The impact of salary dispersion and performance bonuses on NFL organizations Joel Maxcy University of Georgia Mike Mondello The Florida State University

Pay Dispersion and Firm Performance Competing Hypotheses Hierarchical Pay Structure – creates a meritocracy where accomplishments are rewarded monetarily – Efficiency wage theory (Debrock et al 2004) Compressed Pay Allocation – improves teamwork between workers – will more likely occur when teamwork is more important – Lazaer (1989)

Empirical Work: Team Sports 1. MLB A. Bloom (1999) B. Depken (2000) C. Debrock et al (2004) D. Frick et al (2003) Each finds that increased dispersion worsens team performance

Empirical Work: Team Sports 2. NBA A. Berri and Jewell (2004) B. Frick et al (2003) Salary compression does not effect or worsens team performance

Empirical Work: Team Sports 3. NFL A. Frick et al (2003) compression is correlated with better team performance but shy of statistical significance B. Borghesi (2007) compression is correlated with better team performance C. Quinn et al (2007) compression is not correlated with better team performance

Performance Bonuses Agency Theory – Holmstrom, Baker, Gibbons, Murphy Compensation based on performance – is an efficient and effective method Possibly not efficient when – individual and group performance cannot be easily distinguished – determination of the individual bonus conflicts with firm objectives – the bonus relies on subjective evaluation

Application to Team Sports Individual performance – Shirking literature implied positive effect Team performance – No known empirical studies

NFL’s Payroll Constraint and Pay Dispersion The NFL Enforces a “Hard” Salary Cap – Constraint implies that rather than a “teamwork” externality from dispersion... –... additional salary cap money allocated toward superstars leaves fewer dollars are available for mid-tier free agents – A team may be forced to substitute with lowest tier players to meet salary cap constraints

2006 Amendments to CBA Players get smaller percentage of larger pool – More stadium revenues are included – E.G. luxury seating Owners share more revenue Also in 2006 new National Broadcast contracts increases league revenue from $2.2B to $3.74B per year – Split evenly between teams

NFL Payment Methods 1. Signing bonuses – up front payments are rewarded to players for signing a contract or extending a previous one; only source of guaranteed pay 2. Fixed payments – previously agreed upon amounts paid annually and count against a team’s salary cap total, but are not guaranteed over successive years; guaranteed only for current season 3. Performance bonuses – incentive payments based on various individual and team accomplishments. No guarantee must be earned

NFL and Performance Bonuses At least, if not more common, than in other team sports More than 70% of all NFL players receive performance bonus payments Accounted for <10% of total pay through 2005 As of 2006 jumped to about 25% of total pay

Performance Bonuses Team incentives: – Winning games, conference championships, or the Super Bowl – Total points scored, yards accumulated, and team rankings in several statistical categories – Touchdowns yielded, number of yards allowed, or sacks registered Individual incentives : – Statistical accomplishments, e.g. touchdowns scored, touchdowns caught – Physical conditioning benchmarks including weight limits – Rankings compared to other position players

Incentive Bonus Payments by Year

Salary Payments and the Cap Constraint Signing bonuses cap values are prorated over the term of the contract – When a players leaves the team before contract expiration the bonus is accelerated and the team is left with a “dead money” situation Other bonuses are counted against the current year’s cap if LTBE – Or the next year if earned but not classified as LTBE

Management’s Decision Seek or retain highest quality talent at a few key positions – Market will dictate high signing bonus – Greater pay dispersion Spread talent more evenly across roster – More opportunity to implement performance bonuses

Empirical Specification: On-field Performance DWP it =  0 +  1 PAYROLL it +  2 BONUS it +  3 CVPR it +  4 WP it-1 +  5 REVENUE it-1 +  6 ROSTER it +  7 NEWCOACH it +  8 CONFERENCE it +  9 ACBA +  it. Models – OLS – Fixed Effects – Random Effects

Empirical Specification: Financial Performance REVENUE it =  0 +  1 PAYROLL it +  2 BONUS it +  3 CVPR it +  4 WP it +  5 WP it-1 +  6 ROSTER it +  7 NEWCOACH it +  8 CONFERENCE it +  9 ACBA +  it. Models – OLS – Fixed Effects – Random Effects

Data 254 club-year observations from NFL teams over the period – In 200 they began to separate signing bonuses from other bonuses Salary and payroll data were obtained from the USA Today’s NFL Salary database Team revenue data were obtained from Forbes.com The sample contains the full eight seasons for all thirty-two teams except the Houston Texans, who began play in the 2002 season.

Results

Model 1: Dependent Variable = DWPCT

Model 2: Dependent variable = Revenue t

Discussion Significant finding is the strong negative relationship between payroll dispersion and on-field performance in the fixed effects model Positive correlation between incentive bonuses and winning is consistent with agency theory. – relative weakness of estimates implies some inefficiency in their administration – E.g. the games played with the LTBE

Discussion Increases in incentive bonuses carry a positive relationship with revenue – perhaps indicating that more bonuses are paid in a “good” year Salary dispersion and revenue are positively correlated. – Do fans prefer to see teams spending significant dollars on a few superstars, to a less glamorous team that wins more?