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Monday, December 15, 2003

The Salary Arbitration Primer

Almost everything you ever wanted to know about salary arbitration.

There are two types of arbitration under the Collective Bargaining Agreement between the Major League Baseball Players Association and Major League Baseball.  One is grievance arbitration, which is a somewhat standard provision in every labor-management agreement.  It provides a mechanism for an independent third party to determine, just like a judge, resolution of charged violations of the Collective Bargaining Agreement.  The other type of arbitration under the CBA is something more known to fans and the media, but unique to baseball, and that is salary arbitration.  Salary arbitration is a mechanism for an independent third party, or panel of independents, to judge what a player?s salary should be for the upcoming season.


What makes baseball salary arbitration different from traditional arbitration in the labor-management setting, or any setting for that matter, is that it is what is called final offer arbitration.  In most arbitration settings, the arbitrator can craft any decision he feels is appropriate, as long as it conforms to the terms of the agreement and law.  This commonly results in an arbitrator deciding in favor of a remedy less than what the moving party requests, but more than what the responding party would desire.  In final offer arbitration the parties submit their final offer as their proposed remedy for the arbitrator and the arbitrator is bound to select one offer or the other.  There are conflicting views on the effects of final offer arbitration.  Some believe that when there is a single issue involved in final offer arbitration it leads to the parties making more reasonable offers, in an attempt to show the arbitrator that they are the more reasonable party.  Others believe that it provides a mechanism for the parties to make even more outrageous requests.  Instead of focusing on the effects of the offers the parties make in salary arbitration this article will describe how the system works in baseball to foster negotiated settlement on even footing.


The first cases of salary arbitration were heard in 1974 under the terms of the agreement between the parties.  At that time players were bound to their respective teams by the reserve clause, with none of the free agency rights they enjoy today.  Once a player was drafted, he could only negotiate with the team that drafted him until he retired, unless he was traded to or his contract was sold to another club.  Each year the player and team would negotiate terms for a new contract.  If a player chose not to sign for the offer the team put in front of him, he had no power to receive more compensation for his skills.  He could not shop his skills to another team that wanted to hire him.  Now, players with six years of Major League service time are no longer bound to their teams by the reserve clause, they can sign a contract with any team that makes them an offer.  Prior to six years players still are subject to the reserve clause.  In 1974, prior to Messersmith-McNally, the seminal case that created the free agency right for players, the salary arbitration system was the only way for players to put additional pressure on clubs that did not offer contracts that were acceptable to players. 


Under the current CBA there are two classes of players who are eligible for salary arbitration.  One is for players after their third year of service (and the top 17% of players of total service with two years of service and at least 86 days of service in the preceding season) and prior to their sixth year of service, while they are still under the reserve system and the other is certain players who are eligible for free agency.

Since the service time arbitration eligibles are still subject to the reserve clause and can only negotiate with one team, those teams must tender a contract offer to the player on or before the third Friday in December.  The player then has until mid-January to negotiate with his team.  By mid-January the player has to choose whether or not to accept arbitration. If a player in this category has not been tendered a contract by the late-December deadline he becomes a free agent.


Free agents eligible for arbitration are subject to an entirely different set of rules.  Those players must be offered arbitration on or before December 7 and must accept arbitration on or before December 19.  If the player accepts arbitration he is considered signed for the next year.  If the player does not accept arbitration the team may not negotiate with or sign the player from January 8 through May 1.  In many cases offering a prospective free agent arbitration can be a difficult decision for a team because of the free agent compensation model.  If a team fails to offer arbitration to an eligible free agent the team cannot receive compensation, however if a team does offer arbitration, and the player chooses to sign with another team, the former team can receive draft picks from the signing team.  The Athletics will be receiving compensation as a result of Miguel Tejada signing with another team this off season because the Athletics offered him arbitration.  Perhaps expecting him to leave, the Braves offered arbitration to free agent Greg Maddux last season.  He accepted and stayed with the Braves.  This year, they did not do the same thing, so they will not receive any compensation for losing Maddux.


For either group of players proceeding to arbitration hearings, there is a three team panel that determines the salary that will be awarded to the player.  That panel must consider the player?s contribution to his club during the past season (including but not limited to his overall performance, special qualities of leadership, and public appeal), the length and consistency of his career contribution, the record of the player?s past compensation, comparative baseball salaries, the existence of any physical or mental defects on the part of the player, and the recent performance record of the club including but not limited to its league standings and attendance as an indication of public acceptance.  Arbitrators may not consider the financial position of the player and the club, press comments, testimonials, or similar material bearing on the player or the club, except for recognized annual awards, offers made by either the player or club prior to arbitration, the cost to the parties of their representatives, and salaries in other sports or occupations.  Further, the neither party may present evidence related to the luxury tax.


There have been numerous studies that have shown the effects of salary arbitration on player salaries.  Nearly every study has come to the conclusion that the difference between arbitrated salaries and negotiated salaries is not statistically significant.  That is because one criterion used in determining arbitrated salaries is comparable salaries and because the sample size of arbitrated settlements is so low.  Since 1974 when the first cases were heard, and excluding 1976 and 1977 when there were no cases due to no CBA, there have only been 446 cases that have gone to hearing, an average of a little over 17 cases per year. Since the 1994-5 strike significantly fewer cases have gone to hearing.

When arbitration began the parties did not know what to expect from the process.  Although the number of players accepting arbitration in its early years varied considerably, a very high percentage went to hearing.  From 1974-1980, 92 of 212 cases went to hearing with players winning 47.8% of the time. 


Following the 1981 strike, teams offered arbitration much more frequently, even through the collusion years.  From 1981-1993 no fewer than 80 players were offered arbitration in any given year.  Over the 13 year period 1564 players were offered arbitration, but only 267 cases went to hearing.  Although sample size is small, the participation decline from 43% to 17% appears significant.  During that period players won 43.4% of the time.  There are several reasons that could have caused this declining hearing rate.  The more optimistic is that the players and teams, seeing the results in previous years of a nearly 50/50 success rate at hearing, were more likely to negotiate settlement prior to hearing.  Given the choice of selecting a mid-point with complete control over the outcome or leaving it in the hands of a non-interested third party with a fifty percent chance of losing, the parties made rational decisions by negotiating settlements.  The less optimistic reason that the rate declined, is that players realized that the results of collusion would trickle down through the arbitration process, due to it tracking previously negotiated settlements.  Instead they opted for newly negotiated settlements that they could exert more control over.


The 1994-5 strike again resulted in a different approach to arbitration.  The number of players accepting arbitration declined considerably.  From 1994-2002, 725 players accepted arbitration, with only 87 cases going to hearing.  The decline from 17 to 12 percent of cases going to hearing may not appear very large, but there were only two years in which more than 14% of cases went to hearing, and one of those years was the first year in this group at 20%.  Players? success at hearing again declined, during this period to 36.8%.  One commonly held belief is that as salaries increased considerably along with revenues during the 90?s, players saw arbitration as a win-win scenario.  Since they couldn?t lose, why not make a slightly outrageous request at hearing? 


Since the goal of arbitration is to correct the market effects of monopsony on player salaries by adjusting player salaries during their reserve years to that of negotiated settlements, the ultimate positive result would be that all salaries would be negotiated, rather than determined at hearing.  Since the onset of the 1995 CBA an average of fewer than nine cases per year have gone to hearing.  It would appear that the pressure of a potential loss at arbitration has lead to rational negotiation of contracts.


Eugene Freedman Posted: December 15, 2003 at 05:00 AM | 5 comment(s) Login to Bookmark
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   1. dlf Posted: December 15, 2003 at 03:01 AM (#614237)
Enjoyed the informative article. I am not a big hockey fan, but I think the comparison between MLB and NHL salary arbitration is interesting. In hockey, the arbitration panel has the authority to select compensation at any point between the two sides, not merely one extreme or the other. Also, there, the arbitrator(s) can choose the length of the contract and is not limited to a one year agreement.

A few nit picks regarding Eugene's excellent work:

Since the service time arbitration eligibles are still subject to the reserve clause and can only negotiate with one team, those teams must tender a contract offer to the player on or before the third Friday in December. The player then has until mid-January to negotiate with his team. By mid-January the player has to choose whether or not to accept arbitration. If a player in this category has not been tendered a contract by the late-December deadline he becomes a free agent.

I think this is not exactly correct. Super Two's through 5 year service time can negotiate with his team up to and including the arbitration hearing in February. Likewise, in most senses, those players don't have a choice, by mid January or any other time, of accepting arbitration: they can either accept arbitration, accept the unilateral salary offer from the club, or go to work at Shoney's.

What makes baseball salary arbitration different from traditional arbitration in the labor-management setting, or any setting for that matter, is that it is what is called final offer arbitration.

Final offer arbitration is indeed unusual, but it is not exclusive to baseball. Not to turn this into a Labor Law Primer, but there are many (although far from a majority) situations in Interest Arbitration (as opposed to Rights Arbitration) in which Final Offer is the method of choice.

   2. Chris D. Posted: December 16, 2003 at 03:01 AM (#614243)
Nice work. A well-written piece that explains and demonstrates the success of baseball's salary arbitration process.

As to whether arbitration is inflationary, it is neither inflationary nor deflationary. Decisions and pre-arbitration settlements typically reflect the market at a moment in time.

So-called "bad" contracts (those deemed excessive in retrospect) are offset by so-called "good" contracts (those where players sign below market value for whatever reason.

   3. dlf Posted: December 18, 2003 at 03:02 AM (#614253)

Eugene touches on it in the 7th (I think) paragraph above. The CBA provides that any FA may have his salary determined through arbitration if (1) the team for whom he most recently played offers arbitration and (2) he accepts. The specific language is found in Article VI(F)(1). Paraphrasing the legalisms, ALL players may go through arbitration IF the team agrees; plus players with 3-5 years service (and the Super Twos) can unilaterally chose arbitration with the club's only option to terminate the player's services (i.e. non tender).
   4. Eugene Freedman Posted: January 02, 2004 at 03:02 AM (#614293)
1) Can someone explain the 17% thing further? 2) Not mentioned in the article, but can someone explain exactly what a Super Two is, and how their arbitration schedule is different from a regular player?

Super Twos are players with two years plus of service time and eligibility for arbitration. The top 17% of players (based upon service time) with two years of service are eligible for arbitration.

3) Can a player really decline arbitration before years 4 and 5? I don't think I've ever seen this happen. I know they can prior to year 6, and many times they won't even be offered. Can a club not offer and a player not accept in years 4/5?

I may have been unclear with this part. A player can decline if he chooses to resign prior to accepting arbitration or prior to hearing. Otherwise, arbitration is the only option.

monopsony a market with only one buyer.
During a players reserve years there is only one buyer for the player's services, thus it is a monopsony market.
   5. Eugene Freedman Posted: January 16, 2004 at 03:05 AM (#614476)

You should check out Doug Pappas' site, He has a business of baseball section that includes submissions for the entire history of salary arbitration.

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