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December 14, 2006

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Sarah

We might also think that employers, not employees, are averse to multi-year lock-ins due to the fear that employees with the job security provided by such contracts will be inadequately incentivized to work hard. Baseball players, on the other hand, presumably want not just to make money but also to win games. Maybe some employees - trial lawyers, say, to the extent that they exist anymore - have similar incentives, but there's really no winning in doc review, is there?

Also, performance matters a lot in building the value of a baseball player or, maybe, a trial lawyer, but not so much in determining the asking price of a more common commodity. A run-of-the-mill associate at a Biglaw firm will be able to command about the same rate as a third-year lateral whether he or she is at the 25th or 75th percentile in the associate class, right? But a Johnnie Cochran knows that his asking price at the end of a five-year lock-in contract will be a lot higher if he keeps his win average up.

From this perspective, the distinction between positions for which lock-ins make sense and those for which they don't might be something like individual visibility. If an individual - like an elite trial lawyer/law prof or a baseball star - can earn valuable (read: transferable) prestige points for striving despite an assured paycheck (in the short term), a lock-in is likely to be efficient. Of course, stars in any field are scarce (that's why they're stars), and thus any mechanism that works only - or best - for them is unlikely to become widespread.

Marsha

Perhaps this has to be viewed within the wider lens of baseball salary structures. These sorts of multi-year deals generally don't kick in until after the first six years of a player's major league career. At first, the player may earn bonuses, but in the first three years with a team, the team holds all the cards. It owns the player (if it wants to) and need not pay much more than league minimum (although bonuses are common for players with excellent upside potential). For the next three years, the players submit to arbitration, so their salary becomes related to performance, but they are still owned by their teams. Until free agency, by which time a player's long term worth is a much more known commodity, the player is well-compensated (by non-baseball standards) but not at market rates, and has no power in the employment relationship.

Given all this, what happens to players later on makes more sense. The multi-year offer is much more likely to reflect the market (factoring in things such as how desireable it is to play for a specific team or live in a certain city) or else someone else would come in and beat the offer. As Steinbrenner has shown, there's always a deal to be made.

Law firms and universities have much less information about the "players" at stake. Does one law firm know enough about another firm's associates to make a trade for them or buy out their contract? If not, then these deals are non-starters - there is no market rate. For all intents and purposes, this is exactly what the lockstep compensation in most major firms accomplishes. It gives a guaranteed salary (often with a performance-based bonus) for a short period of time, and once both sides have had time to evaluate, the player may choose to sign a long-term deal (partnership). Because the market doesn't really know what you're worth until you're a partner with a book of business, this system substitutes for the multi-year deal.

It seems to me that tenure serves much the same function in faculty, but I know less about the economics of that world so stop here.

Salil

It occurs to me that, as Marsha mentioned, baseball players provide observable statistics for those throughout the league, making market pricing for veterans easier than for associates.

But those statistics differ for DHs and pitchers versus everyday field players. For a DH or a pitcher the stats capture substantially all their performance, while for a fielder, hitting stats are a pretty good gauge of hitting prowess, but "low error numbers" alone are not as full a gauge of value. Thus, for a DH or a pitcher, the stats probably reflect closer to full value than they do for an everyday field player, where the "synergies" with other players described in the original post might play a larger role.

It may be possible to get some insight on what drives these multiyear contracts if the terms of contracts for DHs and pitchers diverge from those of fielders.

Justin Cave

I would tend to argue that multi-year contracts with lock-ins are advantageous to both sides in baseball but not in law firms because they mitigate risks to both sides and because they align the team's interests with the player's interests over the long term.

Baseball players have a significantly greater risk of over- or under-performing their contracts than do law associates. A veteran baseball player knows that there is a substantial probability that before the end of his contract, he will be physically unable to play at a high level. That gives him an incentive to agree to a slightly lower expected career income in exchange for a guaranteed multi-year contract. A team, on the other hand, knows that there is a substantial probability that a player will have an exceptionally good year over the course of the contract, which would increase the probability of that player leaving to the irritation of fans, so they want to lock their players into longer-term agreements. It is highly unlikely that a legal associate would find themselves unable to continue working after a few years, and few associates would substantially exceed expectations, so neither side has particular incentives to negotiate longer deals.

Baseball players also require substantial investments in training the are underwritten by their teams and which the teams need to be able to recapture once the player is productive. There is also a tremendous washout rate, so teams must recapture the value of training from the few that make it through the system. If law school had an attrition rate equal to the attrition rate of minor league baseball, one would expect that law firms and potential associates would find it beneficial to enter into long-term contracts so that the firms would have the incentive to run the training programs and the ability to recapture their expenses either through trades or by getting years of under-priced production in the majors.

Additionally, long-term deals in athletics can be seen as a response to agency problems that are unique to athletics. Teams have the incentive to extract as much production from a player in the short run as possible regardless of the cost to the player, which makes them want players that will play injured and creates incentives to overwork pitchers. Players, on the other hand, want to prolong their career as long as possible to maximize career income. Long-term deals help assure players that teams are protecting their long-term health and assure teams that players will be willing to play through injuries. If law firms demanded that associates perform tasks that threatened their future ability to be lawyers, I would expect that guaranteed long-term contracts would be more popular.

Sarah

Justin's comments seem to me equally applicable to large law firms - lots of up-front investment in training, working young associates into burnout as a matter of course. The agency problems that he mentions are hardly "unique to athletics," as many NYC junior associates will attest.

Justin Cave

I would tend to argue that the law firm equivalent of baseball's minor leagues would be a lawyer's undergraduate and graduate school education since that is the point at which the firm is able to start generating a profit from the work of the newly trained employee.

Because lawyers have the burden of paying for their post-secondary education, law firms don't need long-term contracts to ensure that they recoup their investment in training. They can set salaries at a rate commensurate with the economic value of the associate's output. While law firms obviously make investments in training associates, there is likely no point at which the law firm is paying more for the associate than the associate is able to generate in output for the firm.

I would also argue that the agency problems facing athletes and their employers are far more significant than the agency problems facing law firms and their associates. Associates certainly risk being burned out by the demands of their employers, but the magnitude of the disconnect is quite different. A burned out lawyer still has numerous opportunities for employment, particularly after taking time to "decompress"-- their legal training is still in demand in other areas, though they may be somewhat less lucrative. An injured ball player is all but unemployable in his chosen trade and must start again from scratch. Law firms demand a lot of hours from their associates, but those demands are generally part of the lawyer's training, not something that would be generally expected to lead to their professional decline. Plenty of lawyers, doctors, investment bankers, programmers, etc. will spend years working insane hours-- few of those individuals will discover that their employer has worked them so hard they cannot continue in their profession, though they may find that they want to seek out a position with greater work/life balance. A pitcher, on the other hand, is literally 1 pitch away from blowing out their elbow and ending their career.

saul levmore

Thank you (thus far). These comments are great and the topic is fun.

I don't see that the risk of injury can itself explain the differences among markets. Employers are not better insurers, especially when there could be private insurance contracts that players purchase. All the more so because some career-ending injuries come from off-field activities. Next, the repayment for training costs does not fit the baseball example too neatly, because it is normally the veterans who receive the multi-year contracts. And as for what is known about veteran players, it is true that veterans are known commodities but so are seasoned partners and professors. This ties in with the first comment about star lawyers and academics, for the puzzle is that they we do not find more lock-ins there.

There is also an argument (albeit one I have received in e-mails rather than posted comments) that players simply want security or baseball is different because the statistics are out there for all fans to see. I do not see why that solves the puzzle, but I think it is possible that it is the other way around. Perhaps multi-year contracts are the owner-player (or owner-manager) way of guarding against fan pressure to dispense with a player who had a single, poor year. Fans may call for the fellow's head, but the owner emphasizes the long-term record with a long-term contract and, in this way, something of an inability to behead the latest villain. No similar pressure is brought to bear on lawyers or academics. I think the puzzle is still superior to the proposed solutions.

priscieve

I think the security matters more than you give credit for because it's not a field that you work in until 65. Players are 'old' at what, mid-30s? The amount of time the team & player have to earn money is relatively short and they have to ensure that there is no messing about. More generally, it is an area where physical ability is being bought & sold and the risks inherent in that are not the same as in mental/academic tasks.

bcowan

There does not seem to me to be enough attention in the foregoing analyses to the extreme publicity of baseball salary negotiations. This factor goes pretty far in explaining why the two "star markets" cited, baseball and The Law, appear so different with respect to the multi-year contract practice.

For some reason that does not seem to be present in academic and law firm contexts (except for associates' starting pay), I have been told what (it is purported that) Barry Bonds and young Mr. Matsuzuka will make in salary next year. In contrast, I have been told nothing about any law professor's or big-firm rainmaker's compensation.

In baseball the individual player's and the team owner's interests are aligned in hoping that the player will be a draw for a large number (and broad range in respect to actual interest in baseball itself) of persons to come out to the games.

Players and owners alike seem to believe that people's interest will be piqued, especially people who might otherwise be indifferent, by announcing that a shockingly huge amount of money is to be paid to a ballplayer. It is therefore right for the parties to the contract to cooperate in so structuring and exposing their deal as a whopping sum, since it is the big number that has the power to produce the result they jointly seek: the attraction of emotional interest to their enterprise. It is also why many of the technical features of these deals, such as the salutary effects for both sides of postponing the actual payment and receipt of the money, are less emphasized in the press discussions.

Why does this work? I think it is because a great and fascinating puzzle for many people is how divergent their individual feelings for the intrinsic worth of experience are from some market valuations they encounter. That this divergence is felt very strongly concerning baseball salaries accounts, I think, for the number of articles in the sports press that make reference to "men being paid big money to play a boys' game" and the like.

Strongly felt contrasts make for interest because they upset subjective harmony. People want to have the discord between their valuations adjusted, either by the player demonstrating extraordinary skill, thus justifying the market valuation, or by demonstrating that the guy is just an ordinary bum after all, which shows up the rich owners for the idiots they are.

Since this crucial (for the baseball side)effect is played out with the most salience in the subjective experience of the fans, one might say (as I do say) that the rational choice metaphor is a subspecies of the aesthetic choice metaphor.

Somehow, the owners and players have made a very effective choice for themselves, at least in part, by appealing to certain strong feelings of the public, who are not parties to the negotiations. Why should we confine our analysis to the epistemologically rather limited context of two (idealized) negotiators trying to get the best deal for themselves, when certain actual negotiators themselves are exerting every conjoint effort they can think of to put on an effective collaborative show, as they say, both on and off the field?

Joan A. Conway

Quoting: "In the end, the question is whether to expect baseball contracts to get shorter, or law firm and university contracts to get longer (and tenure is hardly a substitute because that is a one-sided promise), or to find a good reason why the current and disparate conventions will stick."

Neither a law firm nor a university depends upon fans for revenue and television coverage for its investment. This is why they don't deserve the multi-year contracts that baseball players get. Baseball honors its athletes with "hall of fame" status in Coopers Town, New York. Top lawyers may receive published honors but they don't get to go to a museum, and likewise university professors may receive a Nobel Prize, but again they are not stored in a facility to be visited by adoring fans.

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