The Captain's Blog

Major league baseball has achieved competitive balance. Whether you choose to call it parity or mediocrity, the difference between the best and worst teams in the league has seldom been so narrow.

Max/Min Winning Percentage Comparison, 2001 to 2014
Note: 2014 data is as of the August 25, 2014.
Source: Baseball-reference.com (data) and proprietary calculations.

So, how has baseball been able to fulfill Bud Selig’s dream of league-wide balance? The combination of increased revenue sharing and a soft cap created by the luxury tax are two key reasons, but there are several others as well. Clearly, the economic landscape in baseball has shifted, but does that really mean the end to big market teams wielding financial influence in the standings?

Before considering that question, it’s important to point out that payrolls in baseball aren’t really coincident indicators. Because baseball’s collective bargaining agreement denies a player access to the free market for at least the first six major league seasons of his career, it’s often the case that salaries lag performance. As a result, players are often paid as much, or more, for how they’ve produced in the past than what is expected from them in the future. Due to this incongruous relationship, it’s easy to see why payroll wouldn’t necessarily correlate strongly with winning percentage in the current year.

Correlation Between Payroll and Past Success, 2000 to 2014
Note: Periods are as follows Y2Y (current year to current year), Y2LY (current year to last year), Y2LY2 (current year to two years ago), etc. Average period includes all periods ending from 2000 to 2014. Other period ends displayed are a snapshot. Source: Baseball-reference.com (win-loss data), Cots contracts (opening day payroll data with pro-rated signing bonuses), and proprietary calculations.

Since (at least) 2000, there has consistently been a higher correlation between payroll and past success than salaries and current performance. On average, the correlation coefficient (r) between the amount paid to players in a current season and winning percentage in the previous one to three years has averaged approximately 0.50, compared to 0.39 in a same-year comparison. This isn’t a drastic difference, but it does, nonetheless, demonstrate the lagging relationship between payroll and performance.

The notion that winning begets high payrolls instead of vice versa is important because it suggests that year-to-year comparisons should be taken with a grain of salt. In other words, just because this year’s correlation between the two measures is only 0.22 doesn’t mean the link has been permanently broken. In fact, on a lagging basis, the connection is still pretty strong. For example, when 2014 payrolls are compared to 2011 winning percentages, the correlation coefficient is 0.63.

Other factors can skew current year comparisons between payroll and winning percentage, not the least of which is the back loading of contracts. For example, Mike Trout is only being paid $1 million this year, but his performance is more commensurate with the back-loaded salaries of $30 million-plus he will receive at the end of his just-signed contract extension. Although those inflated payments toward the end of the deal are not accounted for in current payroll figures, Trout’s current performance is certainly being reflected in the Angels’ winning percentage.

Another pitfall when comparing payrolls with winning percentage in the same season results from the evolution of rosters. When a big star gets injured, for example, his salary is counted as payroll, but his contribution is eliminated. Then, there are teams who add and subtract players throughout the course of the year. If you looked at the Red Sox opening day payroll of $156 million, it would be hard to fathom the team’s current winning percentage of .435, but only the latter is taking into account the organization’s white flag maneuvering at the trade deadline.

Correlation Between Payroll and Past Success, Four Year Periods form 2000 to 2014

Note: 2014 data is as of the August 25, 2014.
Source: Baseball-reference.com (win-loss data), Cots contracts (opening day payroll data with pro-rated signing bonuses), and proprietary calculations.

Because payroll is really a lagging indicator of success, it makes more sense to compare salaries and wins in larger chunks. Using four year blocks, the correlation between winning and payroll currently stands at 0.40 (2011-2014), or nearly double the one-year comparison. What does that mean? Even though the relationship between payroll and winning in one season is nearing statistical insignificance, the link between salaries paid and sustained success is stronger, although, it should be noted, this correlation is also on the decline from recent levels.

For all the reasons discussed, teams have a greater opportunity to proactively mitigate the link between payroll and performance. However, if they hope to achieve an extended period of success, the relationship can’t be eliminated or even managed without taking considerable risks. That’s something big market teams need to consider, especially organizations like the Red Sox and Yankees, who have seemingly decided to stop flexing their financial muscles in favor of a more lean approach. As both franchises have found out, when you don’t spend as much, performance variability increases. That doesn’t preclude upside, but it introduces much greater downside risk. Is that the chance larger market teams are now willing to take? And, if so, why?

Ironically, the greatest contributor to parity might not be revenue sharing, the luxury tax, and long-term extensions given to young players, but rather the exponential increase and stability of big market revenue. In that sense, a more interesting comparison is between winning percentage and the amount of money a team earns each season. For teams with an inelastic relationship, the impetus to spend might be lower. This is especially true now because a larger percentage of big market revenues come from long-term television deals, which are not subject to short-term influences. When you add in the penalty of the luxury tax and burden of revenue sharing, larger market teams have a declining incentive to win. So, if teams are forgoing sustained success because the financial rewards are no longer worth the cost, it’s likely that baseball will maintain a sustained period of parity, at least until the equilibrium is altered and winning once again becomes the driver of financial success.

So, yes, money can still buy happiness in major league baseball, even if (and, perhaps, especially because) fewer and fewer team owners are willing to pay the price.