Don’t Player Hate, Arbitrate

Ryan Howard’s agent, Larry Reynolds Casey Close, is spending hours each day (or delegating that responsibility to someone else) preparing a case to prove that Howard deserves $10 million instead of the $7 million that the Phillies want to compensate him for his efforts. The system is called arbitration, but why is it used and what tactics are employed by agents? Phil Miller of The Sports Economist takes a look at the arduous arbitration that threatens MLB teams and players around this time every year.

One reason it is unpopular is because of the nature of the hearing process. For the players, they try to maximize their value to their team in the eyes of the arbitration panel: a sort of “how great I art” argument. For the teams, they try to minimize the player’s value: basically arguing “how great thou aren’t.” This is contentious.

Baseball’s labor market consists of three tiers of players: 1. reserved players who have less than three years of service* are, basically, the property of their teams; 2. arbitration-eligibles – players who have at least three years of service are also the property of their teams. But they can have their salaries determined through arbitration; 3. free agents, players who are not the property of their teams and are free to sign with whoever wants to sign them.

The collective bargaining agreement (CBA) restricts what arbitration panels can consider when rendering decisions (Article VI, Section F). Among those considerations are what comparable baseball players have earned as salaries. Because some free agents are comparable to arbitration-eligibles, their salaries, somewhat filtered down and averaged out, become part of the consideration (Dan Marburger’s 2004 Economic Inquiry paper on arbitrator compromise provides econometric evidence of this). That’s one reason why players see a jump in their salaries when they first become eligible.

*A set of players with two years of service are also eligible for arbitration.

Like I have said time and time again, baseball is unique in that any case that actually is heard by an arbitrator must be decided for one side. There is no middle ground. Final Offer Arbitration will render a decision that gives Ryan Howard $10 million (his figure) or $7 million (the Phillies’ figure). This is why we see so many pre-hearing settlements. According to Ed Edmonds of Sports Law Blog, a pre-hearing settlement may not be favorable to the player. His research over the past four years shows that 45% of the pre-hearing settlements were for below the midpoint value (example would be Howard taking less than $8.5 million in a settlement, which is less than the midpoint between $10 million and $7 million) while 22% were at the midpoint. Only 11% settled at a price above the midpoint.

Something to remember, though, is that often times a player is better off taking a settlement a little below the midpoint instead of going to an arbitration hearing only to lose out to the team and be forced to accept an even lower offer. The Phillies and Rays are two teams that have not lost an arbitration hearing, and many other teams have a better than .500 record when proving their cases to the 3 person panel of arbitrators.

Agents often have a very tough time deciding whether to settle their clients cases or take them to a hearing. There is often times a lot to lose coupled with a lot to potentially win by taking a case all the way to arbitration. However, many players would rather not worry about it and will favor getting rid of any risk by settling before hand. Armed with proper research and a solid plan, any agent can get through this tough period unscathed.