The Coase Theorem, free agency, and Major League Baseball: a panel of pitcher mobility from 1961 to 1992.

• Author: Hylan, Timothy R.

1. Introduction

   A great deal of conceptual and empirical work in the economic analysis of the law and property rights has been directed towards resolving a controversy surrounding the Coase Theorem. Many economists and legal scholars interpret the theorem as containing two propositions. The first is that, in the absence of transactions costs and wealth effects, parties will bargain to an efficient outcome. The second holds that the same outcome will be achieved regardless of the distribution of property rights. The latter is known as the invariance thesis and it has been a source of dispute among scholars and between economic theorists and owners of economic enterprises (e.g., owners of professional sports teams) [5; 11; 16; 23; 24; 25; 26; 28; 29].(1) This paper provides an econometric test of the invariance proposition. Major League Baseball presents a natural experiment consisting of an industry in which there has been an explicit change in the assignment of property rights. Beginning in 1879, the reserve clause gave monopsony power to team owners; a player could negotiate salary only with the team that owned his contract and the team could trade or sell the player as management saw fit. In 1976 this system was replaced by the institution of free agency whereby a player with at least six years of Major League experience acquired the right to sell his services to prospective buyers.(2) One implication of the invariance thesis is the testable hypothesis that the mobility decisions made by players after the introduction of free agency would be the same as those made by the owners in the pre-free agency era.

   The abundance of data from professional baseball provides an excellent opportunity for testing many propositions from economics. Detailed measures of an individual player's productivity are collected annually as well as output measures of team performance. Also, one can clearly identify the team where each player is employed and can readily trace the mobility of players over time. Hence, there exist previous empirical examinations of the Coase Theorem, free agency, and the mobility decisions of Major League Baseball players. However, there does not appear to be agreement upon what constitutes an appropriate test of the invariance thesis in the case of baseball free agency. Previous examinations of this issue have used data that differed in terms of the period under analysis, the subset of the population of baseball players used for analysis, measures of labor mobility behavior, and measures of the outcomes of that behavior. The level of sophistication of the statistical tests has also varied widely.(3) A significant contribution of this paper is that it provides an econometric analysis of the mobility behavior of all pitchers who played in Major League Baseball during the 1961-92 period.

   The results of this paper lead to a rejection of the invariance thesis of the Coase Theorem. The empirical analysis shows that after the introduction of free agency, the pitchers with greater longevity in the major leagues are less likely to move relative to their mobility in the pre-free agency period. The results also indicate that, in general, better pitchers are less likely to move and that pitchers playing on teams with higher winning percentages or in large market cities were less likely to move.

   The rest of the paper is organized as follows: Section II provides brief reviews of the labor mobility decision and the Coase Theorem to motivate the expected effect of the introduction of free agency on labor mobility. It also critically examines previous empirical tests of the invariance thesis. Section III discusses the empirical model while section IV briefly describes the creation of the data set and relevant variables. The results of the empirical analysis are presented and discussed in section V. Section VI concludes and outlines an agenda for future research.

2. Labor Mobility, Baseball and the Coase Theorem

   Conceptual Issues

   Labor mobility can be broadly classified as involuntary or voluntary. Involuntary labor mobility is the result of workers being forced to leave their current employment. In general, this may be due to dismissal for poor performance, structural changes in the economy, or shifts in the demand for labor. Player mobility in Major League Baseball during the pre-free agency period would be classified as involuntary mobility. A player would cease to be a member of the team if management released the player from his contract or assigned that player to another team.(4) As the owner of the rights to the player's contract, the team has an incentive to realize the maximum value of that asset. Thus, it is expected that owners will trade players so as to achieve a distribution of player talent that equalizes marginal revenue product (MRP) across teams. If a player on Team A had a higher MRP with, say, Team B, the owners of the two teams would have an incentive to negotiate a deal sending the player to Team B for suitable compensation.

   Voluntary mobility occurs when workers choose to change jobs because they are dissatisfied with their current position or because they expect to find a better one elsewhere. The mobility decision in this scenario depends upon the acquisition of information about alternative opportunities, the costs of moving, and the increase in earnings expected from moving. The attainment of free agent status would allow a player the opportunity to voluntarily move to a team from which he could extract a better offer than he currently possessed.(5) The expected outcome is that a player will move to the team where his MRP is highest. However, this will result in the same distribution of talent that obtained when the owners moved the players. That is, the player distribution will be the one that maximizes league revenues, although in this case it would be the player receiving the rents associated with his provision of labor services.(6)

   The existence of transactions costs and wealth effects may lead to observance of results that are inconsistent with the predictions of the Coase Theorem. The assumption of negligible transactions costs is central to the efficiency version. Should they be large, transactions costs may completely erode the gains from trade and inhibit the exchange of entitlements from lower-valued users to higher-valued users. Thus, the assignment of rights will have efficiency implications when transactions costs are relatively high. Whether transactions costs are significant in Major League Baseball is not clear. Agent fees and league conventions against sales of players are potentially important sources of transactions costs. Agent fees represent perhaps the biggest transactions costs players face in negotiating a salary with a team. Often the agent's fee is a fraction of the total compensation package and the size could be larger than the cooperative surplus. While player salaries generally increased in absolute terms following free agency, it is not clear whether agent fees or other kinds of transactions costs became larger in relative terms to the overall compensation package or even whether they are large enough to affect exchange. League agreements not to sell players for cash might also be a source of transactions costs. A well known example is that of Commissioner Kuhn blocking several player sales by Charley Finley of the Oakland A's during 1976. The action was justified as being in "the best interests of baseball."(7) Fan opposition to the selling of favored players might be a source of transactions costs that could lead owners to agreements not to make such sales. Ultimately, the role of transactions costs is an empirical issue.(8) However, while the absence of transactions costs is important for the efficiency version of the Coase Theorem, the invariance prediction does not necessarily depend upon this issue. Although transaction costs might impair some trades, if the level of transaction costs is roughly the same before and after free agency, then the degree of labor mobility need not have been altered.

   The relevance of wealth effects is the second issue concerning the applicability of the Coase Theorem. In contrast to transactions costs, the absence of wealth effects is crucial for the in-variance proposition. Wealth effects are potentially important in the baseball setting because free agency shifts bargaining power previously held by the owners to the players. Assuming the team is a profit-maximizing firm, it will value a player the same regardless of whether the team or the player has the mobility entitlement. However, receiving the entitlement may affect the behavior of a utility-maximizing player [28]. For example, a preference to play for a championship team or a team near the player's home may manifest itself if the player is feeling wealthier after the change to free agency. As a specific example, when Kirby Puckett re-signed as a Minnesota Twin in December 1992, he reportedly turned down a higher paying offer from the Boston Red Sox, citing his ties to the community and to the Twins organization.(9) Thus, in general, a player's mobility decision could be affected by the change in assignment of property rights.

   Assuming the absence of wealth effects and that the level of transactions costs did not change significantly after the introduction of free agency, the above considerations suggest that Major League Ballplayers will move to teams where their marginal revenue product is highest. During the period before free agency, team management has the incentive to find such a team for the player. Post-free agency, the player has the incentive to find the team where his skills are valued highest.(10) The invariance thesis predicts that the mobility decisions are not affected by the ownership of the property rights; i.e., controlling for player quality, the likelihood of a particular type of player moving from one team to another before the advent of...