in the corporate world for some time now. For example, a
  sales account executive will only gain commissions if he successfully completes
  his job and sells his products. He is paid more if he sells more and vice versa.
  Likewise, baseball players should be held accountable for their performance.
  While it is fairly obvious why players demand guaranteed contracts (and why
  this may never change), there may be room for improvement by adding a greater
  degree of variable pay linked to performance measures. In corporate America,
  many companies fail to properly link performance measures for incentive plans
  with the goals of the company, thereby failing to create shareholder value.
  Similarly, baseball owners fail to establish performance measures that motivate
  their players to achieve the team goal of winning games.

Currently, there is insufficient leverage in baseball player compensation.  A player who signs a lucrative multi-year contract and plays miserably will still, for the most part, receive the same paycheck as if he put up statistics of “Ruthian” proportions.  Similarly, a player who performs well or exceeds expectations will not reap the rewards in his paycheck until he files for free agency or arbitration.  As an example, let’s take a look at David Cone’s 2000 season.  Cone, of the New York Yankees, was paid $12 million last year and went 4-14 with a 6.91 ERA (see sidebar).  Not only are these numbers unacceptable for a player making Cone’s salary, they would be considered poor even for an average pitcher.  On the other hand, the San Diego Padres’ Phil Nevin had a “break-out” year and batted .303 with 31 homers, 107 RBIs, and 87 runs.  However, he was only paid $875,000 at a time when the major league average salary on opening day in 2000 was approximately $2 million.  Nevin is a prime example of a player whose fixed salary did not provide him with the opportunity to earn more for his superior 2000 performance.

The Corporate National Pastime

 

Now more than ever, baseball is a business.  This was clearly shown with the recent
mega-signings of free agents this winter.  Alex Rodriguez’ $252 million, ten-year contract is the
richest in American sports history, and many baseball fans question the logic of one player
receiving such a hefty salary.  In fact, the stakes have risen as of late.  For example, in 1991,
Roger Clemens was the highest-paid player at an average annual salary of $5.3 million; in 1996,
the highest-paid was Ken Griffey Jr. with an average of $8.5 million.  In 2001, Rodriguez’ annual
pay nearly triples that of Griffey.  The prevailing attitude among baseball players thirty years ago
(pre-free agency) could be characterized as “For love of the game”; now it has morphed into
“Show me the money.”

 

For their own reasons, players, fans, and owners alike want to have an association with a
winning team.  Players are competitive people, and it is the fundamental nature of their jobs to
help their team win as many baseball games as possible.  Fans devote much of their time, energy,
and emotion (and often income) to their favorite teams, and want to be rewarded for their loyalty
with a winning ball club.  Owners equate winning teams with increased ticket sales, larger TV
and radio contracts, and expanded merchandising opportunities; in other words, a winning team
represents a strong revenue stream.

Since winning games drives team profitability, players should be compensated according
to how much they contribute to team success.  In the corporate world, value-based management is
used to motivate employees to achieve company goals and increase shareholder value.  Baseball
should be no different.  Currently, there is a disconnection between a team’s goal to win baseball
games and individual player pay.  A player will earn mostly the same amount, whether or not his
team reaches the playoffs.

 

Despite the inherent competitive nature of baseball players, evidence shows that their
efforts are affected by the fixed salary structure currently in place. A key aspect of the current
system is free agency, whereby a player is entitled to sign with any team after his sixth full season
in the major leagues, provided he has no future contract in place.  There have been numerous
examples in the past of players performing well in their “walk” years - the years before they are
eligible for free agency - and then coasting the following season after signing a very lucrative
contract.  For instance, in 2000, St. Louis Cardinals manager Tony La Russa mentioned that
Fernando Tatis, who had a stellar year in 1999, grew “soft” after signing a large contract the
following off-season.  Tatis’ performance was poor in 2000 and he was benched during the
playoffs and subsequently traded to the Montreal Expos this past off-season.  A pay-for-
performance plan, which would treat every year (pre- and post-free-agent contract) the same,
would help ward off the potential gaming that is built into the free agent process.

 

Looking Off the Field for Inspiration

 

Like many Fortune 500 companies, baseball teams suffer from misalignments between
pay and performance.  In the corporate world, when a company’s pay and performance measures
are misaligned, the company does not operate as efficiently as it can.  Employees are not
motivated to focus on the appropriate performance measures that contribute to increasing
shareholder value (i.e., increasing the stock price).  In baseball, while the organizational
objectives are based on winning world championships and not on increasing shareholder value,
the same principles regarding the alignment of pay and performance apply.  Without appropriate
performance-based incentives in baseball compensation, players have less motivation to win
games when they realize they’re out of the playoff hunt.  However, it is still in the best interest of
the team to win as many games as possible.  With this in mind, a baseball owner should consider
linking pay and team-enhancing performance in his players’ contracts.

 

While baseball teams should reward players for contributing to team success, it would be
a mistake to design compensation programs where a player’s pay is directly tied to the number of
games his team wins.  In a company, tying pay directly to stock price does not always ensure the
best performance.  Employees at lower levels have a much smaller impact on the company’s
stock price than top management, and they would deem it unfair to tie their pay to something over
which they have little if any control.  On the other hand, if the employee’s pay is linked to a
performance measure which he can directly influence and which ultimately helps the company,
the company’s goals and compensation design are aligned properly.

Companies use a variety of performance measures, depending on their industry.  For
instance, a capital-intensive company such as a railroad is more likely to use a measure such as
return on invested capital (ROIC), while a start-up that needs cash might be more likely to use a
metric such as revenue growth.  In baseball, an owner should tie a player’s compensation to
performance measures that an individual player can be held directly accountable for and that
drive a team to win (e.g., OPS = on base percentage + slugging percentage).  By linking a portion
of a player’s pay to his on base and slugging percentages, a player would focus on these statistics. 
This example would be a positive development, as higher OPS contributes to players’ driving in
and scoring runs, which along with preventing the other team from scoring, are the fundamental
ways that baseball games are won. Of course, an owner can mix and match any number of
performance measures to motivate a player to focus on certain statistics. As long as these
statistics drive a team to win, tying pay to the appropriate performance measures will ultimately
benefit a team.

Executing the Game Plan

 

One must consider the implications of altering a baseball player’s package to incorporate
performance measures.  In the corporate world, it is not uncommon for a CEO to have a target
annual incentive opportunity of 100% of his base pay with a maximum annual incentive of 200%. 
Therefore, if he achieves the target bonus level, only 50% of his compensation is delivered
through a fixed base salary; the other 50% is through variable pay.  However, a CEO could also
surpass his target annual incentive and earn more for superior performance.  Similarly, a player
contract with 50% of target pay linked to performance would protect owners from overpaying for
a poor performer and protect the player from being underpaid if he delivers superb performance.

In order to implement a pay-for-performance system, a baseball team owner must
establish reasonable targets for his players.  Once again, we can look to the corporate world for
guidance in developing performance targets.  In the business world, targets are typically set two
ways.  One common approach consists of a company benchmarking its relevant performance
measures against its competitors, thereby assessing how well it is performing versus its peers. 
Likewise, a team owner could benchmark a player’s performance against other major league
players of similar experience who play the same position.  This external analysis provides insight
into a player’s market value.  A second target-setting approach consists of a company developing
an expected performance level based on the company’s performance over previous years. 
Likewise, an owner could use the historical performance of a player to develop future target
levels.  This approach focuses on creating performance targets from an individual perspective. 
By using one or both of the above methodologies, an owner can set quantifiable targets that
communicate the level of expectation for a particular player.

 

Most likely, Texas Rangers owner Tom Hicks signed Rodriguez with the expectation that
he would perform similarly to his 2000 season: 41 homers, 132 RBIs, and 134 runs.  If Rodriguez
puts up comparable numbers and reaches target levels of performance (assuming homers, RBIs,
and runs are the performance measures), Hicks should be happy with paying him $25.2 million. 
Under the alternative pay-for-performance program, Rodriguez would have $12.6 million
delivered as base salary and an additional $12.6 million as his annual bonus.  In effect, his target
bonus opportunity is 100% of his base salary.  If Rodriguez plays poorly and fails to reach
threshold performance levels, he would only earn his base pay of $12.6 million.  If he performs
much greater than his targets (e.g., 60 homers, 160 RBIs, and 160 Runs), he could receive a
maximum of $37.8 million ($12.6 million in base pay and $25.2 million as a maximum incentive
payout).  This potential to make 200% of his target annual incentive for extraordinary play
counterbalances the increased risk associated with 50% variable pay.  Conceptually, Hicks should
feel comfortable with paying Rodriguez so much money, because Rodriguez’ superior
performance would help the Rangers win and, therefore, the Rangers’ revenue would increase. 
Of course in reality, whether one player could significantly help a team win is debatable.


There has been much talk in recent years about the corporatism that has infiltrated
  baseball. This is a trend that has taken such firm hold in Major League Baseball
  that it is unlikely to abate in the future. Given that this is the case, baseball
  should engage in some of the same target setting and performance-based compensation
  design that is so prevalent throughout general industry. Companies have typically
  utilized pay-for-performance compensation programs in order to align the interests
  of their employees with those of their investors. Along the same lines, baseball
  player compensation should be aligned with baseball fans’ and owners’ desire
  to see their team win. One of the major complaints about baseball from fans
  has been unreasonably escalating salaries that are not reflective of players’
  current performance. It could be the ultimate irony that bringing the corporate
  concept of pay-for-performance to baseball may be the only way to shift the
  fans’ focus away from the salary charts and back onto the field, where it belongs.


Andrew Park and Matthew   Sandler are employees of SCA   Consulting, a firm that offers management consulting services specializing   in pay-for-performance programs. They design compensation programs that are   meant to align employee pay and performance with company goals.

 

Adam Park Posted: May 22, 2001 at 06:00 AM | 9 comment(s) Login to Bookmark
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Reader Comments and Retorts

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Statements posted here are those of our readers and do not represent the BaseballThinkFactory. Names are provided by the poster and are not verified. We ask that posters follow our submission policy. Please report any inappropriate comments.

   1. Tangotiger Posted: May 22, 2001 at 12:06 AM (#603826)
That's it? No offense guys, but that was alot of talk, and no one is going to buy it. First off, OPS? Even if you do Linear Weights or Runs Created, and comparing to "players at same position", you have to worry about park factors, opposition, what is the player's positions, etc. And what about defense? What will Rey Ordonez command? How about starters and relievers?

First off, there's NOTHING wrong with the capitalistic free-market approach. This is what this country was built on. Secondly, why NOT tie TEAM payroll to wins? You could have something like Mike Piazza negotiating for 15% of team payroll while Fonzie negotiates for 10%. Then, if the Mets win 90 games, maybe that is 80 million$. Piazza gets his share, and that is 12 million$. Someone like Vladimir Guerrero might negotiate for 25% of team payroll because the Expos aren't that good. The Expos 60 wins might translate to 40 million$. Vlad gets his cut (10 million$). Of course, all this only works if you have revenue sharing.

In any case, this may be a radical idea, and maybe even a bad idea. But tying a player's salary to a set of statistics that are influenced by things beyond their control (batting order, park factors, playing time, injuries) will never work.
   2. Darren Posted: May 22, 2001 at 12:06 AM (#603827)
I don't have a problem with having players' pay tied to statistics. It already is, only in a less iron-clad fashion.

The problem I have with this article is that it seems a smidge 'pie-in-the-sky.' Of course having player salaries tied to their performance is something many of us would like to see. But why would the players ever agree to it? Are the really going to eschew their multi-year deals for a year to year chance to make 50% more than they might otherwise make? Most players are already paid as if they're going to perform at peak levels anyway. A bonus structure is only going to hurt most players.

Take A-Rod: he can either have $252 million guaranteed or the chance to make between 12 and 37 million each year. I can't imagine who, knowing the chance for injury or skills falling off, would choose the latter. And when you get to guys who are making a million a year, you're talking about the difference of being set for life or throwing caution into the wind to make a little more.
   3. Cris E Posted: May 22, 2001 at 12:06 AM (#603828)
You are selling (and I use that term advisedly) a solution in search of a problem. Arbitration is the culprit here, not formula vs free market contracts. The "One Stupid Owner" model that arbitration is based on gets a lot of bad precedents set that everyone has to live with for years. On the other hand, when Nevin had that breakout year that he wasn't compensated for, when Cone sucked the chrome off trailer hitches, what happened? The Padres still lost games and money and the Yanks still won the series and turned a huge profit.

Why would a player facing injury, uneven playing time or unexpected job competition want to sacrifice the security of a multiyear deal for set money? Think of the uneducated players, the fringe guys, the ones that will not get enough playing time to warrant a 50% bonus.

Let's try something else: Why would a team on a budget allow for a 30% or 50% swing in salary costs? If a salesman moves 18% more product then I have a direct increase in income that I can pay him from. If my pitchers improve by 18% and I win 90 games I may see an improvement in revenue, but my increased costs for that success could be on the order of $10m. If you read that Salon article the other day there's no hard guarantee that fans will follow wins. Think of the 99 Reds, 00 As or 01 Twins: money is a very real concern and success that does not translate to cash (ie making or missing the playoffs) does not necessarily pay for itself.

   4. David Nieporent (now, with children) Posted: May 22, 2001 at 12:06 AM (#603832)

Some people have brought up valid problems with the specifics of the proposal, but it seems to me that the larger issue remains: it's a solution in search of a problem. With all due respect to the authors, citing the opinion of Tony LaRussa as the sole evidence in favor of the proposition that the phenomenon exists is pretty weak, particularly when the premise upon which the theory is based (that Tatis had a poor year) is demonstrably incorrect. And even if the phenomenon _is_ real, that doesn't make it a problem. It's part of the normal risk of signing a free agent, and as such will be built into the bids for those players.

A quick aside: Cris, arbitration is not a "One Stupid Owner" model. Arbitration is based on each side bringing up comparable player_s._ If the owners have four or five comps, and the player focuses on one comp whose salary is far out of line with everyone else's, who do you think is going to win?

As to the main point, I'm at a loss to understand how a free market system based on bidding can be described as "not fair to owners." Some players get paid more than their production indicates. Others get paid less. As a group, it should balance. But how isn't it "fair?"
   5. Tangotiger Posted: May 23, 2001 at 12:06 AM (#603833)
"It is not right to link player pay to team revenue, which is itself driven by team performance"

That is not the case at all. There may be SOME correlation, but the Yankees revenue stream will outstrip any other team , REGARDLESS of how bad the Yanks play. If over a set of years, the Yanks play .400 ball, then there will be some fall-off. But you guys are talking about direct pay for direct performance (same year). Revenues do not follow that directly. As I said, if baseball has 1 billion$ of revenue, then they can tie that directly to wins, and distribute the money accordingly. (Then you have to worry about the Yanks operational expenses being far different from the Expos).

I agree, it is a solution in search of a problem. If the owners don't want to pay A-Rod (like the Mets), they won't. If the owners want to pay Jeter, they will. I would LOVE to work in an industry where I'd have access to companies bidding for my services, and negotiating long-term contracts.

Does anyone complain about Jack Nicholson's negotiations of Batman? Base pay plus 15% of gross revenue.

As for the "search" for the perfect statistics, you will never get it. There are so many variables to account for that someone is not going to like it (especially with defense). Believe me, myself and others on baseball.fanhome.com spend countless hours trying to figure this stuff out. We know we are close, but there will always be some unmeasured aspect that will throw a wrench in the whole thing.

And if the Expos players happen to all have career seasons that require them getting 100 million$ in salary, how would the Expos pay that?
   6. Tangotiger Posted: May 24, 2001 at 12:06 AM (#603837)
Rob Deer, that was exactly my point. Go back to the 1994 Expos, for a team having many young players (so the Expos were paying them cheap), but having "career type years". This team would have won 108 games if not for the lockout. If the team is winning 108 games, it follows that many players will have "great stats". This will invariably mean 90 million$ in "earned income". The Expos could not have afforded that, even though we were getting 35,000 fans per game in that last month. We don't have the cable money to pay for this.

As someone else said as well, A-Rod's salary therefore would have to be 12 milloon to 38 million$, if we are to believe that his 25 million$ was an "average" pay for his performance. In actual fact, as that reader pointed out, the star players are actually being paid ASSUMING THEY REMAIN AT PEAK LEVEL for the lifetime of the contract. This explains Kevin Brown and Mike Mussina and Mike Hampton. As we know, pitchers carry such a high risk, that one of these guys will surely blow their arm at some point.

To use the author's concept, A-Rod should actually be paid between 10 million$ and 26 million $ (I will grant that Texas would have paid that much if they were GUARANTEED A-Rod would not be hurt. They surely would not have paid any more.) So, the question comes back, why in the world would any player accept such a risk? As that reader pointed out, when it comes to the fringe player, he wants his base salary as high as possible as quickly as possible.

I submit that the readers of this forum have contributed more, and understand far better, the mechanisms and pitfalls of the salary structures of baseball more than the authors. You guys do not need to take too much offense to that, as you are probably better than Bob Costas.

The Expos and A's etc can only survive the way the Edmonton Oilers of 1980-1988 survived. You draft good young guys, you take advantage of the high-risk, high-potential Gretzky, Messier, Fuhr, Kurri, Coffey represented, take advantage that the salary structure compensates players over 27 so pay the younger players less, and win 5 Stanley Cups in 7 years. This is how young start up companies win (go after the smart college kid with no corporate track record so they can invest in the company, and not in the salaries).
   7. Tangotiger Posted: May 27, 2001 at 12:07 AM (#603841)
"...but we were more writing this article to raise the issue and start a debate..."

A reader going through your article does not get that sense.

"baseball players should be held accountable for their performance"
Not true. Owners pay players based on supply and demand. On the expectation of what they may produce. Like a stock. If your stock tanks, do you get a sort of rebate? If it soars, do you pay more for it afterwards? If owners truly wanted pay-for-play they would make every player a free agent every year. That's the Charley Finley idea.

"...there may be room for improvement ..." For who? The owners? Why would you want to improve their lot?

"...baseball owners fail to establish performance measures that motivate their players to achieve the team goal of winning games..."
Are owners thinking that players don't try hard enough? Maybe there is a few lazy players, but this is true in any system. Players are pretty consistent in performance year-to-year.

"... [Nevin] was only paid $875,000 at a time when the major league average salary on opening day in 2000 was approximately $2 million..."

This is true in every industry. It takes a few years before you establish your credentials, and "name your price". In the meantime, the owners have you by the b-lls. But this is the only thing saving the Expos and other small-market teams. They take advantage of the young players by paying them below-market value. If you try to make them all pay-for-play, you will KILL the small-market teams.

The purpose of your article was to tell us that baseball has a structure that is comparable or should be comparable to the corporate world. The purpose was not to "raise the issue". The readers of this forum have raised the issue and sparked debate. Not for nothing, but you have proposed a terrible idea that is not in-line with the reality of the baseball world.
   8. Tangotiger Posted: May 29, 2001 at 12:07 AM (#603843)
I agree, these are fair negotiations between two parties who are after their own self-interests. Wouldn't you move from NYC to SF if your salary would go from 60,000$ to 120,000$? This is your decision.

As for past/future. Well, you look at past performance to justify future expectations. If A-Rod were 35 and not 25, the baseball world would have factored in declining performance. You are paid (baseball players, and the world in general, and stocks, and bonds) based on what you can deliver. But the best guage for this is what you've done in the recent past. Even then, when Clemens signed his 3-yr deal with the Jays, the Jays did not reward Clemens for his .500 performance over the previous 4 years, but on the expectation (or more accurately HOPE), that he would revert to his Cy Young form. Jays got lightning. Most teams get the empty bottle. In any case, it is good faith negotiations on two parties. Leave them alone.
   9. Tangotiger Posted: May 29, 2001 at 12:07 AM (#603847)
Thanks much for your replies.

"Were we trying to actually propose the practicality of our system, we would have done the analysis."
I, and along with the other posters on this board, obviously had many comments on the practicality. Based on the comments on this board, we were looking for the analysis. The analysis is usually more informative.

"Thanks for your comments on our "terrible" idea, but again, it was a concept not meant for practical consumption."
As you've mentioned a couple of times. Thank you.

"We agree it's not in-line with reality as it is today, but that doesn't mean that the current baseball status is the way is should be. That's our point. "
That's true. There's always room for improvement. As long as it's a concept that the player's union will also accept. An unbiased CHANGE in concept is obiously the goal.

Thanks for the back-and-forth replies. Most authors would have shunned from such comments, but it is commendable that you guys took the barbs. Good luck in your next article.

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