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.
Posted: May 22, 2001 at 05:00 AM | 9 comment(s)
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