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Uncertainty, specific investment, and contract duration: evidence from the MLB player market

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Abstract

This study empirically investigates how uncertainty and specific investment determine contract duration. Using detailed individual labor contracts of Major League Baseball players, the empirical estimations find that, given that players are more risk-averse than clubs, contract length exhibits a positive relationship with the level of productive uncertainty. This implies that the risk-sharing hypothesis dominates the competing hypothesis of efficient production in individual labor contracts. Moreover, contract length is positively related to specific investment, highlighting that the prediction of the transaction cost theory also holds on individual labor contracts.

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Notes

  1. Klein et al. (1978) mentioned that a short-term contract such as one transaction, non-repeat-scale contract cannot solve hold-up problem efficiently.

  2. See Guriev and Kvasov (2005) for the review of theoretical literature on contract duration and specific investments and Rich and Tracy (2004) for brief summarized theories on the contract length–uncertainty nexus.

  3. This number was calculated by 913 registered players (including players listed on the disable list) in 2011.

  4. Pitchers are usually separated into starting pitchers, relief pitchers, and closing pitchers. They are evaluated by different statistics (Krautmann and Oppenheimer 2002), implying that pitching statistics are less universal than hitting statistics. Thus, this study adopts only hitters’ contract information.

  5. Cot’s Baseball Contracts Web site is http://www.baseballprospectus.com/compensation/cots/, which provides a lot of information publicly about contract details.

  6. A small subset of outstanding players, known as Super Twos, is also eligible for arbitration after their second year.

  7. According to MLB’s reserve clause, players, basically, are eligible for free agency after 6 years of MLB experiences. The details about free agents’ qualifications can be seen from MLB Reserve Clause.

  8. Free agents may have a stronger bargaining power in contract negotiation and acquire a contract with a longer term, while this power, if any, is brought about by competition in contract offering across MLB franchisees.

  9. This is based on the fact that union, which is a group organized by workers, has a greater power to demand rights and to protect workers from being exploited than individual workers when facing uncertainty; therefore, unions have better ability to face uncertainty than individual workers.

  10. According to Williamson (1979), specialized training and learning-by-doing economies in production operations are illustrations of human specific investment. Indeed, catchers need to be specially trained to understand coaches’ tactical thinking as well as establish a good pitcher–catcher relation through the learning-by-doing process.

  11. One might argue that catchers can get a longer contract is arising from their defensive position which puts them at a heightened risk of injury, rather than devoting more team-specific human capital. If this conjecture is true, a player may self-select other positions, because the starting position is easily replaced by other talented players in this highly competitive industry. Actually, our dataset shows that catchers’ average injury days per season are 15.95 days. It is only slightly higher and lower than those of other infielders (15.67 days) and outfielders (18.60 days), showing no significant difference.

  12. The differences between actual performance and forecast performance can be positive or negative. If the difference is positive, it means that a player’s realized performance is better than the team’s forecast. This “positive” difference, which may result from a player’s special qualities, such as the good ability to deal with pressure, may be preferred by teams and therefore may offer front office incentives to provide a long-term contract for that player. However, the “negative” difference, which is not favored by teams, may curb a team’s inclination to offer long-term contracts.

  13. The details about principal component analysis (PCA) can be seen in Pearson (1901).

  14. In MLB literature, Krautmann and Oppenheimer (2002) and Link and Yosifov (2012) include length as an explanatory variable in the salary equation and find that salary bears a positive relationship to contract length.

  15. The information about the population of various metropolitan areas is obtained from US Census Bureau.

  16. Although PCA has the advantage of providing objective weightings through data analysis, it is noteworthy that an attempt to use only one variable to represent a set of statistics will inevitably incur losses of information of the original statistics.

  17. Current salary is the only endogenous variable in our model. For a single endogenous variable, the criterion for judging weak instruments is that the \(F\) statistic of the first-step least-squares regression of two-stage least square should be larger than 10 or a weak instrument problem occurs (Staiger and Stock 1997). In our case, the \(F\) statistic of the first-step regression equals 33.24, suggesting that the variable, the average salary of the player’s prior contract, is a valid instrument.

  18. WAR is a composite index of offensive and defensive performance for players. It is relevant to salary, but pre-determined when players negotiate the contract with MLB franchisees. It is also less related to the residuals of contract duration equation. For the detailed interpretation of WAR, please see http://www.baseball-reference.com/about/war_explained.shtml.

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Correspondence to Chih-Hai Yang.

Appendix

Appendix

See Table 5.

Table 5 Weight schemes and total variance explained

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Lin, HY., Yang, CH. Uncertainty, specific investment, and contract duration: evidence from the MLB player market. Empir Econ 50, 1009–1028 (2016). https://doi.org/10.1007/s00181-015-0963-6

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