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Termination Risk and Agency Problems: Evidence from the NBA
Abstract
When agents with a significant risk of termination in the short term have discretion over project selection, they may have incentives to underinvest in projects whose results would be realized only in the long term, and owners may take this agency problem into account when deciding whether to grant those agents discretion in decision-making. Because NBA rookies who participate in games gain NBA experience that likely improves their long-term performance, decisions of NBA teams about whether to let rookies play provide a useful context for investigating this potential agency problem. We develop a model that identifies when owners will choose to leave coaches with discretion over rookie participation decisions and shows that, in the presence of such discretion, coaches facing a higher termination risk can be expected to use rookies less often. Testing our model using NBA data, we find evidence that is consistent with the predictions of our model. © The Author(s) 2018. Published by Oxford University Press on behalf of Yale University. All rights reserved.
... In the next section, we explain the dataset and empirical methodology we employ, followed by our 1. See for example, Cohen et al. (2018) and Peeters et al. (2020) for analyses of managerial discretion and performance using data from US basketball and baseball. main empirical results. ...
We argue that liquidity constrained firms face strong incentives to hire experienced, but low ability workers instead of novice workers with higher upside potential. Using four decades of high-frequency information on worker performance in a “superstar” labor market allows us to estimate the revealed ability of experienced workers at the time they are hired by a new firm. More than one-fifth of these hires are “substandard” in that the revealed ability of the hired experienced worker lies below the mean ability of recent novices. Even more hires (around 40%) are “mediocre,” as their ability falls short of the hiring threshold that maximizes the long-run average ability of the active workforce. Replacing mediocre hires by novice workers would increase the average ability of the workforce by 0.1 standard deviations.
... We go beyond their work by examining contract choice across a number of different governance institutions. 6 2 Papers that investigate this issue include Schmidt and Schnitzer (1995), McMillan and Woodruff (1999), Dixit (2004), and Cohen et al. (2015). ...
This paper examines the role governance institutions play in the adoption of contracts. We develop a simple model of the contracting relationship in a setting where unverifiable outcomes exist and use it to interpret data on groundwater irrigation contracts in Bangladesh. A distinguishing feature of this market is the variety of village-level institutions which impose different degrees of punishment for contract violation. Consistent with the model, we find households adopt contracts that rely on unverifiable outcomes, which are not formally contractible, when punishment for contract violation is weak. Conversely, households adopt contracts that rely on formally contractible and verifiable outcomes when punishment is severe. This evidence is consistent with contract terms being chosen optimally given what is or is not formally contractible.
Workplace flexibility in the context of collaborative tasks offers many benefits but also carries several risks. While more collaborators can reduce fatigue and enhance performance (we call this the ‘fatigue effect’), coordination costs also increase (we call this the ‘coordination costs effect’). We investigate this trade‐off in a complex team task with high effort costs in a natural setting. We use an instrumental variables approach combined with an extensive sensitivity analysis to identify the effect of in‐game substitutions on performance in professional basketball. Results indicate that an increased number of collaborators (players) has a negative effect on team performance. We also find that the most successful teams are able to optimally trade off both effects.
This article discuss the innovation and its relationship with organizational institutionalism from a prism of the notions of organizational strategy. Nowadays, we see that organizations have a greater trend towards "intelligent" survival. This is understood as a sum of long-term innovation strategies, combining different theoretical and practical elements that generate strong and robust institutions that can achieve the economic and/ or social objectives proposed by the organization with high profitability.
We describe two methods for correcting an omitted variables problem in discrete choice models: a fixed effects approach and a control function approach. The control function approach is easier to implement and applicable in situations for which the fixed effects approach is not. We apply both methods to a cross-section of disaggregate data on customer's choice among television options including cable, satellite, and antenna. As theory predicts, the estimated price response rises substantially when either correction is applied. All of the estimated parameters and the implied price elasticities are very similar for both methods.
In an influential article, “Unraveling in Matching Markets,” Li and Rosen (1998) note the first seven picks, and 17 among 29 first round selections of the 1997 NBA draft, were not college seniors. In 2004, the first pick in the NBA draft was a high school senior, and 25 of the first 29 picks were not college seniors. Li and Rosen (1998) suggest early entry is a form of unraveling in a labor market as firms attempt to secure the most promising player. We suggest recent NBA contract provisions implemented to slow the early entry of talented players have instead provided additional incentives to both players and firms for early entry into the NBA. In particular, the lowering of the fixed wage contract and lengthening of rookie contracts have given firms limited monopsonistic power and the ability to capture economic rents. We explore two competing models that predict why teams choose a talented player sooner under the new rookie contract system. The first model is the traditional human capital model, and the second is the Lazear (1995) option value model. To test why unraveling occurs, we use a panel study of all NBA players for 12 years from 1989 through 2002. The data include individual player performance statistics on a season-to-season basis, salary, and draft number.
The concept of mixed strategy is a fundamen- tal component of game theory, and its norma- tive importance is undisputed. However, its empirical relevance has sometimes been viewed with skepticism. The main concern over the practical usefulness of mixed strategies relates to the " indifference" property of a mixed- strategy equilibrium. In order to be willing to play a mixed strategy, an agent must be indif- ferent between each of the pure strategies that are played with positive probability in the mixed strategy, as well as any combination of those strategies. Given that the agent is indif- ferent across these many strategies, there is no beneé t to selecting precisely the strategy that induces the opponent to be indifferent, as re- quired for equilibrium. Why an agent would, in the absence of communication between players, choose exactly one particular randomization is not clear.
With superior data on compensation and productivity, as well as the occurrence of abrupt, dramatic market structure and player allocation rules changes, sports labor markets offer an excellent setting in which to test economic hypotheses. This paper reviews evidence from sports in four areas: employer monopsony, discrimination, the Coase Theorem, and incentive contracts, supervision and performance. There is considerable evidence of monopsony as well as for the existence of some forms of discrimination against minority athletes. Incentive contracts have strong effects on player performance and behavior, and there is mixed evidence on the predictions of the Coase Theorem.
We show that executives with more short-term incentives spend less on long-term investment. We examine a unique event in which hundreds of firms eliminated option vesting periods to avoid an accounting expense under FAS 123-R. This allowed executives to exercise options earlier and to profit from boosting short-term performance. Our identification exploits that FAS 123-R's timing was staggered almost randomly by firms' fiscal year ends. CEOs responded to option acceleration by cutting investment, increasing equity sales, and departing more frequently. Accelerating firms' stocks initially rose, but then underperformed over the long term. Our findings support managerial myopia theories.
The paper studies how a person's concern for a future career may influence his or her incentives to put in effort or make decisions on the job. In the model, the person's productive abilities are revealed over time through observations of performance. There are no explicit output-contingent contracts, but since the wage in each period is based on expected output and expected output depends on assessed ability, an "implicit contract" links today's performance to future wages. An incentive problem arises from the person's ability and desire to influence the learning process, and therefore the wage process, by taking unobserved actions that affect today's performance. The fundamental incongruity in preferences is between the individual's concern for human capital returns and the firm's concern for financial returns. The two need be only weakly related. It is shown that career motives can be beneficial as well as detrimental, depending on how well the two kinds of capital returns are aligned.
I exploit unique data on National Football League (NFL) players’ contracts to show how contractual arrangements in the NFL shape renegotiation and through that channel significantly affect players’ compensation and allocations. I show that a change in the timing of payments through the use of roster bonuses leads to contractual renegotiation and termination earlier in the off-season. This change in renegotiation incentives has quantitatively important consequences for players’ compensation and allocations. Players are willing to forgo approximately $260,000 for a contract with modified renegotiation incentives. Moreover, players who are terminated earlier sign more valuable subsequent contracts and rematch with other teams more frequently. These predictions are consistent with a model in which players in the NFL are subject to contractual holdup. Designing renegotiation incentives through an altered timing of payments—the roster bonus—ameliorates this problem, which substantially increases ex post transfers of players and changes player allocations.
This paper links the imminent vesting of a CEO’s equity to reductions in real investment. Existing studies measure the manager’s short-term concerns using the sensitivity of his equity to the stock price. However, in myopia theories, the driver of short-termism is not the magnitude of incentives but their horizon: equity will not induce myopia if it has a long vesting period. We use recent changes in compensation disclosure to introduce a new empirical measure that is tightly linked to theory - the stock-price sensitivity of shares and options vesting over the upcoming year. This sensitivity is determined by equity grants made several years prior, and thus unlikely to be driven by current investment opportunities. A one standard deviation increase in the sensitivity of imminently vesting equity is associated with a decline of 0.23% in the growth of R&D (scaled by total assets), 75% of the average R&D growth rate of 0.3%. Similar results hold when including advertising and capital expenditure. In addition, CEOs with imminently-vesting equity are significantly more likely to meet or beat analyst earnings forecasts by a narrow margin.
We study professional tennis players’ decisions of whether to challenge umpires’ calls using data on over 2,000 challenges in 35 tennis tournaments. The decision to challenge, which is simple to characterize, trades off reversing the umpire’s call against losing subsequent challenge opportunities. Qualitatively, players are more likely to challenge when the stakes are greater and when the option value of challenging is lower, as theory predicts. Quantitatively, players’ actual behavior is close to an optimal challenging strategy prescribed by a simple dynamic model. Our findings illustrate that professional decision makers develop decision rules that can approximate optimal behavior quite well.
We use a publicly available data set drawn from the professional sport industry to test for the impacts of coworker heterogeneity on firm performance. We focus particularly on the National Hockey League (NHL). NHL teams are truly global firms - they employ workers (players) from a variety of non-English-speaking countries, all of whom are integrated into a single work group (i.e. team). Players from different countries not only bring different languages and cultures, but also bring different playing styles - styles which must be effectively integrated into a cohesive playing unit. We use a panel data set that spans the seasons 2001-02 to 2007-08, and we control for a wide variety of variables that may affect a team's output. The question we pose is: all else equal, does the specific nationality mix on a team matter? In other words, for a given number of foreign players on a team, is it better to have all foreign players from a single country, or should teams attempt to employ foreign players from a variety of countries? Our results indicate that teams that are made up of mostly homogeneous European players appear to gain an advantage in team performance. Also, it appears that NHL teams perform better when their European players tend to come from the same country, rather than being spread across many European countries. We suggest that firms need to be cognizant of the way in which they diversify since the gains from diversity may be greatest when the foreign component of the workforce has, within itself, a higher degree of homogeneity.
We find that institutional ownership in publicly traded companies is associated with more innovation (measured by cite-weighted patents). To explore the mechanism through which this link arises, we build a model that nests the lazy-manager hypothesis with career-concerns, where institutional owners increase managerial incentives to innovate by reducing the career risk of risky projects. The data supports the career concerns model. First, whereas the lazy manager hypothesis predicts a substitution effect between institutional ownership and product market competition (and managerial entrenchment generally), the career-concern model allows for complementarity. Empirically, we reject substitution effects. Second, CEOs are less likely to be fired in the face of profit downturns when institutional ownership is higher. Finally, using instrumental variables, policy changes and disaggregating by type of owner we find that the effect of institutions on innovation does not appear to be due to endogenous selection.
We document sizeable and surprising differences in investment behavior between stock market listed and privately held firms in the U.S. using a rich new data source on private firms. Listed firms invest substantially less and are less responsive to changes in investment opportunities compared to matched private firms, even during the recent financial crisis. These differences do not reflect observable economic differences between public and private firms (such as lifecycle differences) and instead appear to be driven by a propensity for public firms to suffer greater agency costs. Evidence showing that investment behavior diverges most strongly in industries in which stock prices are particularly sensitive to current earnings suggests public firms may suffer from managerial myopia.
Despite its presumed role as an engine of economic growth, we know surprisingly little about
the drivers of scientific creativity. We exploit key differences across funding streams within
the academic life sciences to estimate the impact of incentives on the rate and direction of
scientific exploration. Specifically, we study the careers of investigators of the Howard Hughes
Medical Institute (HHMI), which tolerates early failure, rewards long-term success, and gives
its appointees great freedom to experiment; and grantees from the National Institute of Health,
which are subject to short review cycles, pre-defined deliverables, and renewal policies unforgiving of failure. Using a combination of propensity-score weighting and difference-in-differences estimation strategies, we find that HHMI investigators produce high-impact articles at a much higher rate than a control group of similarly-accomplished NIH-funded scientists. Moreover, the direction of their research changes in ways that suggest the program induces them to explore novel lines of inquiry.
Major League Baseball umpires express their racial/ethnic preferences when they evaluate pitchers. Strikes are called less often if the umpire and pitcher do not match race/ethnicity, but mainly where there is little scrutiny of umpires. Pitchers understand the incentives and throw pitches that allow umpires less subjective judgment (e.g., fastballs over home plate) when they anticipate bias. These direct and indirect effects bias performance measures of minorities downward. The results suggest how discrimination alters discriminated groups' behavior generally. They imply that biases in measured productivity must be accounted for in generating measures of wage discrimination. (JEL J15, J31, J44, J71, L83)
This paper develops a social custom model to investigate the validity of two beliefs in the shirking version of efficiency wages as follows: (i) more intensive supervision of the employer will induce the workers to increase their work effort; (ii) the firm faces a trade-off between the wage (carrot) incentive and the supervision (stick) incentive. It is found that two conflicting effects, namely the disciplining effect and the crowding out effect, will emerge when the employer raises the level of monitoring. In a situation where the crowding out effect dominates the disciplining effect, a rise in monitoring intensity tends to lower, rather than enhance, work effort. It is also found that, if tighter monitoring leads to a reduction in work effort, the firm should treat both wage and supervision incentives as complements, rather than as substitutes.
This paper investigates the hypothesis that CEOs in their final years of office manage discretionary investment expenditures to improve short-term earnings performance. We examine the behavior of R & D expenditures for a sample of firms in industries that have significant ongoing R & D activities. The results suggest that CEOs spend less on R & D during their final years in office. However, we find the reductions in R & D expenditures are mitigated through CEO stock ownership. There is no evidence that the reduced R & D expenditures are associated with either poor firm performance or reductions in investment expenditures that are capitalized for accounting purposes.
This paper examines the familiar argument that takeover pressure can be damaging because i t leads managers to sacrifice long-term interests in order to boost c urrent profits. If stockholders are imperfectly informed, temporarily low earnings may cause the stock to become undervalued, increasing t he likelihood of a takeover at an unfavorable price; hence the manage rial concern with current bottom line. The magnitude of the problem d epends on a variety of factors, including the attitudes and beliefs o f shareholders, the extent to which corporate raiders have inside inf ormation, and the degree to which managers are concerned with retaini ng control of their firms. Copyright 1988 by University of Chicago Press.
This paper examines a single, narrow decision—the choice on fourth down in the National Football League between kicking and trying for a first down—as a case study of the standard view that competition in the goods, capital, and labor markets leads firms to make maximizing choices. Play-by-play data and dynamic programming are used to estimate the average payoffs to kicking and trying for a first down under different circumstances. Examination of actual decisions shows systematic, clear-cut, and overwhelmingly statistically significant departures from the decisions that would maximize teams' chances of winning. Possible reasons for the departures are considered.
Final-offer arbitration in Major League Baseball provides an ideal setting for examining the empirical regularities that are associated with bargaining failure, since final offers, salaries, and player statistics, which provide the fundamental facts for the case, are all readily available. Using data for players eligible for arbitration for 1990-93, we conduct a wide variety of empirical tests regarding the relationship between aggressive offers and arbitration outcomes. We find that aggressive offers by players trigger arbitration and that more aggressive offers are associated with inferior financial outcomes in arbitration. Overall, clubs appear to outperform players in arbitration. Unexpectedly high or low offers are less common for players who have previously been through arbitration, which suggests that learning occurs. Our results are inconsistent with simple one-sided asymmetric-information models of arbitration. The results are more consistent with an optimism model or a model in which some players are risk loving.
This paper is concerned with the effect of nonmonetary incentives on behavior, in particular with the study of social pressure as a determinant of corruption. We offer empirical evidence that shows how professional soccer referees favor home teams in order to satisfy the crowds in the stadium. Referees have discretion over the addition of extra time at the end of a soccer game to compensate for lost time due to unusual stoppages. We find that referees systematically favor home teams by shortening close games where the home team is ahead, and lengthening close games where the home team is behind. They show no such bias for games that are not close. We further find that when the rewards for winning games increase, referees change their bias accordingly. Lastly, we identify that the mechanism through which bias operates is to satisfy the crowd, by documenting how the size and composition of the crowd affect referee favoritism. Copyright (c) 2005 President and Fellows of Harvard College and the Massachusetts Institute of Technology.
This paper develops a model of inefficient managerial behavior in the face of a rational stock market In an effort to mislead
the market about their firms' worth, managers forsake good investments so as to boost current earnings. In equilibrium the
market is efficient and is not fooled: it correctly conjectures that there will be earnings inflation, and adjusts for this
in making inferences. Nonetheless, managers, who take the market's conjectures as fixed, continue to behave myopically. The
model is useful in assessing evidence that has been presented in che “myopia” debate. It also yields some novel implications
regarding firm structure and the limits of intergation.
We present a multiperiod agency model of stock based executive compensation in a speculative stock market, where investors are overconfident and stock prices may deviate from underlying fundamentals and include a speculative option component. This component arises from the option to sell the stock in the future to potentially overoptimistic investors. We show that optimal compensation contracts may emphasize short-term stock performance, at the expense of long run fundamental value, as an incentive to induce managers to pursue actions which increase the speculative component in the stock price. Our model provides a different perspective for the recent corporate crisis than the increasingly popular `rent extraction view' of executive compensation.
This paper studies managerial decisions about investment in long-run projects in the presence of imperfect information (the market knows less about such investments than the firm's managers) and short-term managerial objectives (the managers are concerned about the short-term stock price as well as the long-term stock price). Prior work has suggested that imperfect information and short-term managerial objectives induce managers to underinvest in long-run projects. We show that either underinvestment or overinvestment is possible, and we identify the connection between the type of informational imperfection present and the direction of the distortion. When investors cannot observe the level of investment in long-run projects, suboptimal investment will be induced. When investors can observe investment but not its productivity, however, an excessive level of investment will be induced.
The NBA provides an intriguing place to assess discrimination: referees and players are involved in repeated interactions
in a high-pressure setting, with referees making split-second decisions that might allow implicit racial biases to become
evident. We find that more personal fouls are awarded against players when they are officiated by an opposite-race officiating
crew than when they are officiated by an own-race refereeing crew. These biases are sufficiently large so that they affect
the outcome of an appreciable number of games. Our results do not distinguish whether the bias stems from the actions of white
or black referees.
The authors examine managerial investment decisions in the presence of imperfect information and short-term managerial objectives. Prior research has argued that such an environment induces managers to underinvest in long-run projects. The authors show that short-term objectives and imperfect information may also lead to overinvestment and they identify how the direction of the distortion depends upon the type of informational imperfection present. When investors cannot observe the level of investment in the long-run project, suboptimal investment will be induced. When investors can observe investment but not its productivity, however, overinvestment will occur. Copyright 1993 by American Finance Association.
Although the theoretical literature on corruption is well developed, empirical work in this area has lagged because it has proven difficult to isolate corrupt behavior in the data. In this paper, we look for evidence of corruption in an unlikely place: the highest echelons of Japanese sumo wrestling. This paper provides strong statistical evidence documenting match rigging in sumo wrestling. A non-linearity in the incentive structure of promotion leads to gains from trade between wrestlers on the margin for achieving a winning record and their opponents. We show that wrestlers win a disproportionate share of the matches when they are on the margin. Increased effort can not explain the findings. Winning on the bubble is more frequent when the two competitors have met often in the past. Success on the bubble tends to rise over the course of a wrestler's career, but declines in his last year, consistent with the game theoretic predictions. Wrestlers who are victorious when on the bubble lose more frequently than would be expected the next time they meet that opponent, suggesting that part of the payment for throwing a match is future payment in kind. Systematic differences across wrestling stables suggest that the stables play a role in facilitating the corruption. In times of increased media scrutiny, the match rigging disappears.
We present a multiperiod agency model of stock-based executive compensation in a speculative stock market, where investors
have heterogeneous beliefs and stock prices may deviate from underlying fundamentals and include a speculative option component.
This component arises from the option to sell the stock in the future to potentially overoptimistic investors. We show that
optimal compensation contracts may emphasize short-term stock performance, at the expense of long-run fundamental value, as
an incentive to induce managers to pursue actions which increase the speculative component in the stock price. Our model provides
a different perspective on the recent corporate crisis than the “rent extraction view” of executive compensation.
The paper studies how a person's concern for a future career may influence his or her incentives to put in effort or make
decisions on the job. In the model, the person's productive abilities are revealed over time through observations of performance.
There are no explicit output-contingent contracts, but since the wage in each period is based on expected output and expected
output depends on assessed ability, an “implicit contract” links today's performance to future wages. An incentive problem
arises from the person's ability and desire to influence the learning process, and therefore the wage process, by taking unobserved
actions that affect today's performance. The fundamental incongruity in preferences is between the individual's concern for
human capital returns and the firm's concern for financial returns. The two need be only weakly related. It is shown that
career motives can be beneficial as well as detrimental, depending on how well the two kinds of capital returns are aligned.
The paper presents a dynamic contracting model of myopic firm behaviour caused by the fear of early project termination by
outside investors. Although the parties can conclude longterm contracts, asymmetric information between investors and firms
can make it impossible to implement profitable long-term projects. The paper characterizes the structure of optimal, renegotiation-proof
contracts for unmonitored and monitored finance. Monitoring by investors, although itself subject to distorting incentive
constraints, is shown to be able to overcome the short-term bias of investment and thus to lengthen the firms' planning horizon.
Of late, concern has been expressed that American managers tend to make decisions that yield short‐term gains at the expense of the long‐term interests of the shareholders. In this paper, we have attempted to investigate managerial incentives for such decisions. We find that, when the manager has private information regarding his or her decisions, there exist situations wherein the manager has incentives to make decisions which yield short‐term profits but are not in the stockholders best interests. This incentive for suboptimal decisions arises because the manager, by taking decisions yielding short‐term profits, hopes to enhance his reputation earlier, thus boosting his wages. We also find that this incentive is inversely related to her experience, the duration of her contract, and the risk of the firm.
"This paper examines contract-related incentive effects using a unique dataset on individual performance and individual contracts. Evidence from professional basketball players in the 1980s and 1990s shows that individual performance improves significantly in the year before signing a multi-year contract but declines after the contract is signed. One interpretation is that workers strategically increase effort to obtain the most lucrative, multi-year contract but then reduce it once the contract is locked in. This highlights the double-edged nature of long-term contracts: good for employers when workers are fighting for them, but less so when workers have them." ("JEL" J22, J3) Copyright 2006 Western Economic Association International.
Data at different levels of aggregation are often used in two-stage estimation, with estimates obtained at the higher level of aggregation entering the estimation at the lower level of aggregation. An example is customers within markets: first-stage estimates on market data provide variables that enter the second-stage model on customers. We derive the asymptotic covariance matrix of the second-stage estimates for situations such as these. We implement the formulae in the Petrin--Train application of households" choice of TV reception and compare the calculated standard errors with those obtained without correction. In this application, ignoring the sampling variance in the first-stage estimates would be seriously misleading. Copyright Royal Economic Society, 2003
“Corporate Investment and Stock Market Listing: A Puzzle?,”
- Asker
“The Causes of Bargaining Failure: Evidence from Major League Baseball,”
- Farmer
“Favoritism under Social Pressure,”
- Garicano
“The Effect of Coworker Heterogeneity on Firm-Level Output: Assessing the Impacts of Cultural and Language Diversity in the National Hockey League,”
- Kahane
“Innovation and Institutional Ownership,”
- Aghion