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Skepticism and Solutions to Imaginary Problems in the NBA

The NBA -- if it is interested in the problem of payroll equity -- doesn't have to demand its players accept less money. They could accomplish the same objective by demanding teams like the Lakers accept less money.
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A few weeks ago I offered a post linking two apparently different demands. Currently the NBA would like its players to accept lower salaries. And perhaps from the beginning of time, rich people would like to pay less in taxes. Both of these demands are framed as follows: The people making the demand claim that if they are given more money, the people giving the money (NBA players and non-rich people) will be better off. Although such an argument could be thought of as clever, the empirical support for these claims doesn't seem to exist.

This discussion of how rich people ask for money closed with a brief discussion my skepticism regarding the NBA's claim that the league is suffering large financial losses. And I promised more on this subject in the future.

Before I could get to that next post, though, I heard from Tim Frank of the NBA. Mr. Frank is Vice-President of Communications for the NBA. And his argument re-iterated what was said at two months ago.

Given Mr. Frank's communication, I thought I would take a bit of time responding to the NBA's comments from early July. Before I get to this response, though, here is a bit of background.

Silver Questions the NBA

About two months ago the NBA locked out its players. The NBA argued this move was necessary because the league was losing large sums of money. And the only solution to this problem was for the players to accept a large cut in pay.

At about this time, Nate Silver -- in the New York Times -- examined the NBA's claims of financial distress. Silver's analysis revealed that the NBA's claims of massive losses were a bit overstated. In fact, Silver argued the NBA had actually earned a profit in 2009-10.

For the NBA, Silver's analysis is a very big problem. If Silver's analysis is correct, the NBA's lockout of players is not about saving a league from financial ruin, but rather about 30 NBA owners deciding to use their bargaining power to take millions of dollars from the players.

The NBA responded quickly to Silver's argument (again, you can see the response at And their response focused on the numbers Silver used in his analysis. These numbers came from and Financial World magazine (and posted in one place by University of Michigan economist Rod Fort). And that means Silver did not use numbers taken directly from the NBA.

Of course the NBA actually has the correct financial numbers. And when the NBA looked at these numbers they discovered that Silver was very wrong. At least, that's what the NBA told us. The NBA didn't actually reveal all their numbers. All they said in response to Silver is that when they look at their secret numbers, they see very large losses.

Although the NBA notes the size of these losses, they fail to tell us how they reached this conclusion. And that is has been the problem with the NBA's argument from the outset. The NBA won't let Silver -- or anyone outside the NBA -- look at their measures of revenue and cost. As Silver noted in response to the NBA...

...I simply have no way to adjudicate the N.B.A.'s claims. Mr. Frank's (vice-president of communications for the NBA) statement includes several specific claims that have the league has not made publicly before, but in general the league has not made substantial detail on its financial condition, or its accounting procedures, available to the general public.

The Forbes data may suffer from this lack of publicly-available information, but they remain the only independent estimates of the league's financial condition. In my view, a degree of skepticism is appropriate toward any claims made about the N.B.A.'s finances.

I look forward to continuing to report on the story as further information becomes available.

Since this exchange, no further information has come from the NBA. So we are left with a choice. Do we simply believe the NBA? Or should we be skeptical? After all, this is a league where...

  • wages to workers are capped (players in the NBA get 57% of BRI, or Basketball Related Income).
  • a substantial portion of the NBA's capital (i.e. sports arenas) is provided by the state.
  • and firms have substantial monopoly power in the market place.

Again, I am certainly skeptical. Until I see the actual revenue and cost numbers -- and see how these numbers were determined -- I simply have a hard time believing the NBA's story.

The NBA Reveals it Doesn't Know How to Forecast

Despite this skepticism, though, I want to imagine for a moment that the NBA is actually telling the truth. What would this tell us about the NBA?

The answer to this question focuses on why the NBA might be losing money. One might suspect that the NBA has been impacted by the recent recession. But the NBA claims it is not just the recession. The NBA claims the league has lost money in every year of the just expired CBA.

One should note why this claim is necessary. If the NBA only lost money in the past few seasons then the players could argue that these losses were due to a temporary economic condition (the recession -- despite what some people in the media seems to suggest -- is not permanent). And therefore, the league does not need a permanent change to the percentage of revenues going to the players.

By claiming the losses have existed since 2005, though, the NBA runs into another problem. Are we to believe that the NBA signed an agreement that immediately led to losses? Certainly it is possible that in 2005 the NBA did not know revenues and costs in 2010-11. But shouldn't the NBA have known what revenues and costs were likely to be in 2005-06 and 2006-07?

It is not unreasonable to expect that the NBA should be able to project revenues and costs for one or two years. And therefore -- if the NBA's claims are to be believed -- we must believe that the NBA made an agreement knowing the league would lose money. Oddly enough, at the time the CBA was renewed in 2005, the NBA did not announce that losses were going to soon follow.

Again, we are back to skepticism.

Two Plans to Solve an Imaginary Problem

Here is what I think the real story is in the NBA. Although the league pays 57% of the BRI to its players, every team doesn't pay the same amount. For example, the Los Angeles Lakers paid more than $90 million to their players in 2010-11. Meanwhile, the Sacramento Kings paid less than $45 million.

If we believe that spending on players leads directly to wins, and if we believe the Kings would suffer massive losses with the payroll of the Lakers, then the NBA might have a problem.

Unfortunately for the NBA's argument, from 2005-06 to 2010-11 a team's relative payroll (i.e. pay relative to the league average in that season) only explains about 12% of the variation in team wins. In other words, 88% of team wins is about something else besides how much a team pays its players. To illustrate, the Utah Jazz were fifth in the NBA in total payroll and missed the playoffs. The Chicago Bulls had the best record in the NBA with a payroll that ranked 27th in the league. Again, how much a team spends doesn't tell us much about how much they win.

But what if you really believed -- despite the evidence -- that payroll equity would solve the NBA's problems? There are two ways to achieve this objective.

Here is the NBA plan: Reduce the percentage of revenue that is paid to the players. This plan could bring the Lakers payroll down to a level closer to what we see in Sacramento. And this would also mean that NBA players would get much less.

Here is another plan that also leads to payroll equity: The NBA could force the high revenue teams to share more revenue with the low revenue teams. And if they also required that the low revenue teams spend this money on players, then we would also see more payroll equity in the NBA. This move could also be taken with the league still committing 57% of revenue to players. In other words, payroll equity doesn't necessarily require a pay cut for players.

The NBA clearly favors the first choice. This choice gives the NBA more equitable payrolls and higher profits. But if payroll equity is the real goal, the second choice would also work. The problem is profits would be lower.

We should emphasize that payroll equity is probably not going to lead to better competitive balance (a point I have made before). Payroll caps and revenue sharing have not been shown to enhance competitive balance. Furthermore, the relative lack of balance in the NBA has more to do with the scarcity of elite talent than whatever rules the NBA seeks to impose on its labor market.

Nevertheless, the NBA -- if it is interested in the problem of payroll equity -- doesn't have to demand its players accept less money. They could accomplish the same objective by demanding teams like the Lakers accept less money. Will this happen? Well, currently the NBA is talking to its players. Unfortunately, we have seen little evidence that owners of teams like the Kings are meeting with owners of the Lakers.

Until that meeting takes place, only one solution to the payroll equity problem is being pursued. And that solution to this imaginary problem (and it is imaginary since payroll equity is not really going to make the NBA a better league) is the solution that coincidently results in the NBA owners collecting bigger profits.

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