Professional Athlete Contracts and the Sunk Cost Trap
by 2 November 2012, 12:00 PM
We’ve all been there before. Having paid for this shiny new appliance we expected to work as advertised, until we get it home and turns out to be a piece of junk, but we keep using it because of how much we paid.
Professional sports teams are the same way, whether it’s a former first round draft pick who hasn’t lived up to his potential or a big free agent signing that really hasn’t panned out, teams in all sports have been ensnared in the sunken cost trap. In economics, a sunk cost (K), is the amount spent on tools for production that you don’t ever expect to get back. For example if Nike builds a new factory for $1 million, its initial profits are zero not a loss of $1 million, because the cost of building the factory is sunk.
In each sport there are examples of teams investing a lot in a player either through the draft, by trade, or through free agent signings, only to have that athlete flop. Inexplicably, many of these players still receive significant playing time despite their lack of ability because of the high level of investment that has been placed in them. From a purely economic perspective, prior investment in a player should not factor into the decision; the team will never recoup what they put in, so they should objectively evaluate their player.
However professional sports is unique in that there are dual objectives: to field the best team but to also make the most money. To that end fielding the best team may not maximize utility, because the high paid player that should be benched is often popular among the fanbase. There are three recent examples of different variations of this phenomenon, each from a different sport, which should help illustrate what I’m talking about.
The first player is Alex Rodriguez, the much maligned Yankees third baseman whose dismissal playoff performance drew the ire of the media. For A-Rod the writing has been on the wall for years now as his numbers have steadily declined each season to the point that after this season he should be a platoon player. His slugging percentage, ISO, and OPS dropping off significantly against right handed pitchers, with his BB/K ratio decreasing by more than half. These numbers should only get worse as time goes on, but platooning a player getting paid $25 million dollars a year would not go over well with fans. New York teams have historically been about maximizing revenue rather than fielding the best team (ask the Knicks), so expect to see A-Rod as an everyday player in pinstripes for years to come despite the numbers being against him. It’ll be interesting to see when his play gets so bad that they can’t even justify having him play anymore, but I don’t believe we’re at this point yet.
This is not the case for the second player, Kendrick Perkins, who despite being paid $9 million a year should be firmly shackled to the bench. For years now Perkins has been below replacement level with his single digit PER, yet OKC refuses to bench or even amnesty him, and as a result lost out on resigning James Harden. This is a case where Perkins presence in the lineup won’t have much of an effect on team revenue, so it should only be a matter of time before he has to start bringing tweezers to games.
The last and most controversial example is the Eagles QB Michael Vick. Vick’s contract is an unmitigated disaster, having been signed for $100 million, $60 million of which is guaranteed. Needless to say, Vick was never going to live up to such a contract, and now the Eagles find themselves in a situation where his poor play along with a variety of other factors are creating problems. While Vick is probably still the best QB on the roster, his large contract makes it unlikely that the Eagles will be able to develop a young QB or sign another to take his place, even if he continues to struggle. Benching Vick would be a huge pill to swallow, and would essentially be an admission by the organization that they screwed up big time (they did whether they admit it or not). Fans surely would react poorly and attendance would drop, which further decreases the chance Vick will be riding the pine. This is a no-win situation, where the sunk cost and potential drop in revenue are so high that it severely clouds judgment. The most likely scenario is one in which the team continues to stink it up as Andy Reid refuses to commit to the run, while Vick takes more and more hits while throwing interceptions.
Each situation is different, the principle is the same: bad contracts that are not viewed as sunk costs prevent teams from moving on and hinder progress even more.