Individual Team Incentives and Managing Competitive Balance in Sports Leagues: An Empirical Analysis of Major League Baseball

Abstract

Major League Baseball and other professional sports leagues have long been concerned with competitive imbalances caused by differences in local revenues. The fear is that in the absence of salary caps or other regulatory mechanisms, smaller-market teams will be unable to remain competitive. This research uses a structural dynamic programming model to analyze ownership's payroll investment decisions. This model estimates the relationship between optimal payrolls and local-market populations and the influence of long-term customer equity dynamics on payroll investments. In addition, the author analyzes the impact of a recent policy intervention that implemented revenue transfers from high-local-revenue markets to low-local-revenue markets. The statistical results indicate that market population has a significant impact on the value of a team's payroll investments. For example, optimal payrolls double as the population increases from 2.5 million to 7.5 million. Furthermore, rather than improving competitive balance, the adoption of revenue sharing has decreased the incentives for small-market teams to remain competitive. The author uses the estimation results to evaluate alternative approaches to managing competitive balance. Specifically, the results suggest that basing revenue-sharing payments on local-market population and (higher) attendance rates reduces payroll dispersion.