Salary Cap and Luxury Tax Line in NBA - Case Study Example

Salary Cap and Luxury Tax Line in NBA

Professional sports offer economics a unique chance to examine industrial organizations and labor economics. Sports generate a complete set of accurate and detailed data comprising of performance and compensation measures for every employee in the industry, as well as the entire firm performance about their past success and peers. Labor economics analyzes the relationship between employers and workers. Within labor market in sports, employees are the players and the employers are the clubs (Totty & Mark 48). The National Basketball Association (NBA) provides a unique chance for expanded study in labor economics given several recent and past changes implemented in the association's latest CBA (Collective Bargaining Agreement) (Yam 4). Clubs in the NBA face crucial salary allocation decisions. Schouten (1) purports that the league players offer different values to their respective clubs; therefore, it is worth varying the amounts of money. Managers have to determine ways of allocating the aggregate salary provided to their signed athletes. A vital question to ask is this case is whether a deliberate salary cap could be the best way to allocate payments amongst NBA teams. The word “best” in this case is interpreted in various ways. First, it can be perceived as a wage distribution that increases wins. Wins are important to both management and fans. Second, "best" can be regarded as a payment distribution that maximizes team revenues in the attempt of making money.

Brief History of Players’ Salaries and Salary Cap

Like other types of sports, basketball has experienced its fair share of “dark ages” for athlete salaries during the years of team-owner application of the reserve section. NBA teams having the exclusive right to sign the athlete they choose draft athletes. Once an athlete signs a contract, he becomes the individual property of the team. The initial application of the reserve clause was to tie an athlete to a particular team for life unless he was put on waivers, traded, or sold (Totty & Mark 53). With the right to continued use of athletes’ services, teams had monopsony control (that is, they were the only buyers present in the market. This ensured that the team owners had little motivations to pay high salaries. This led to the emergence of salary caps and luxury tax lines.

In professional sports, a wage cap (or salary) is a rule or agreement that places a boundary on the amount of money that a team can spend on salaries of their players (Staudohar 3). The limit exists as a total limit or a per-player limit for the roster, or both. Many sports leagues have applied salary caps, both as a means of maintaining overall costs down as well as to incorporate equality between various teams so rich teams cannot embed dominance by signing several more top players than their competitors (Staudohar 5). Wage caps can be a critical issue in negotiations between players’ unions and league management unions, and have been the focus of many lockouts by administrators and owners and strikes by players.

Salary Caps and Competitive Balance in NBA

Theoretically, there are two main advantages derived from wage caps – control of costs and promotion of equality between teams (Larsen, Aju & Erin 382). Primarily, an operative salary cap bars rich teams from some destructive conducts, such as signing a host of high-paid star players to prevent rival teams from getting access to top talents as well as ensuring that victory is achieved through superior economic capability. With a wage or salary cap, each sports club has roughly equal economic power to attract different players, which contributes to equality by generating approximately equal playing talent for each club in the league (Baschnagel 23). This, in turn, produces economic advantages, both to the individual teams and the league.

NBA league needs to ensure that there is a level of parity between clubs so that games are thrilling for the fans without inevitable end. Totty & Mark (46) note that sports leagues that have adopted the theory of salary caps do so because they think that letting wealthier teams accumulate talent influences the quality of the sporting product they need to sell. If merely a handful of dominant clubs can challenge and win consistently for the championship, several of the contestants will be punctured by the superior team, limiting the attractiveness of sports for viewers on television and fans at the stadium (Baschnagel 41). Television revenue is an essential part of the income of several sports around the globe, and the more exciting and evenly matched the contents, the most thrilling the television product. This means that the value of television broadcast rights is higher. Unbalanced leagues threaten the financial visibility of weaker clubs, because if there is the inexistence of long-term hopes of their clubs winning, fans of weaker teams will gravitate to other leagues or sports.

A wage cap can also aid in the control of the costs of clubs and prevent events in which teams will sign high-maintenance contracts for established players to accrue benefits of immediate success and popularity, only to later fall into financial difficulties because of these expenses (Baschnagel 31). Without caps, there is the danger that clubs will overspend money to win now at the cost of their long-term stability (Larsen et al. 390). Besides, club owners who apply similar risk-benefit appraisal involved in business may risk not only the fortunes of their clubs but also the viability and reputation of the entire league.

Monopoly and Game Theory

Vrooman (6) states that the perfect game is a joint and beneficial contest between opponents that are evenly matched. The practical economic issue is that games played in professional sports leagues occur between teams from different home markets that form poorly competitive natural cartels. However, the inherent plurality of various sports leagues implies that any club is only as robust as its weakest competitor is and that the success of a league relies on the teams' competitive balance.

Sports economics have celebrated the golden anniversary of its history and origin in Rottenberg’s pre-Coasian argument concerning the neutral implications of free agency on sports players’ labor market (Vrooman 14). According to the organization’s invariance proposition, availability of free agency would bring the equal talent distribution as the additional system that tied a player to one club for life. The variation was that free agency would be in a position to weaken monopolistic exploitation of players stuck in reserve and allow their respective salaries to reach their marginal revenue product.

In its strongest nature, the invariance proposition holds that sharing of revenue would not influence the distribution of talent among clubs and would only strengthen the exploitation of players. The most rational way to limit the dominance of strong revenue clubs is by enhancing competition in the local monopoly markets, instead of increasing the power of monopsony in the players’ labor market (Deeks 1).

Theorists from Europe have applied non-cooperative game theory to highlight that the invariance proposition does not apply in open markets of European soccer, and that sharing of revenue leads to reduced competitive balance (Vrooman 22). The distinction of the open market may not make a difference in the long-term, however, because the closed and open labor market systems are founded on assumptions that owners are maximizers of benefits/profits. As a result, it is likely that sports-owners are players who sacrifice their profits to win (Dietl, Markus, & Alexander 12). That is, at the least, the owners of sportsman become maximizers of winnings and they are driven by spending in order to win at all costs.

The sportsman influence is constrained by zero-profit instead of maximum profit, and the dissimilarity between open or closed labor markets becomes academic. In the event that club owners are sportsmen, then instinct prevails over absurdity and sharing of sharing enhances competitive balance (Dietl et al. 14). As “usual cartels”, the main four North American sports leagues have historically hosted major-league monopsony and monopoly power. There is a growing evidence in this appraisal that these sports leagues have been dominated by owners of sportsmen who are willing to pay their players their average revenue product in the bid to win. The shares of revenue that players get have exceeded 60% in each of the main leagues (Golliver 1). Erosion of the power of monopsony has compelled the cartels of sports leagues to exploit their power of monopoly in the negotiation of the fees of media rights as well as the extortion of subsidies of public venue cost.

Using Gini Coefficients to measure competitive balance in NBA

Gini coefficients can be used as a determinant of competitive balance in major sports leagues. While the coefficient is applied as a means to assess wealth or income distributions, this traditional economic measure is also helpful in testing the distribution of wins in a particular sports league (Schouten 11). The coefficient always lies between one and zero, where zero shows an equal distribution of team wins and one shows a single club winning all the games played. A league is said to indicate a perfect competitive balance when every club wins exactly half of the played games. Schouten (11) states that a coefficient that is closer to one is an indication of a league where few teams win several games that are played.

Source: Schouten (12)

Conclusion

If club owners are aligned to profit maximization, then the theory of invariance proposition maintains that sharing of revenue enhances player exploitation and fails to influence competitive balance. If club owners are bound to maximize on the wins, then competition will be more unbalanced. Sharing of revenue among sportsmen increases competitive balance, payrolls, and league revenues. Experimental evidence from NBA and other major sports leagues defy the supposition of competitive invariance, profit maximization, and exploitation. There is conflicting evidence that sportsmen have dominated NBA since its advent. Because of the internal rivalry among owners of athletes, monopsonistic exploitation has disappeared over the last decade. The other main leagues have the same carrying capacities for athlete costs at two-thirds of league revenues. Besides, the current payroll cap percentages are identical at around 60%. As anticipated, sharing of revenues in NBA fosters competitive balance without or with joint application of salary caps.