Moral Hazard in Long-Term Guaranteed Contracts: Theory and Evidence from the NBA<br />Arup Sen, Boston University<br />J. ...
The Central Question<br />Do players play harder towards the end of their contract<br />If the answer is yes, is there a r...
Anecdotal Motivation:Thecurious case of the Seattle Supersonics<br />In 2004-05<br />Had many key players (and their coach...
Theoretical Model<br />Performance is a combination of effort and ability (in our model performance=ability+ effort)<br />...
Theory Results<br />Why can long-term contracts be optimal then?<br /> Players are risk-averse and willing to give per-per...
Empirical Analysis <br />We want to see whether player performance improves as the end of the contract draws closer.<br />...
Empirical Analysis contd…<br />Data- Unbalanced panel 654 players in the NBA from 2000-06 (with player information going b...
Results<br />The effect of years remaining in contract on player performance is significant and negative.<br />Performance...
Results contd..<br />If we take players for whom we see 2 consecutive years spread over 2 contracts then there is a 16% dr...
Other Key Points<br />Why not heavily incentivize players?<br />Multi-tasking (easier in other sports)<br />Team success m...
The Last part of the puzzle<br />Do players actually give up salary on a per-period basis?<br />Tough to test empirically....
Alternative Interpretations<br />We don’t necessarily take our model literally but we feel that it provides a useful insig...
Conclusion<br />This is useful analysis for many labor markets that have guaranteed contracts- the prime example is academ...
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Moral Hazard in Long-Term Guaranteed Contracts – Theory and Evidence from the NBA

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2011 5th MIT Sloan Sports Analytics Conference

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Moral Hazard in Long-Term Guaranteed Contracts – Theory and Evidence from the NBA

  1. 1. Moral Hazard in Long-Term Guaranteed Contracts: Theory and Evidence from the NBA<br />Arup Sen, Boston University<br />J. Bradford Rice, Analysis Group<br />
  2. 2. The Central Question<br />Do players play harder towards the end of their contract<br />If the answer is yes, is there a reason why do teams award long-term contracts when incentives would seem to be maximized with short term contracts?<br />Are players ‘fooling’ teams repeatedly with the improved performance in the later stages of the contract?<br />Can this be an equilibrium?<br />Is this applicable to other labor markets?<br />
  3. 3. Anecdotal Motivation:Thecurious case of the Seattle Supersonics<br />In 2004-05<br />Had many key players (and their coach) in the last year of their deals<br />Thought to be reasonably talent deficient they made a surprising run to the second round of the playoffs after winning 50 games<br />In 2005-06<br />With many of the same pieces signed to big deals they went 35-47.<br />Arguably the biggest fall off was Jerome James who went to the Knicks and proceeded to provide the blueprint for Eddy Curry.<br />
  4. 4. Theoretical Model<br />Performance is a combination of effort and ability (in our model performance=ability+ effort)<br />The only ‘benefit’ players get from exerting costly effort is to affect future contracts.<br />Players are risk averse and teams are risk- neutral.<br />Incentives are largest in the final period of the new contract, at which point players are anticipating a new contract.<br />Main Result<br />Players improve performance as the contract expiry comes closer<br />Long-term contracts can be Pareto optimal in spite of the ‘moral hazard’ concerns that come with guaranteed contracts.<br />
  5. 5. Theory Results<br />Why can long-term contracts be optimal then?<br /> Players are risk-averse and willing to give per-period wage concessions in return for job security and avoiding random shocks from year to year.<br />Players are concerned about the effect that not putting forth effort might have on their reputations and may be ’persuaded’ to put forth some effort in non-contract years.<br />We see a steeper period to period improvement in younger players.<br />For older players, whose value is already established the slope of effort levels is lower- which is consistent with what see empirically.<br />
  6. 6. Empirical Analysis <br />We want to see whether player performance improves as the end of the contract draws closer.<br />Independent variable of interest- years remaining on current contract<br />Dependent variable- NBA player efficiency index<br />Our estimation equation- Performance= α+β*years remaining+µ*controls on observable player ability <br />Our coefficient of interest is β, we expect the sign to be negative and we run a few variants of this equation.<br />
  7. 7. Empirical Analysis contd…<br />Data- Unbalanced panel 654 players in the NBA from 2000-06 (with player information going back to as early as 1991)for a total of 2260 player-year observation.<br />Source: basketball-reference.com, USA today salary database<br />Controls- various player characteristics including physical attributes, college attended, draft position etc<br />The fact that we have multiple observations for 90% of players in our dataset means we are able to do fixed effects analysis.<br />
  8. 8. Results<br />The effect of years remaining in contract on player performance is significant and negative.<br />Performance improves as we move closer to the end of the contract. Players perform 7-8 % better in the last year of their contract compared to the penultimate year. They do a whopping 23% worse when they have 3 years left on their contracts. <br />On average the first year has them performing 7 % worse than an average year (we control for team specific experience).<br />
  9. 9. Results contd..<br />If we take players for whom we see 2 consecutive years spread over 2 contracts then there is a 16% drop-off from the contract year to the subsequent year. <br />There is an obvious bias here but still it acts as a useful robustness check.<br />The coefficient on the interaction of experience and years remaining is positive suggesting that the adverse effort incentives for more experienced players is reduced.<br />A player with 2 years experience will see a 15% increase in performance from the penultimate to final year which is twice the output differential a player with 6 years experience sees. <br />
  10. 10. Other Key Points<br />Why not heavily incentivize players?<br />Multi-tasking (easier in other sports)<br />Team success may lead to free-riding<br />Collective bargaining and real world concerns.<br />Are teams fooled in equilibrium?<br />No, in equilibrium they anticipate this increasing effort profile when negotiating the terms of the contract. <br />They contract based on the maximum incentive compatible level of effort that they can coax out of the players.<br />
  11. 11. The Last part of the puzzle<br />Do players actually give up salary on a per-period basis?<br />Tough to test empirically.<br />Anecdotal evidence that players opt out of lucrative last years of long-term contracts to get longer guaranteed deals- e.g. Richard Jefferson.<br />
  12. 12. Alternative Interpretations<br />We don’t necessarily take our model literally but we feel that it provides a useful insight into how this market operates<br />Can think of ‘ability’ as evolving over time- qualitatively that is the same as our model<br />Also recent years may serve as a better benchmark of performance going forward and hence the player’s value. Our results are consistent with that interpretation<br />
  13. 13. Conclusion<br />This is useful analysis for many labor markets that have guaranteed contracts- the prime example is academia with the tenure system.<br />While the NBA as a market has many peculiarities it also gives insight into how utility maximizing individuals will behave especially when reputation matters.<br />

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