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February 2, 2010

Expanded Horizons

Arbitration Negotiations

by Tommy Bennett

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Arbitration avoidance is in full swing as we enter the month of February. Forty-four players have exchanged salary figures with their clubs. Of those, all but 18 have reached deals avoiding arbitration, which begins in approximately two weeks. Most of the remaining 18 will also reach deals. Perhaps a handful will proceed to arbitration. This year's most interesting case is Tim Lincecum, a Super Two player who is set to go to his arbitration hearing armed with two Cy Young awards. The gap between the salary Lincecum is seeking ($13 million) and what the Giants have submitted ($8 million) is the largest for any player this year. It's worth wondering, as a sharp reader did during my first BP chat, how teams and players come up with the numbers they exchange.

Tug of War or Rubber Band?

There are two forces that shape both parties' decisions in the arbitration process. First, teams and players recognize that most cases settle before reaching arbitration, and that most cases settle at or near the midpoint between the player figure and the team figure. However, the two sides also must grapple with the small but real possibility that they do not reach a deal and the case goes before a three-person arbitration panel. Although the percentage of cases that proceed to a hearing is small (just three of the 45 non-free-agent cases in 2009), the structure of the arbitration process looms large. It is unclear whether there are any general trends that dictate which cases go all the way to arbitration (for example, whether such cases adhere to the Priest-Klein selection hypothesis), although this remains a question of interest for me.

The vast majority of arbitration-eligible players agree to deals that avoid hearings. Often, hearings create bad feelings that carry over into the season. Furthermore, the process is expensive and time-consuming. For both sides involved in the process, it is usually easiest to agree to a deal that is exactly at the midpoint. For example, in 2009, the (unweighted) average settlement was 46 percent of the difference between the two numbers. In other words, the average settlement was very close to the midpoint, and it slightly favored teams. So far this year, the corresponding figure has been 44 percent, perhaps reflecting weaker overall demand. Nevertheless, by far the most common single settlement percentage is 50 percent. Here is a simple table showing the settlement percentages for 2009. Zero represents the team figure and 100-percent represents the player figure:


 Percentage       Cases
of Difference    Settled
    0-25            2
   26-35            3
   36-45            6
   46-55           16
   56-65            3
   66-75            0
   76-100           1
Here is a similar table for this year:


 Percentage       Cases
of Difference    Settled
    0-25            0
   26-35            1
   36-45            9
   46-55            6
   56-65            0
   66-75            0
   76-100           0

Note again here that the distribution appears to favor teams ever so slightly. This is a somewhat odd result that we shall return to later. However, suffice it to say that most of the cases cluster near the midpoint of the two figures.

Incentives to Cheat

This phenomenon gives teams and players a peculiar set of incentives. If, by striking deals at the easy focal point of 50 percent, parties hope to save time and money, they had better hope that the practice doesn't distort incentives. But the possibility exists for it to do just that. For every dollar a team reduces its figure by, the anticipated settlement price declines by fifty cents. Similarly, for each dollar a player increases his figure, his anticipated salary increases by fifty cents.

This set of incentives, if teams and players always settled at the midpoint, would be unstable. Teams would simply offer zero dollars and players would submit exorbitant figures. Of course, this doesn't happen in reality because the parties to the dispute are conscious of the possibility that they will go all the way to the hearing, which is binding. Because of the unique nature of baseball's arbitration rules, the arbitrators may not select any salary figure they like, but rather they must choose either the player figure or the team figure. That is to say, it's an all-or-nothing affair.

What incentives does this create? In fact, it creates exactly the opposite set of incentives from the ones created by the midpoint settlement norm. Each dollar that a club reduces its offer by increases the likelihood that an arbitrator will select its figure. Because the outcome at arbitration is binary, that likelihood is crucial. If one party can appear ever so slightly more reasonable than the other, it wins the whole pie. Of course, the other party seeks to appear yet more reasonable. In essence, the fact that the parties bargain in the shadow of the law means that they are forced toward the middle of the settlement range.

These two forces work against each other. The first, the fact that parties tend to settle at or near the midpoint of the settlement range, pushes their salary figures apart. The second, the structure of baseball's arbitration hearings, pushes the parties back together. However, in individual cases, the parties may miscalculate. If one party is willing to submit a figure very close to the expected salary for the player and the other does not, the party close to expected value may insist on proceeding all the way to a hearing. In that case, the party far from the midpoint may end up holding the bag. I suspect this is what happened with Lincecum. Although his $13-million filing was a record for a player in his first year of eligibility, it is perhaps closer to what he could expect to earn than the number submitted by the Giants. If that is the case, Lincecum may insist on proceeding all the way to a hearing, where his case centered on the two Cy Youngs might carry the day.

Question of the Day

Which of these forces do you think is stronger: the norm of midpoint settlement, or the incentives created by the structure of baseball arbitration? Am I right about Lincecum's salary figure, or are the Giants in fact closer? How likely is a deal at the midpoint ($10.5 million)?

Related Content:  The Process

33 comments have been left for this article. (Click to hide comments)

BP Comment Quick Links

marooner

Another oddity of the system is that in normal litigation, there is an incentive to assert publicly that your demands are extremely reasonable given the circumstances, and should carry more weight than the unreasonable demands of your opponent.

In either-or arbitration, there is an incentive to indicate that you will ask for some crazy number which will never be granted, in order to sucker your opponent into submitting a less reasonable number than they otherwise would have.

I suspect this is what happened in the Lincecum case. Rumors have been spreading of his agents' intention to submit 20+ million dollars, which seems to have caused the Giants to confidently lowball. That has left Lincecum's record high actual number as the more reasonable option, even if it's slightly on the high side.

Feb 02, 2010 09:40 AM
rating: 6
 
Tommy Bennett

This is an extremely good point.

Feb 02, 2010 11:32 AM
rating: 0
 
sunpar

Lincecum has the advantage of precedent: Ryan Howard got $10M in 2008 after winning the MVP award one year and finishing in the top 5 another year. How could they possibly select $8M for Lincecum when he has 2 Cy Youngs? I'd have to think that they'd rather go up to $13M rather than $8M, hence destroying the 50/50 split possibility.

In this case, I think the Giants settle closer to Lincecum's $13M, maybe $11.5-$12M.

Feb 02, 2010 09:42 AM
rating: 0
 
deep64blue

There are so few comparables it's by no means a slam dunk that the Giant's lose this, although Lincecum has greatly increased his chances by going for a lower figure than was being bandied about.

Feb 02, 2010 11:26 AM
rating: 0
 
Richie

The farther away the two parties are, the less inclined either should be to just 'split the difference', I should think. (Researchable, is it not??) Yet most do, pretty much. I'd suggest this shows the arbitration structure force is stronger.

Feb 02, 2010 09:59 AM
rating: 0
 
goldenyeti

Can someone explain this Priest-Klein selection hypothesis?

Also, if 0 is the player figure, and 100 is the team figure, wouldn't an average settlement of 46% indicate that pre-arbitration settlements slightly favor the player?

Feb 02, 2010 10:33 AM
rating: 0
 
Tommy Bennett

Addressing the second point first--that was a mistake in the original article. Thanks for catching it! It should be that 100% is the player figure and 0% is the team figure.

The Priest-Klein hypothesis, which was originally developed to describe legal cases that proceed all the way to trial, basically tells us that we can't learn anything about the likelihood of one party or another to win based merely on the fact that it did in fact proceed all the way to trial. In the baseball arbitration context, the question is whether cases that proceed all the way to arbitration tend to favor (on the merits) players or teams. Because there are so few data points each year for this, it's a tough hypothesis to test. Nevertheless, my presumption is that the Priest-Klein hypothesis would apply, and that players and teams win arb. cases at about equal rates.

Feb 02, 2010 11:31 AM
rating: 0
 
goldenyeti

Thanks for the explanation.

Now that I understand it, I wonder if there might be some risk tolerance considerations that would make it more likely for the player to win, because players would only be willing to go to arbitration if they thought they were likely to win. Teams might be willing to gamble a few hundred thousand dollars on an arbitrators decision, but for a player who may not have made big bucks up to this point that is probably a lot harder to do.

Feb 02, 2010 13:37 PM
rating: 2
 
BurrRutledge

That's an interesting point. The player's salary is going to be an extremely high percentage of his income. However, a player's salary is only a relatively small percentage of a baseball team's payroll/expenses. Where a $1m difference in arbitration could be a ginormous percentage of a player's income, it would represent a comparatively modest impact on a baseball team's operation. As you say, risk/reward.

Feb 03, 2010 10:55 AM
rating: 0
 
Jack G

You'd have to assume that the relative strengths of the forces would depend strongly on the risk tolerances of the parties negotiating--the sample size is likely too small, but I wonder if greater budget constraints of the team or injury risk of the player tend to push arb figures towards the midpoint. I.E. the Red Sox dealing with a position player vs the Marlins with a pitcher

Feb 02, 2010 10:47 AM
rating: 0
 
Tommy Bennett

Yeah, it is interesting. Last year, the Blue Jays signed relievers Brian Tallet and Shawn Camp to deals at about the 20% mark. I'm not sure why this was the case, and you're right the sample size is too small. I bet there's something to it, though.

Feb 02, 2010 11:27 AM
rating: 0
 
bhalpern

Is it possible that we're seeing a natural stabilizing factor at work in settlement that offsets the opposing incentives that influence the arbitration offers by teams and players?

For instance, did both Tallet and Camp choose high numbers because they thought the Jays would go low but the team didn't do that? Consequently Tallet and Camp would have been reasonably sure they would lose in arbitration and were forced to settle around 20%.

And did the inverse occur in the one case >75%? That seems to be a likely path for Lincecum to follow as others above have noted. He could push the Giants all the way to arbitration. But if the Giants were to offer him $12m at this point I would be surprised for Lincecum to risk that much guaranteed for even a very small risk of getting stuck at $8m.

An arbitration question also: Could a team's (or player's) compromise offer be used in any way at arbitration? Since the arbitrators can't pick a mid-point salary, an arbitrator's knowledge that the team offered the player something very close to that mid-point might make it more likely the arbitrator would side with the team.

Feb 03, 2010 14:14 PM
rating: 0
 
harderj

Have been reading up on this. So even though your question was awhile ago, here's what I found. According to Scully (1989), prior offers cannot be considered by the arbitrator.

Dec 13, 2010 04:31 AM
rating: 0
 
Dave Pomerantz

Risk tolerance was my first thought while I was reading this article as well. I'm glad somebody else brought it up.

Feb 03, 2010 10:51 AM
rating: 0
 
ScottyB

What about cases in which the player and team settle, but not on a one-year deal, but with a multi-year deal?

Feb 02, 2010 10:52 AM
rating: 0
 
Tommy Bennett

It's a very good question. For the purposes of the data above, I ignored multiyear deals. Strictly speaking, this is only a good assumption if we think that these players would have signed close to the midpoint also, but that may not be the case. Players who sign long-term deals tend to be a better group overall. Some of it is the very tricky problem of recreating a hypothetical. I'm inclined to say that they would probably still sign near the midpoint, but what do you think?

Feb 02, 2010 11:25 AM
rating: 0
 
ScottyB

They probably use the data at hand (the player and team offer) and agree to a mid-point like number for year 1 and an estimate of what a year +1 arb salary would be for year 2, etc etc until FA years where there's a significant raise.

This tactic is increasingly popular (at least it seems like it is) and is a GREAT way teams can retain homegrown talent (DWright, ELongoria, etc.). It also skews the current FA market by taking a lot of the best players off it- meaning the resulting FA signings look worse than they would be if teams didn't work out multi-year deals with arb and pre-arb players.

(Great article BTW)

Feb 02, 2010 14:11 PM
rating: 0
 
oskinner

Lincecum's agents did an excellent job of elemental game theory, whether by luck or by design we may never know.....if you think the Giants are going low, then you also go lower than you might otherwise, increasing the likelihood your number is the "more reasonable" and carries the day.....if you think the Giants are going to minimize their risk by submitting a higher number than they might otherwise, then you also go high on the chance the arbitrator will pick your number, knowing your downside is limited.....as the A's Mike Norris is reported to have said after losing in salary arbitration: "No problem, I was either going to wake up rich or richer."

Feb 02, 2010 12:29 PM
rating: 1
 
ScottyB

I'd love to see a piece about the psychological meaning of money to pro athletes and how it can alter decisions like the ones you've discussed. It definately is their way of keeping score and determining relative worth/status.

Feb 02, 2010 14:13 PM
rating: 0
 
rweiler

I think the Giants screwed themselves by coming in too low. If there offer was $10.5m, or slightly more than Howard got, their number would probably seem closer to being the true value. Given how much money guys like Sabathia, Santana, and the Giants own Barry Zito are making, $13.5 million seems pretty cheap for Lincecum. Also, the Giants gave $8m to Randy Johnson last year for 2/3rds season of league average work. It's hard for them to claim that they don't expect anymore from a 25 year old Lincecum than they expected from a 46 year old Johnson. On the other hand, part of Johnson's attraction was the marketability of the 300th win.

Feb 02, 2010 14:42 PM
rating: 0
 
sharksrog

I think your $11.5-$12.0 million is right on track. The Giants should have come in at $10.0 or $10.5 million. That could have given them a realistic chance of winning.

Feb 02, 2010 15:48 PM
rating: 0
 
sharksrog

The only thing the Giants can argue is that the market is going down. The problem from their standpoint is that it is going down for middling talent, but not for the top dogs, which Lincecum clearly is.

The Giants have already admitted they have almost nothing regarding Lincecum's performance to argue against him with. Even the Phillies had Howard hitting only .235 against southpaw in his season going into arbitration and 181 and 199 strikeouts.

Lincecum's performance has been eerily similar in all situations -- except when the margin is over four runs.

I can see it now:

Lincecum: How do back-to-back Cy Youngs look, especially since it hasn't ever been accomplished before in a pitcher's first three full seasons?

Sabean: We have looked carefully at Tim's record and have discovered that he's merely average when we are five or more runs ahead or behind. Tim's going to have to prove he can pitch in one-sided games before he can be considered a truly consistent pitcher.

In one-sided game we might as well have Barry Zito pitching. Oh, wait.

Feb 02, 2010 15:54 PM
rating: 2
 
rweiler

The only even half way plausible argument the Giants could make is that Lincecum's numbers are largely due to pitching 1/2 his games in The Phone Company Park. All 10 HR he gave up last year were on the road and his road ERA last year was 3.21 as opposed to 1.88 at home. The problem with that argument is that the park didn't help the rest of their pitchers all that much, and over his career, his home/road splits aren't so extreme. And even on the road he was pretty as good as Johan Santana.

Feb 02, 2010 16:51 PM
rating: 0
 
sharksrog

Game theory would indicate that the more off reasonable the team's offer is, the more off target the player's offer can be and still have a reasonable chance of winning, wouldn't it?

The lower the Giants went, the HIGHER Tim could afford to go.

IMO the Giants went low simply to give them more room in which to work a settlement with Tim. They don't want to go to a hearing. It's against their organizational philosophy.

If I were Tim, I would use the leverage of a likely arbitration win to forge a long-term contract. From the Giants' point of view, that becomes an iffy proposition -- especially with this year's ceiling capped at $13 million.

They have control over Tim for four seasons regardless. How about a four-year deal with three option years?

Feb 02, 2010 15:58 PM
rating: 0
 
oskinner

If you think Lincecum has an 80% chance of prevailing, there is no way he should settle for less than #12 mil (his $13 mil less 20% of the $5 mil difference between the two)

Feb 02, 2010 19:44 PM
rating: 0
 
oskinner

Your game theory suggestion is valid, but not in a non-linear binary situation like an MLB arbitration hearing.....

Feb 02, 2010 19:48 PM
rating: 0
 
marooner

"...the Giants went low (because) they don't want to go to a hearing."

But by going low, the Giants eliminated any leverage they would have in settlement negotiations. Increasing the distance between their number and Lincecum's only decreases the likelihood of a settlement, since (a) a larger difference between reserve prices makes negotiation more difficult, and (b) it gives Lincecum less incentive to compromise, since he can probably win outright.

Feb 03, 2010 14:45 PM
rating: 1
 
choms57

Does this article confirm that Ruben Amaro is some sort of secret genious? Hhahahah, sometimes I say the craziest things.

Feb 02, 2010 18:39 PM
rating: 0
 
sportspopery

1. Is there any way you can link to an abstract of the Priest-Klein article? I end up learning more about economics in your articles that I ever do in class.

2. What if Lincecum just showed up to the hearing, plopped down his Cy Young awards on the desk in front of him, and stared at the arbiters the entire time? I wonder how that would impact the decision-making process...

Feb 03, 2010 04:34 AM
rating: 4
 
oskinner

That's basically all he is going to have to do....

Feb 03, 2010 13:12 PM
rating: 0
 
zzbillfitz

Does anyone remember in the early days of arbitration when a player actually submitted a salary request that was LOWER than than the offer made by the club? Can't remember the player's name, but I do remember it happened.

Feb 05, 2010 16:22 PM
rating: 0
 
gersh22

Where did you get your settlement values from, and how do you measure them compared to the midpoint?

What about when a player signs a multi-year deal with, different yearly rates, as often happens to avoid arbitration? The player will generally make below midpoint the first year of a multi-year deal, only to make more later, and so you have to be more specific about the settlement values. AAV can be misleading, too.

Feb 06, 2010 12:31 PM
rating: 0
 
WaldoInSC

IIRC, the Giants are banking on the argument that Lincecum is not an exceptional case, and thus his salary should not be subject to free market forces. This is more a philosophical difference than a difference in linear value, which gives the team at least a hook to hang it hat on in arbitration.

I don't see that bucket holding any water with a reasonable arbitrator, but maybe SF brass does.

Feb 06, 2010 13:09 PM
rating: 0
 
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