Fun with Incentives: Baseball Contracts Edition

Continuing in the long line of “why do people structure these things in such a crazy way” posts, we have the sad story of Phil Hughes. Hughes is a pitcher for the Minnesota Twins. Like many other players, Hughes’ contract has specific benchmarks that reward bonuses. One in particular gives him $500,000 if he pitches 210 innings this year.

209 2/3s innings? Worthless! Who needs someone who pitches 209 2/3s innings?

But 210 innings? Yep! Definitely worth a half million dollars.

You can see where this is going. The Twins were rained out on Friday. He pitched in a double header today. However, this pushes his next start back a day, his start after that by another day, and so forth. Due to some unfortunate timing, this will ultimately mean he will (probably) end up with one fewer start than he should otherwise. Extrapolating a reasonable expectation of number of innings per start, losing this one start will likely mean he will not reach the 210 inning threshold and thus not receive a $500,000 bonus.

For completeness, this post might all be for nothing. If Hughes averages 7 2/3s innings per start for the remainder of the season, he will reach 210 innings and the point will be moot. But it seems doubtful that this will happen for two reasons. First, the Twins have him under contract for two more years; with the team eliminated for the playoffs, it makes little sense to stretch him out when a younger pitcher in greater need of MLB experience could get those innings. Second, if you were the owner of the team and could reasonable limit his innings for the rest of the season, why wouldn’t you save yourself a half million dollars?

So why oh why are contract structured in this way? I don’t have a good answer. It would be exceedingly easy to simply structure contracts so that the incentive pays a pitcher a fixed amount per inning. This ensures that teams will use pitchers for the number of innings that is economically worthwhile and do not face the incentive-twisting discontinuity between 209 2/3s innings and 210 innings.[1] Transaction costs could conceivably force actors to accept these discontinuities, but that does not seem to be a problem here. Instead, agents and players seemingly accept these contractual terms despite the obvious conflicts of interest they create.

[1] To be fair, the contract has something like this built-in. Hughes receives quarter million dollar bonuses for 180 innings and 195 innings. But there is still no good reason to create these discontinuities.