The Effect of the Increased Wage Gap on the Competitive Balance of Major League Baseball

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Haverford College. Department of Economics
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Even though the free agency clause was introduced in 1976, the distributions of average team salaries remained relatively compact up until around 1994. During this period of time, baseball team owners were found to be guilty of collusion in their restriction of free agents. This forced the salaries of the players to remain relatively low as compared to what their market value would have been in an open bidding market without restrictions. In 1994 and 1995 there were two work stoppages in which the players prevailed over the team owners in opening up the markets for free agents to be able to earn contracts that more accurately represented their true market value. It was at this time that disparity between teams payrolls began to differentiate at a rapid rate, which has led to a great controversy in modern day baseball. The question that concerns both the fans and Major League baseball itself is whether the growing disparity in wages has damaged the competitive balance of the sport. More specifically, do large market teams have an unfair advantage and increased likelihood of winning due to their ability to purchase higher priced talent? Ultimately, players will be profit maximizers unless that player has personal ties to a certain team or city. In the end a player’s salary will be determined by the team that offers him the most money. We must also assume that owners are profit maximizers, and that the marginal cost of a player’s salary will be equal to or less then the marginal product of that player. Each interested team will individually assess how much they believe the player would be worth to them, and will accordingly offer that player a contract of a particular value. The factors used in their analysis of any given player involve many complicated decisions based on: the player’s marginal revenue product, the positional needs of the team, the availability of substitutes for that player, the opportunity cost of the player, the knowledge of the market that the owner and player have, and the size/worth of the market that the team plays in. Theoretically, this means that the teams with the most resources available to them can buy the best available players, thereby giving them an unfair advantage over the teams that can not afford to pay the high priced contracts of these top quality players. This paper will analyze the trends of major league baseball between 1995 and 2004 to see if the competitive balance of the sport has been lost, or if the disparity in team wages is a fair part of the sport that arises from different variables that affect the different teams in a given year. This paper will proceed as follows: section II explores some of the relevant literature that has examined the competitive balance in baseball and the factors that go into producing a winning team. Section III contains the methodology and analyses of regressions run on winning percentage based on different measures of team performance, including team payrolls. Section IV takes a further look into the competitive balance of baseball and examines how it has changed over the last ten years. Finally, Section V will draw conclusions based on all the analysis of the trends in baseball from 1995 to 2004.