Wednesday, July 23, 2008

Pay and Performance in MLB

In chapter 1 of our book - The Wages of Wins - we set out to dis-spell some myths. One of those myths is that sports team payroll and performance are related in any sizable measure. To do this we use relative team payroll as opposed to absolute team payroll, where relative team payroll is team payroll/average team payroll. While the correlation coefficient between team payroll and team performance is about 0.43, the coefficient of determination (which is more important) is 0.18, meaning that over 80% of the variation in winning percent is determined by something other than team payroll, or that payroll does not tell us much about wins. I have written about this difference at the Wages of Wins Journal, so I will not re-hash this here.

Here's a visual look at pay and performance in MLB in 2008 and over the last four seasons! The lines in blue are for teams that perform better than their rank in payroll and the lines in red are teams that do not. While not a definitive analysis, it seems to show about half the teams have blue lines and half have red lines, which is a crude way of seeing correlation. Remember, correlation is where two variables move together. Yet as an economist, I am interested in how changes in one variable (such as payroll) effect changes in another variable (team performance). This idea is what economists call a marginal impact. For those of you who have had a Prin. of Micro course - all those marginal revenues, marginal costs, etc. - this is what it is all about. So what is the effect of a change in team payroll on the change in team performance. After running the numbers, the effect is significant. In other words, payroll matters in determining performance in MLB. This is somewhat reassuring, but the amount that payroll matters is less than 20%. Why?

Think of it this way - if every team exactly doubled their payroll would that double every teams performance. Absolutely not. No team can have a winning percent greater than 1.000 by definition. So a change in payroll will have an impact on performance - GM's make decisions that they think will put the best team on the field subject to what they are allowed to spend on team payroll, and this does have an impact on winning in MLB. It's just that other variables have a lot more impact on winning, so not too much emphasis should be placed on team payroll.

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