The Value of Arbitration

Who benefits from baseball's arbitration process?

Each year, players in their third year of service wait anxiously after the season. Their hope is that they will land in the top 1/6 of players in their year of service for time spent on the major league roster. If they do, they are rewarded with arbitration rights. Indeed, this past winter Mark Grudzielanek, of the Expos, bemoaned his fate of just missing the line, after a one-day pout last spring over having his contract renewed.

As most readers are aware, the market for players is biased heavily towards the team in the first two years. It used to be like this for all players under the reserve clause. The player sold his talents in what economists call a "monopsony", where there is only one buyer. In free agency, in contrast, there is a virtual monopoly held by the best players -- there's only one Clemens or Bonds, and all teams would love to have that superstar.

Arbitration lies in a middle ground between these extremes. Each side has to present a final offer, and an arbitrator or arbitrators (this year they used three-person panels) must decide which offer is taken. Nearly all contracts are decided before the arbitrator picks a number. But clearly, players in the fourth year of service get some benefit, so much so that owners offered to allow players to become free agents two years sooner if the players' union agreed to give up arbitration rights. The players refused.

Another attribute of less monopsonistic markets for players is that they are supposed to lead to less discrimination. An important paper by Donald Cymrot about ten years ago showed that minority players who were eligible for free agency rights received the same return per point of offensive average (or OA; total bases plus walks plus steals over at bats plus walks) as did white ballplayers, but whites earned almost 70% more per point of OA than minority players when neither had free agency. (footnote 1)

A colleague here at St. Cloud State, Orn Bodvarsson, and I have spent some time studying whether Cymrot's results could be extended to arbitration.

Our latest paper (footnote 2) provides the most comprehensive evidence we can find on whether discrimination is lessened by salary arbitration. And the answer is relatively shocking: If there was discrimination during the Cymrot study, we cannot find it any more. We no longer find any discrimination for minority hitters. If anything, non-white hitters make more per unit of production (we use slugging average, walks and steals separately rather OA) than do white hitters. For pitchers, there's a suggestion of discrimination against non-white pitchers, but the probability of this is about 88%. In other words, there's a better than 10% chance we found discrimination where there really isn't any. So the best I can say is that there kinda-maybe-is-a-little-bit of discrimination against minority pitchers, and wait for someone with more and better data to do a better study.

Here, however, are some more results that we can issue with some certainty:

We measured the degree to which a player was underpaid or overpaid in some year compared to his peers in that same year. This would be the difference between the predicted salary from an equation relating salary to performance, and the player's actual salary. We guessed that players who had predicted salary above the actual would be more likely to file. This turned out not to be true. However, we did find that non-white pitchers filed more often than white pitchers.
The threat of filing (i.e., our estimate of the probability that a player would file) was correlated with salary the player received to play the following season. The higher the player's threat to file, the higher salary the player received.
There was some premium received if you actually did file. Atop the payoff for a threat to file, there was a 20-30% premium paid to those players who actually did file. This likely accounts for the high number of players who did file, even though they subsequently settled with the team without going before the arbitrator.
Combining those points, even though we could not find directly that discrimination occurred against any players, minority pitchers tended to file more, and filing more made it more likely those players would receive larger raises in their arbitration years.

That players get a big raise in their arbitration year is not surprising. By the time the third year ends, we know pretty well if the player will have some value. Those that do not are not going to be given a chance to visit the arbitrator -- they become the flotsam and jetsam that occupy the waiver wires or get non-roster invitations each spring. The huge gains many report for the "average" fourth-year player is bogus in that a big part of the "average" is no longer playing.

It's also not surprising that players get some return on actually filing for arbitration. The process is not fun. There are lawyers and expert consultants to pay and the psychic cost of having your employer rip you in the hearing. Some general managers prefer to pay a little extra to a player as a good will measure to keep them from the process. It probably also helps come free agency.

So what are the value of arbitration rights? Remember, the players were offered two years of additional free agency years (years 5 and 6 of service) in return for scrapping arbitration in the last protracted contract agreement. This was the one point the players were adamant in refusing. Since my sorting argument two paragraphs ago would occur both in arbitration and in free agency, the sorting argument cannot be the reason why players prefer arbitration. My guess is that the way arbitration settlements are made is quite favorable to ballplayers, and it will take some very large concessions from the owners to rid themselves of this creation.

Footnotes:

1. Donald J. Cymrot, "Does Competition Less Discrimination? Some Evidence," Journal of Human Resources 20, Fall 1985, pp. 605-12.
2. "The Value of Arbitration Rights in Major League Baseball: Implications For Salaries and Discrimination," Quarterly Journal of Business and Economics, forthcoming Winter 1998. See also Banaian and Bodvarsson, "Reverse Regression and Salary Discrimination in Major League Baseball: The Case for Discrimination," in Alvin Hall, ed., Cooperstown: Symposium on Baseball and the American Culture. Westport, CT: Meckler Publishing, 1990.

King "Sparky" Banaian is associate professor of economics at St. Cloud State University in St. Cloud, Minnesota. When not wondering whatever happened to Tim Laudner, he writes on central banks and economies in transition.