Peculiarities of the Major League Baseball Posting System

Peculartes of the Major League Baseball Postng System Duane W. Rockerbe Unversty of Lethbrdge Revsed July 2007 Abstract The postng system used n major league baseball to obtan free agent players from Japan has some smlartes and many dfferences from the transfer system used to obtan foregn free agents n European football. Ths paper uses aucton theory to explan the desgn of the postng system. The unque features of the postng system are found to be a compromse between major league baseball clubs and Japanese clubs. The system mantans lower wnnng bds than would otherwse be the case, but t prevents foreclosure by rval bdders whch could lead to market falure. Keywords: postng system, baseball, aucton theory, colluson 0

The transfer system n European football s well known and very lucratve for professonal clubs. Large amounts of money change hands and world qualty players move among clubs such as Real Madrd and Chelsea. Lttle known to Europe and most of North Amerca s the transfer system used n major league baseball called the postng system. The postng system s currently used only for Japanese players wshng to move to North Amerca (curously the system does not operate n reverse). The system lacks the suspense and glamour of the European system, but t s growng and t could reach out to other countres n the near future. Indeed, the world took notce n November of 2006 when the Boston Red Sox pad a record $51 mllon for the exclusve rghts to negotate wth ptcher Dasuke Matsuzaka of the Sebu Lons club. The rules and characterstcs of the European transfer market are qute well known to readers of ths journal, but the postng system mght seem a mystery. Its rules are very dfferent and they were probably set up for dfferent reasons. Ths paper uses aucton theory to explore the dfferences between the two systems and to assess the effcences of the postng system. The Postng System n MLB The postng system developed as a result of complants by Japanese professonal baseball clubs followng the case of Hdeo Nomo. Nomo, a ptcher, wshed to leave hs Japanese club, the Kntetsu Buffaloes, and play for the Los Angeles Dodgers, but could not secure a release from hs contract. Snce Nomo could release hmself from hs Japanese contract by retrng, he dd so, and then promptly sgned a new contract wth the Dodgers n 1995. Many Japanese baseball fans left ther nterest n Japanese baseball behnd to follow the performances of Nomo n North Amerca. The fear was then that the best Japanese players would follow Nomo, resultng n losses n attendance and televson ratngs n Japan. The postng system was agreed upon by MLB and Japanese baseball (the Puro Yakyu or Professonal League) as a way to both dscourage Japanese players from movng to major league baseball (MLB) and to provde compensaton to Japanese clubs. Japanese players who are wthout contracts n Japan are not subject to the postng system. The system frst came nto use n the wnter of 1999 wth the purchase of Ichro Suzuk by the Seattle Marners from the Japanese club Orx Blue Wave. 1

A Japanese player who wshes to leave hs Japanese club and move to MLB must notfy hs club. The club can then agree to place the player on a postng lst wth any other players on any other Japanese clubs who also wsh to move. Nothng prevents a MLB club from dscussng the possblty of postng a player wth the player's agent before the postng perod closes (November to March). The postng lst s then provded to the Commssoner of MLB who notfes all MLB clubs of the posted players. Interested MLB clubs submt a sealed bd to the Commssoner's Offce wthn four days. The Commssoner opens the bds and notfes the Japanese club of the amount of the hghest bd, but not who the bddng club s. The Japanese club has 30 days to accept or reject the bd and the bd s not subject to negotaton. If rejected, the Japanese club retans the player s rghts and the player cannot be posted agan untl the next off-season. If the bd s accepted, the Japanese player must agree to a playng contract wth the wnnng bdder by the close of the postng perod. Only at that tme does the Japanese club receve the wnnng funds. If the player cannot agree to a playng contract, hs rghts revert back to hs Japanese club and no payment s made. The postng system s not heavly used snce only the top Japanese baseball players have any chance of beng sgned by MLB clubs. Snce ts ncepton n November of 1999, only twelve players have used the system and only eght have sgned contracts wth MLB clubs 1. For the most part, the wnnng bds are qute low ($300,000 to $1 mllon) compared to European standards, perhaps ndcatng only a passng nterest by the MLB club. Three notable exceptons are the wnnng bds of $13 mllon, $11 mllon and $51 mllon pad n the years 2000, 2003 and 2006 for the players Ichro Suzuk, Kazuhsa Ish and Dasuke Matsuzaka. In these three cases, and most of the others, the player's Japanese clubs were n fnancal dffculty, requrng the sale of the player to generate needed revenue. MLB clubs are free to bd to ther maxmum value for the player snce the transfer fee does not count towards the team payroll (whch s taxed above a threshold level). Revenue sharng s also used wth the objectve of makng the dstrbuton of revenues n MLB more equtable. Any club payng a large amount for a Japanese player, 1 Source: http://www.baseball-reference.com/bullpen/postng_system 2

or any other player, wll only receve a fracton of the player's contrbuton towards team revenue. The rules ncorporated n the postng system are n stark contrast to the rules used n the European transfer system. Lke the postng system, players can be sold across clubs and the player receves none of the transfer fee. The player must then agree to a new contract wth the bddng club before the transfer fee s pad. If unsuccessful, the transfer s voded and the player's rghts reman wth the orgnal club. Lke the postng system, transfers can only be made durng specfc perods of the year, the months of January and August. Those are the only smlartes. The top executve of each countres football league does not get nvolved n the sale of a player, except to approve the sale n a perfunctory way after all the agreements have been settled. Clubs wshng to sell players can negotate transfers wth any club they choose, although rather oddly, the player's agent s usually nvolved n negotatng the transfer fee of whch the agent may receve a percentage. Players may request to be placed on a transfer lst f they wsh to leave ther club, but clubs may also transfer players wthout ther ntal consent. The bddng for players s not restrcted to only one bdder and bddng wars are frequent. Transactons are only loosely regulated, f at all, and scandals are frequent 2. Major league baseball and Japanese baseball chose to desgn a very dfferent transfer system from that used n most of the rest of the world. In the next secton, we use aucton theory to explore the desgn of the postng system. An Aucton Theory Approach A prvate value aucton occurs when each bdder has a prvate valuaton of the player's worth that s unque so that there s no common market value attached to the player. In ths case, the true value of the player s just equal to the prvate valuaton and the wnnng 2 For a revew of the transfer scandal n England n 2006, see http://news.bbc.co.uk/sport1/h/football/eng_prem/5398006.stm 3

bdder wll be the one wth the hghest prvate valuaton. Vckey (1961) showed that the wnnng bd would be the same regardless of the type of aucton (ascendng bd, descendng bd, frst prce sealed bd, second prce sealed bd) so that the auctoneer and the seller are ndfferent between the type of aucton. Club owners may very well assgn dfferent valuatons to the same free agent player snce the player's revenue generatng potental may dffer across clubs. The aucton s effcent n the sense that the bdder wth the hghest prvate valuaton wll wn the aucton. We wll show that ths type of aucton fts the European transfer system, but not the postng system n MLB. Two factors dstngush the postng system: the partcpaton of the Commssoner of MLB as an ntermedary n the aucton, and; the dentty of the wnnng bdder s not revealed to the Japanese club unless the bd s accepted. The objectve of the Japanese club s to receve a bd as hgh as possble above ts reserve prce, whle the objectve of the Commssoner, actng as an agent for MLB clubs, s to nsure the wnnng bd s only slghtly above the reserve prce. The model developed here follows Jehel and Moldovanu (1996) and Callaud and Jehel (1998) and wll show that two crtcal factors are necessary to explan the postng system: a formalzed system of sde payments among the colludng clubs - revenue sharng - and revenues that are not part of the revenue sharng arrangement. Sde payments are necessary to compensate the losng bdders n the postng system for the antcpated reducton n ther wnnng percentages, and thus revenue. In MLB, the current revenue sharng arrangement requres each club to contrbute approxmately 35% of ts annual local revenue to a central fund managed by the Commssoner s Offce. At perodc ntervals durng the season, each club receves an equal share of the central fund. Local revenue ncludes mostly gate revenue and some concesson revenue (food, parkng, etc.), but excludes revenue from luxury sutes, local rado and televson broadcastng and some other revenues. Hence the revenue sharng system s a formal and enforceable arrangement for makng sde payments. The margnal revenue product of any newly acqured player s partly shared wth all other clubs n the league so that the negatve externalty mposed on other clubs s partly elmnated. 4

Colluson takes the form of a sort of pre-aucton among MLB clubs that determnes whch club wll make the wnnng bd, what the wnnng bd wll be, and the amount of sde payment that s requred to each losng member of the bddng cartel. The sde payment s necessary to compensate the losng bdders for the loss n revenue they may experence by allowng the wnnng bdder to mprove hs or her club (assumng that revenue s a functon of wnnng percentage). The revenue sharng system used n MLB s a formal, but mperfect mechansm to facltate the necessary sde payments. The dentty of the wnnng bdder s concealed from the Japanese club snce ths nformaton contans a valuable rent a more accurate estmate of the non-local revenue of the wnnng bdder that mght be extracted by the Japanese club. Setup of the Model There exst n clubs from a total of N clubs n a league ( n N ), ndexed by = 1,.,n, bddng to purchase a sngle player from a sngle seller (the Japanese club). Each buyer places a prvate valuaton, v, on the player deally equal to the player s dscounted lfetme margnal revenue product for the club. For a gven player for sale, the dstrbuton of valuatons s assumed to be unform wth known upper and lower lmts, however the poston of a specfc clubs valuaton wthn the dstrbuton s not known. We assume that the dstrbuton of prvate valuatons s ndependent of the type of aucton (collusve or non-collusve). The attrbutes of the player to be sold that determnes each v can be obtaned at zero cost. The seller places a reserve prce of R on the player so that any bd below R wll not be successful. Losng bdders suffer an externalty that we assume s not dentcal for all losng bdders. The magntude of the externalty s assumed to ncrease the greater s the v for the wnnng bdder. Ths runs contrary to the exstng aucton lterature, but we feel t s approprate due to presence of dmnshng margnal revenue product wth wnnng percentage. The nature of sportng contests s that for one club to be more successful, others must be less successful. Other clubs then move down ther concave revenue schedules at ncreasng rates and the externalty becomes larger. 5

For now, we assume an aucton wthout sde payments. Wthout a sde payment (revenue sharng), all losng bdders wll prefer that the player not be sold. The wnnng bdder wll max NC NC obtan a net proft of v, where b s the amount of the wnnng bd ( b NC R ) b n the non-collusve aucton. Any losng bdder ncurs a loss equal to the monetary value of the externalty that s commonly known. We also assume that non-local revenues are zero, however we relax ths assumpton n a later secton. The European Transfer System We use the European transfer system as the base case. The European transfer system can best be descrbed, usng the termnology of Vckrey (1961), as an ascendng bd aucton where the wnnng bd (ndexed ) s just slghtly hgher than the second hghest bdder NC (ndexed -1) and less than the wnnng bdder's valuaton ( v < b < v ). Unlke the baseball postng system, football clubs are free to negotate wth each other for transfer fees wthn the two transfer "wndows". If negotatons break down wthn the transfer wndow, teams are free to re-enter the transfer market and negotate a transfer fee wth any other nterested bdder. The results of an ascendng bd aucton wthout colluson are well known. In a publc value aucton, Mlgrom and Weber (1982) showed that an ascendng bd aucton wll generate the greatest wnnng bd and the smallest wnner's curse. The aucton s effcent n the sense that the bdder wth the hghest prvate valuaton wll wn the aucton. Ths keeps the player's surplus n the hands of the owners who wll deally be wllng to bd up to the antcpated surplus. Ths also keeps player salares lower than would otherwse be the case wth North Amercan type free agency snce wnnng bdders may suffer a wnner's curse and wll have less money left over for salares. 1 Collusve Bddng We now develop an aucton model wth collusve sde payments. The bddng model s a three-stage game. In stage 0, each buyer formulates hs or her v based on costless nformaton about the player to be sold. In stage 1, the bdders play a colluson subgame 6

durng whch they choose a set of bds to submt to the aucton (one of whch s known to the bdders as the wnnng bd) and on the dstrbuton of sde payments. In stage 2, the Commssoner selects the hghest bd as the wnnng bd and nforms the seller wthout revealng the dentty of the wnner. At ths pont, the seller may accept or reject the wnnng bd. We do not explctly model the barganng process between the Japanese player and the wnnng bdder as ths process s symmetrc to the European transfer system. We focus on stage 1 of the bddng model as ths largely determnes the outcome for the stage 2. Wthout defecton by any of the bddng clubs, the collusve subgame n stage 1 wll result n rng effcency (Graham and Marshall (1987)) f the sde payments to all clubs sum to zero (the wnnng bdder cannot borrow to make the necessary sde payments). Sde payments are automatcally collected and pad through a revenue sharng system where each club s allowed to keep a share equal to α of ts local revenues ( 0 α 1). Rng effcency requres that the net proft for the wnnng bdder be the maxmal wnnng proft among all bdders after all sde payments have been pad, thus the rng effcency condton s max 1 α max C max C α v + v b = γv b R (1) N where = (( N 1 ) α + 1) N < 1 b C γ and s the collusve bd. It wll be n the best nterest of the losng bdders to select the bdder wth the hghest valuaton to wn the aucton and to arrange a b as close to R as possble n order to guarantee the rng effcency condton s met. If ths does not occur, an ascendng bd aucton wll take place durng the pre-aucton n stage 1 so that bddng club wth a prvate valuaton equal to preval. It s also requred that the wnnng bdder be at least as well as off by colludng as by not colludng, although ths s a weak condton snce abandonng revenue sharng requres a super-majorty vote of owners (Easton and Rockerbe (2005)). max v wll 7

γ v b > v b (2) max C max NC Condton (2) smplfes to max NC C ( 1 γ ) v < b b (3) whch states that the ncrease n the bd by not colludng must exceed the post-revenue sharng local revenue C max nterval R b γv. to mantan rng effcency. The wnnng bd wll fall wthn the Foreclosure of Collusve Bddng There s a potental for the collusve agreement n stage 2 of the game to fal f one of the losng bdders overstates hs or her prvate valuaton of the player for sale. We refer to ths stuaton as foreclosure. Foreclosure means that one bdder prevents the bdder wth the hghest prvate valuaton from obtanng the rghts to negotate wth the Japanese player, even though the wnnng bdder has no nt enton of sgnng the player to a contract. Formally we state ths stuaton s max v j > v for j. Ths strategy could be used by one of two or more clubs that are strong rvals, for nstance, the Boston Red Sox and the New York Yankees. The Red Sox owner smply submts a sealed bd that s nflated beyond the arranged bd submtted by the owner of the Yankees 3. Snce the Red Sox owner has no ntenton of sgnng the Japanese player to a contract, but merely wshes to prevent the Yankees from obtanng the player's negotaton rghts, the sze of the wnnng bd b j has no relevance. The Japanese player cannot re-enter the postng system untl the next off-season, so the foreclosure s effectve and costless. Foreclosure can only occur n the bddng model f the externalty s not dentcal for all 3 Economcs suggests that the owner of the Yankees wll submt a bd that has an upper bound equal to the antcpated surplus that the player wll generate over and above the antcpated salary. 8

clubs, but nstead there exsts a dstrbuton of values for t. It s purely mechancal that low revenue clubs experence a net ncrease n revenues after revenue sharng, whle hgh revenue clubs experence a net decrease. Usng the Red Sox - Yankees example, f the Yankees acqure the rghts to the player up for aucton, the best compensaton the Red Sox wll receve s a 1/30 share of the ncrease n revenue the Yankees experence from the new player. Ths mght not be enough to compensate for the reducton n the Red Sox revenue snce the two are close dvsonal rvals. Condtons (1) and (2) for rng effcency are volated but the clubs cannot revert to the ascendng bd aucton of the European transfer system snce the Red Sox are only one vote. The Red Sox owner may then resort to foreclosure. If strong rvalres are prevalent n MLB, foreclosng mght prevent the postng system from operatng at all. MLB clubs that antcpate foreclosng behavor by a rval club smply won't bother partcpatng n stage 1 of the game and market falure may result f condtons (1) and (2) are volated. The only players who wll make the jump from Japan to MLB wll be margnal players that have lttle mpact on the relatve strengths of MLB clubs. Ratonal Japanese clubs that antcpate recevng the much needed transfer revenues would surely antcpate foreclosng behavor and nsst that some mechansm be bult nto the postng system to prevent foreclosure. Allowng MLB clubs to bd drectly wth the Japanese club wll not prevent foreclosure of compettve bddng. One soluton s suggested from the nsurance lterature. MLB clubs could be requred to pay a "deductble" for the rght to enter the bddng process. Only the wnnng bdder would lose the deductble f t faled to agree to a contract wth the Japanese player. The deductble would need to be hgh enough to dscourage foreclosure and to gve the postng system credblty to the Japanese club. Unfortunately the use of a deductble may prevent some lower revenue MLB clubs from bddng, snce there s always some postve probablty that the honest wnnng bdder wll not be able to reach a contract agreement wth the Japanese player. Currently, a deductble s not a feature of the postng system, perhaps for ths reason. Alternatvely, the postng system could be changed to 9

game. We now augment the rng effcency condtons n (1) and (3) by ntroducng non- allow a Japanese player to re-enter the system durng the desgnated postng perod f contract negotatons fal. Foreclosure could stll occur f the wnnng bdder drags on contract negotatons to the end of the postng perod. The role of the Commssoner's offce n the bddng process may be to prevent foreclosure, partcularly f the Commssoner s present at the pre-aucton n stage 1 of the game. He wll know who the wnnng bdder s at the end of stage 1 and wll easly be able to detect a foreclosng bd n stage 2. It s not really known f n bds are opened, or just one. If the latter s the case, then the appearance of a second unexpected bd s smply rejected. In ths way, the Commssoner can act as a flter between the wnnng bd and the Japanese club. If ths s ndeed the role of the Commssoner n the postng system, there s no reason the Japanese professonal league would not agree to nvolvng the Commssoner's Offce n the process. Mantanng Anonymty of the Wnner The Commssoner nsures that the wnnng bdder remans anonymous when he presents C the value of b to the seller. The Japanese club s assumed to know that wnnng bd wll be the bdder wth a prvate valuaton of v max snce t understands the structure of the local revenues equal to v ~ that are not ncluded n the revenue sharng arrangement. max 1 α max max C max max C α v + v + v~ b = γv + v~ b R (4) N max NC C ( ) v + v~ max < b b 1 γ (5) We assume that the club wth the hghest prvate valuaton from local (shared) revenues also possesses the hghest prvate valuaton from non-local (unshared) revenues. Equatons (4) and (5) defne absolute upper bounds for a collusve bd, but bddng wll 10

lkely revert back to equatons (1) and (3) wthout non-local revenues. Clubs wll not bd any amount of ther v ~ snce ths wll not affect whch club wns the aucton n stage 1. The only effect wll be to transfer surplus from the wnnng bdder to the Japanese club. Ths s not n the nterest of the bddng cartel because the wnnng bdder has a memory and wll do the same to ts rval who bd up the wnnng bd. Although the Japanese club sets a reserve prce R, t would prefer to receve a bd greater than R. Through the rng effcency condtons n (4) and (5), the Japanese club knows that the hghest valuaton bdder wll wn the aucton n stage 1, but that t wll not need to bd any of ts v ~. If the dentty of the wnnng bdder s make known to the Japanese club, t can refuse the wnnng bd n the hopes of recevng a hgher bd. Bddng clubs can antcpate ths response and bd some or all of ther v ~ n stage 1 f the player s valued hgh enough. Concealng the dentty of the wnnng bdder prevents bddng clubs from needng to form an expectaton of how much v ~ mght be necessary to eventually wn the player. Ths keeps the wnnng bd to the amount mposed by the rng effcency condtons n (1) and (3). The wnnng bdder s always the same club n our setup, but secrecy of the wnner keeps the wnnng bd lower than would be the case wthout secrecy. Conclusons Ths paper began by descrbng the postng system used by MLB and the Japanese Professonal League and then posed the queston why the postng system was desgned the way t s. Why dd the postng system not replcate the features of the European transfer system? Three curous features of the postng system were dentfed: the use of a collusve frst-prce sealed bd aucton, the use of the Commssoner's Offce as an auctoneer, and the nablty of the Japanese club to learn the dentty of the wnnng bdder untl after the wnnng bd s accepted. Colluson s a realty n the cartel professonal leagues that exst n North Amerca. In our setup, cartel members accept a revenue sharng arrangement as an nvoluntary system to compensate clubs for any 11

externalty mposed when one club acqures a star free agent player (although ths arrangement s not perfect). In exchange for ths, losng bdders agree to allow the wnnng bdder to wn the free agent aucton wth a bd that s lower than the wnner s prvate valuaton of the player. MLB clubs wll pay lower transfer fees to Japanese clubs that are sellng players. The Commssoner acts as a colluson medator to prevent the foreclosure of competng bds, partcularly f two or more rval clubs are consderng placng bds. Ths s to the beneft of the Japanese club n that market falure s avoded. Foreclosure can occur n the European transfer system as well, although the falure to reach a contract agreement s not defntve evdence of foreclosure. In ether system, foreclosure could be avoded by requrng the wnnng bdder to post a bond n the event that t does not sgn the Japanese player to a contract. Of course, there s some postve probablty that a contract agreement wll not be made wthout foreclosure, but ths event should be dscounted nto the wnnng bd by ratonal bdders. Mantanng the secrecy of the wnnng bdder prevents colluson between MLB clubs and Japanese clubs. Such acts of colluson are to the detrment of other bddng clubs and possbly to the Japanese player. We show that mantanng secrecy of the wnnng bdder also prevents MLB clubs from bddng too hgh, whle havng no effect on whch club wns the aucton. An nterestng queston 4 remans gven the market power of MLB clubs. MLB has pllaged the talent from rval leagues n ts long hstory: the Federal League n 1916, the Negro Leagues of the 1930 s and 1940 s, and the Mexcan Leagues of the 1950 s. Why does MLB not do the same to the Japanese professonal league and drop the postng system altogether? Ths could be accomplshed by ncludng foregn-born players n the annual MLB draft, thus conferrng ther rghts to MLB clubs at mnmal cost. Although the aucton model developed n ths paper cannot address ths queston, we can offer two explanatons why the postng system s preserved. Frst, the cost of developng young 4 Ths queston was suggested by an anonymous referee. 12

players s a substantal nvestment and the probablty of the nvestment yeldng a good return at the major league level s very small. Payng more to acqure a known talent mght be a better nvestment, partcularly f player development costs n Japan are lower. The second, and more lkely explanaton, s that MLB clubs are purchasng more than a baseball player when they wn the postng system aucton. Most of the players who are sold through the postng system are superstar players n Japan whose marketng capabltes can be exploted by MLB clubs. When the Seattle Marners acqured Ichro Suzuk through the postng system n 2001, they acqured much more than a very good rght-felder. The Marners (owned by Nntendo) also purchased an nternatonal brand that has yelded the club large merchandsng and meda revenues that would not be forthcomng from most other players. If nstead the Marners drafted the same player as a hgh school teenager and developed hm through the North Amercan mnor leagues, he would not have the same nternatonal recognton, even f he performed on the feld to the same standard. The same marketng strategy s used by some of the world s top sports clubs (Barcelona FC and Ronaldhno) and by those who strve to be (the LA Galaxy and Davd Beckham). In summary, the postng system s a compromse between MLB clubs and Japanese professonal clubs. MLB clubs are collusve and do not bd as much as they could under a European transfer system. Ths s because the revenue sharng system automatcally compensates the losng bdders for any negatve externalty mposed on them by the wnnng bdder (albet mperfectly). Bds wll be lower than possble under a European transfer system, but Japanese clubs understand ths and do the best they can, gven that foreclosure s prevented. 13

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