Baseball Teams Might Not Be Good Investors

Buy low, sell high. That's the most fundamental rule of investing, but it's far from clear that MLB teams understand that. 

Players are the most crucial investment of an MLB team. Without them, there is no product for teams to sell. Unfortunately, they also are quite expensive - and since local governments pitch in hundreds of millions of dollars for the teams' stadiums, players are probably a team's biggest business expense. 

At the heart of it, players are just like any other asset: teams invest money in them and hope performance exceeds that investment. There's a lot of uncertainty about the investment - will the player get injured or tank? - and there's competition between buyers to get players. If a team's analysis of a player is right, or at least lucky, they can 'make a profit' off of a contract. 

There's no team better at identifying undervalued assets and signing them a reasonable prices than the Tampa Bay Rays - and it's no coincidence that their management team worked on Wall Street before joining the team. The team's methods are becoming more common, but it's harder to put them into practice than to understand them. At least that's what must be going on in MLB front offices around the it seems as if it is, because the biggest contracts in baseball consistently are bad investments.

There are many ways to approach the question of whether or not a player's contract is a good deal for the team. Fangraphs even puts out an estimated dollar value of each player's performance. I took a different approach.

I wanted to check whether or not teams were paying for a player's past performance instead of future performance. In other words, did teams buy high instead of buy low? As it turns out, most of the time teams buy high. At least for the largest 100 contracts (that are 3+ years old), the average season of a player ismore valuable before they sign a lucrative new contracts than after.

It's kind of amazing how much teams have gotten it wrong on some cases. Up until 1999, Ken Griffey, Jr. was worth an average of 6.4 bWAR each year. Among these 31 contracts, only Alex Rodriguez, Barry Bonds, and Albert Pujols put up bigger numbers pre-contract. But after Griffey, Jr. signed a $116.5 million contract with the Cincinnati Reds before the 2000 season, he was only worth 1.5 bWAR. Injuries and old age had run down Griffey, Jr., who had previously been one of the best players of his generation.

That's a trend: most players don't reach free agency until after their 6th season in the league, so many of their best years (statistically) are already behind them by the time they sign a big-time contract. Most players peak when they are about 27. Teams are betting against time every time they hand out a contract, but especially when that contract is $90 million or more. 

The second largest drop-off was from San Francisco Giants' starting pitcher Barry Zito. Zito was a Cy Young Award-winning pitcher with the Oakland Athletics with a solid history, albeit with a reputation of inconsistency. When the Giants signed him before the 2007 season, they fell victim to another common trend among overvalued free agents: Zito wasn't being resigned by the Giants, he was being lured away from the team he'd been with since the minor leagues. When teams sign a player away from another team, they are thought to overpay more often. Without being the player or his agent, it's hard to tell if that's true - but this is baseball, where most theories are based on hearsay and tradition. 

So what have I proven? Well, it's hard to prove anything, but I've applied some basic analysis to results before and after teams offer big contracts to show that MLB teams usually sign players to large contracts just as their abilities start deteriorating. Teams hold onto big name players for too long. My analysis misses something, however. The teams that buy low are never going to have their contracts show up at the top of all-time lists.

Case in point: the Tampa Bay Rays signed Evan Longoria to a six-year, $17.5 million contract during his rookie season. Longoria has gone on to become a three-time All-Star and two-time Gold Glove winner. He could have one of the top 100 contracts of all-time if the Rays weren't so proactive. 

Brandon Moss provides a different type of buy low scenario. Instead of being a star prospect who was locked up early, Moss was a player continually on the fringe of the majors. After moving through the Red Sox and Pirates organizations, the Oakland A's signed him, basically to fill an organizational need. Fast forward to 2014, and Moss is an All-Star, having put up 73 home runs and 7.3 bWAR since 2012.

But maybe teams don't care that much. Maybe they know they have a problem, but just don't want to deal with it yet. And I'm not just talking about the Yankees or Dodgers or one of the other teams that spends money like a venture capitalist in Silicon Valley in 1998. That's because from their perspective, it's probably completely rational for them to hand out bad contracts.

Some years just don't have very deep free agent classes. If six teams need an upgrade at third base and there are only two third basemen on the market, then those are two lucky third basemen. Their price will be high, since there is a shortage. For a team that believe it is a contender - nearly good enough to have a realistic shot at the World Series - then who cares about an extra $10 million? A World Series is a World Series! That's worth much more than $10 million, for the ticket and merchandise sales, for the goodwill of their fans..

But obviously, only two teams make it to the World Series and only 5 or 6 teams really have a realistic shot at it. So in all likelihood, many teams have illusions of grandeur about their chances of winning. Not all of those 6 teams will have a glaring hole at third base, so some of the bidders might be overconfident fringe teams. It's a classic blindspot in self-assessment that most of us have: an inability to honestly judge ourselves. Just in this case, there's a lot more money on the line.

More broadly, baseball teams aren't the only ones who make this mistake. This is just the Peter Principle of professional athletes. Instead of being promoted until the point of incompetence, the players are paid until the point of worthlessness - even when the marginal value of those players drops far below the marginal cost. That is the point at which economics guides teams to stop buying, but when looking at the biggest contracts issued before 2012, teams couldn't control themselves - either hoping that the players they signed were going to beat the odds or that they had a realistic shot at the World Series. Now you might argue that teams have plausible beliefs that the players would perform better than they actually did; but after all the experience they've had with bad contracts, it's hard to justify that kind of overconfidence.

Just today, however, my beloved Minnesota Twins gave us all a reason to be optimistic. They traded Kendrys Morales to the Seattle Mariners for an above-average prospect. Instead of re-signing a one-dimensional player on the wrong side of thirty years old (who had previously told the media he wanted to sign a long-term deal with the Twins), the Twins did the rational thing. At the end of the season, Morales would be worth nothing to the Twins, so they traded him when he did have value. Maybe it's not selling high per se, but getting Stephen Pryor is worth more than getting nothing.