New Working Paper: Risk Aversion in Sports Contract Negotiations

I got curious about sports free agency after Jered Weaver resigned with the Angels for five years and $85 million. Pitchers of his caliber on the free agent market pick up much larger contracts. Why didn’t Weaver wait it out until free agency? And, given that he was going to resign with the Angels, why did he sign when he did and not a month before or a month after?

After working out the logic, I think I have a reasonable answer. I will be presenting my findings at the SABR conference at the end of the month, but the paper is available here right now.

The basic concept involves risk aversion. Weaver alerted me to the idea when he asked “how much more money do you really need?” Although Weaver would have certainly made more money had he made it to free agency, there was inherent risk in waiting. What if he suffered a catastrophic injury in the meantime? He would go from making nine figures to virtually nothing in the blink of an eye. As such, Jered willingly accepted a smaller amount in expectation; the luxury of guaranteed money was worth paying the premium.

My conference paper expands on this idea. I show that if a player is risk averse enough, he will always resign with his team no matter how much money he would make on the free agent market. This is good news for teams, as the exclusive bargaining rights allow them to leverage the risk of injury to get their players to accept contracts for smaller amounts—which is exactly what we saw in the case with Jered Weaver.

However, risk aversion is an internal trait that is difficult to directly observe. Teams might not know exactly how risk averse a player is, which makes it hard to know how much the team should offer the player. My paper investigates such a dynamic. In this case, the team increases its offers over the course of the season. The player accepts when the team finally meets his requirements. Meanwhile, the team is willing to increase its offers because playing games credibly demonstrates the player’s tolerance for risk. This explains why we see variation in the timing of contract signings; more risk averse players sign earlier in the season, while more risk tolerant players sign later on.

The paper also proves three other neat findings. First, you may intuitively believe the team would only benefit from increasing player safety. However, the model shows that the team actually benefits in contract extension negotiations from some level of danger—otherwise, the team cannot exploit the player’s risk aversion at all. Second, it questions the wisdom of suspending contract negotiations during the season, as it prevents the team from learning more about the player as the season progresses. Finally, it advises teams to pay more attention to players’ level of risk aversion during the draft season; all other things being equal, more risk averse players sign for less money, which allows the team to concentrate its resources on other players.

You can view a version of my presentation on YouTube below. If you are going to the SABR conference, then please drop in to Ballroom 3 from 3:00 to 3:25 on Thursday to see me make the presentation in person. And, once again, you can click here to download the full paper.