Valuation of Athletes As Risky Investments

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The Valuation of Athletes as Risky Investments: A Theoretical Model
Article in Journal of Sport Management · December 2007

DOI: 10.1123/jsm.22.1.50
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1
Running head: THE VALUATION OF ATHLETES AS RISKY INVESTMENTS
Haim Kedar-Levy1
Michael Bar-Eli1
1
School of Management, Ben-Gurion University of the Negev, P.O.B. 653, Beer-Sheva 94105,
Israel.
Please send all correspondence to:

Professor Michael Bar-Eli
Department of Business Administration
School of Management,
Ben-Gurion University of the Negev,
P.O.B. 653, Beer-Sheva 94105, Israel.
mbareli@som.bgu.ac.il
Tel. +972-8-6472208
Fax: +972-8-6477691
An electronic
Electronic
copy of
copy
thisavailable
paper is available
at: http://ssrn.com/abstract=983811
THE VALUATION OF ATHLETES AS RISKY INVESTMENTS
Abstract
The desire to hire the best athletes and coaches in order to maximize team performance
necessitates generous compensation contracts, which in turn increase the risk of financial distress
or even bankruptcy for team owners. Indeed, one of the largest expense items in the budget of
professional sport teams is the remuneration of players and coaches. Yet an investment made
today in a given team yields an uncertain income in the future, as team profitability depends on
the (uncertain) performance of each player and the synchronization among players – both
influenced by the coach. We present a formal theoretical model that assesses athletes' valuation,
accounting for the abovementioned factors. The optimal compensation schedule is determined
empirically by regressing expected performance measures of each player with the aggregate team
performance. Once the optimal schedule has been determined, the expected rate of return for the
owner is earned at the lowest possible risk.
An electronic
Electronic
copy of
copy
thisavailable
paper is available
The study of sports finance is in its infancy (Fried, Shapiro, & DeSchriver, 2003). To date,
most of the focus of research in this area has been on the financial management of professional
sport teams and sport businesses. One of the issues requiring further research is the concept of
organizational value (Gerrard, 2004), which is highly related to the value of talent. In this
context, one may ask what can be considered “reasonable” compensation for a star player or a
successful coach.
Levin, Mitchell, Volcker, and Will (2000) report that the average major league baseball
(MLB) club spent 53% of its budget for payroll in 1999. Obviously, overpayment may result in
the financial distress and potential collapse of sport clubs, thereby emphasizing the importance of
developing formal analytical measures of athlete value. Debates over baseball players’ salaries
are documented at least as far back as 1879 (Vrooman, 2000, p. 364), including court rulings
between leagues from the beginning of the 20th century, and much later marking the record 232-
day strike of MLB players starting in August 1994 over their employment terms. Unlike sport
finance, the field of sport economics is much more established, originating with the seminal
paper of Rottenberg (1956). In this paper, Rottenberg proved that there is no economic
justification for maintaining the reserve clause in a player’s contract, according to which the
rights of the player are bound to one team for life. In a series of papers, El Hodiri, Fort, and
Quirk (El Hodiri & Quirk, 1971, Fort & Quirk, 1995, Quirk & El Hodiri, 1974, Quirk & Fort,
1992) arrived at a number of results that provide a sound formal basis for the analysis of sport
economics.
Scully (1974) established the method of empirical measures of sport labor markets by
estimating the value of an individual player through his Marginal Revenue Product (MRP).
Scully applies a two-step test: First, player performance statistics are regressed against team
success rates, and second, a team’s success rates are regressed against team revenue, together
with variables such as market size and stadium age. This methodology has been modified in a
number of studies to account for statistical issues, such as time-varying regression intercepts
(e.g., Krautmann, 1999; MacDonald & Reynolds, 1994), as well as operational aspects.
Krautmann applies a different measurement procedure and concludes that relatively new players
(3-6 years) are paid 85% of their MRP, compared with an estimated 25% of MRP when Scully’s
procedure is applied on the same data. Krautmann attributes this gap to the need for the team to
recover training costs. Blass (1992) estimates that 76%-86% of position players (i.e., non-
pitchers) who were eligible for free agency in the 1985-1986 season were overpaid. Zimbalist
(1992a, 1992b) found that players with less than six years of experience were paid 20%-33%
below their MRP, while players with more than six years of experience were paid 24% above
their MRP in 1986, and 32% in 1987, 28% in 1988, and 40% in 1989. Holbrook and Shultz
(1996) focus on star players and estimate the evolution of their salary as a function of various
performance measures such as hitting statistics, strikeouts, and errors. They conclude that next
period salary is a function of current period salary and performance.
A related aspect is the question of the relevance of market size; Scully (1989) argues that
team revenue depends directly on the size of the market from which the team draws fans. While
some researchers disagree (e.g., Vrooman, 1996), Quirk and Fort (1999) argue that under free
agency “a player will end up playing for the team for which he adds most revenue … and he will
earn something between what he is worth to that team and what he would be worth to the team
that places the second highest value on his services” (p. 81). Modified Scully tests that account
for the impact of market size on players’ salary (see Burger & Walters, 2003; Hall, Szymanski,
& Zimbalist, 2002; Quirk & Fort, 1999; Sommers & Quinton, 1982; Zimbalist, 1992b) found a
measurable size effect; the most striking being reported by Burger and Walters - up to six-fold.
Zimbalist (1999) argued that a $25 million contract with a player (referring to the 2002 contract
with Alex Rodriguez of the Texas Rangers) is hardly justifiable, as this player has to generate
more than $25 million in net profits before the investment turns a profit for the team owners. In
the same year, 2002, the average team payroll was $65 million. In short, the question of whether
salaries and compensation plans for players and coaches in professional sports are still
“reasonable” appears to be relevant.
Needless to say, overpayment may result in financial distress – or even collapse – of clubs
that commit to paying salaries beyond their capabilities. Such “foolish financial decisions”
(DeSchriver & Mahony, 2003, p. 250) often lead to financial crises, as seen in several cases
described in detail by Gerrard (2004) with respect to the English Premier League (e.g., Leeds
United) and the Italian Serie A (e.g., Fiorentina); more recently, clubs in the First German
Bundesliga (e.g., Borussia Dortmund) can be added to the list. Thus, the failure to establish
appropriate wages for athletes raises the need to assess players’ and coaches’ valuation more
thoroughly.
The literature on player valuation has ignored the role of risk when measuring player
MRP, yet risk is inherent in any business, and the business of sport is not an exception.
“Standard” business risk stems from variability in the relevant economic environment (e.g., fans’
available income, ticket prices, fluctuations in the markets for branded goods or broadcasting
rights, etc.) Yet, sport business is also risky because players’ performance is uncertain and to a
great deal depends on the specific team members recruited, the coach, the goals of the
management, and the way all of these are synchronized. In this paper we extend the Capital
Asset Pricing Model (CAPM), developed in the mid 1960s by Sharpe (1964), Lintner (1965),
and Mossin (1966) to the valuation of each individual player in a team and of the coach, and to
their collective contribution to the value of the entire team. We found no model in the sport
management literature that values professional athletes and/or coaches while explicitly
incorporating the fact that they are paid cash today for uncertain returns in the future, with these
returns depending on the combined performance of all team members with each other and with
the coach. Accordingly, this paper presents such a formal valuation model for professional
players and coaches. The model accounts for the potential income from each player, but also
acknowledges the uncertainty involved in the return the player is expected to yield as well as the
intra-team performance of each player with all other players. This latter notion allows us to
assess the role and value of the coach.
A number of important results stem from the model, both conceptually and empirically.
First, the model can be used to assess the proportional budget allocation among team players,
when these proportions are determined by each player’s synchronization with other players as
well as by his/her expected MRP. Second, the model implies that there should be a positive,
linear functional relationship between the return each player should earn and the co-variability of
his/her return performance versus the return performance of the entire team. Third, the model can
be estimated empirically with the input data being a time series of expected MRP estimations,
possibly based on Scully’s procedure, as well as actual pay. In Section 3 of this paper, we
illustrate the empirical procedure and demonstrate its implications for distinguishing between
fair compensation and over/under payments. We also offer a few examples of actual calculations;
an Excel worksheet where the entire model is solved is available for interested readers upon
request.
1. The Formal Model
We form a single period model of a sport team with n positions, each filled by a single
player, which the owner selects in a free market. We assume that there is a continuum of players
across all relevant measures of talent and pay. Each player i (i=1,2,3,…n) is paid at present a
positive price pi in a competitive market for players with no constraints such as drafting rules or
transaction costs. Player i is expected to generate a team-specific Marginal Revenue Product
(MRP) E ( MRPi ) , which includes income from all core and peripheral businesses of the team
(we do not index teams in order to simplify notation). MRP of player i is team-specific since the
same player can be more productive in one team than in another, as we analyze formally below.
Expected net profit from the player to the team owner at the end of the period is the difference
between the expected contribution of the player and his/her cost: E (d i ) E ( MRPi ) pi . Hence,
the expected rate of return over the period from player i is E (ri ) E (d i ) / pi . Expected returns
are ex-ante positive through the choice of pi , since the team owner is assumed not to hire a
player who is expected to yield a loss. Nevertheless, ex-post returns may be positive, zero, or
negative, depending on players’ actual performance. The expected rate of return from each
2
player is assumed to be normally distributed with mean E (ri ) and variance i . The covariance
between expected rates of return from players i and j is denoted i, j and the correlation
i, j
coefficient between them i, j . We shall address below the difference between co-
i j
variation that stems from inherent properties of different positions, and co-variation that stems
from individual properties of specific players who may occupy a given position, such as their
personalities, style, and the like.

It is assumed that team owners desire the highest possible returns, yet they are also
assumed to dislike risk, measured by the variance (or standard deviation) of expected returns.
These “risk-aversion” preferences are considered “rational” in the financial economics literature,
and are represented by a convex indifference curve between risk and return. Notice that “risk-
aversion” does not imply that investors will not undertake risk; it implies that they will require
compensation for bearing risk. Related studies that assume profit maximization by team owners
include Fort and Quirk (1995), Fort and Scully (1989), Quirk and Fort (1992), and Zimbalist
(1992). Vrooman (1997) suggests an alternative approach. Our model rules out non-rational
preferences.
Team owners face an optimization problem where the variance of the collective (entire
team) rate of return should be minimized for a given expected return from all players in the team.
The mean rate of return from all players in the team, henceforth referred to as a portfolio since it
represents a pool of risky investments, is the linear function
E (rP ) x1 E (r1 ) x2 E (r2 ) ... xn E (rn )

n , (1)
xi E (ri )
i 1
where xi is the proportional budget allocation to the player playing in position i, out of total
payroll budget available, and E (rP ) is the expected rate of return from the entire portfolio, P.
The notion of the “portfolio” is central to our analysis; informally portfolios differ from each
other when a given payroll budget (in monetary value) is distributed across positions in different
proportions. Alternatively, two portfolios will also differ if their monetary value is different
while proportional allocations across positions are similar. Throughout the analysis below, we
shall assume similar budgets, unless mentioned otherwise. Formally, assuming similar budgets,
different portfolios are different vectors of budget allocations such as X A {x1A , x 2A , x3A ,..., x nA }
and X B {x1B , x 2B , x3B ,..., x nB } . We define feasible portfolios in sport teams as strictly positive
allocations, and these are the only portfolios addressed from now on. Notice that the owner can
change the proportional allocation through selection of different players; when an owner pays
more for a specific player in a given position, s/he practically chooses to invest in one of the
better players available for this position, thereby revealing his/her strategic preferences in
constructing the team. For simplicity, equation (1) will be written in vector form as,
E (rP ) X T E ( R) (2)
where E (R) is the vector of all expected returns and X T is the transposed vector of all
proportions xi . The variance of a portfolio of n uncertain returns from all team players,
combined, is given by
n n
Var (rP ) P xi x j ij . (3)
i 1 j 1
As (3) implies, calculating the variance of the rate of return of the entire team implies that
we need to account for the covariance of returns across all pairs of players i and j, as well as for
their individual variances. The variances and covariances are then weighted by proportions xi .
The variances and covariances alone can be represented by an n n symmetric matrix of the
form
11 12 13 1j 1n
21 22 23 2j 2n
31 32 33 3j 3n
S . (4)
i1 i2 i3 ij
n1 n2 n3 nn
The diagonal of matrix S contains all n variances, and all off-diagonal elements are
covariances, where i, j j ,i . Since by (3) the variance of the entire team’s rate of return is
calculated by multiplying each covariance between i and j by xi and x j , respectively, the
variance of a portfolio of n assets can be written in matrix notation as
P X T SX . (5)
Having defined the variables in the owners' decision making problem, we can formalize it
as minimizing the standard deviation of returns that a specific portfolio is expected to generate,
such that the expected rate of return on the portfolio is, say, A . Formally,
Min P xi x j ij ,
i j
Subject to:
A xi E ( Ri )
i
Applying the Lagrange technique, we define the Lagrangean
1
2
L xi x j ij A xi E ( Ri ) ,
i j i
and by equating the partial derivatives with respect to xi and to zero, we solve for the optimal
proportions according to which the budget should be allocated across all players in all positions,
for a given A . Feldman and Reisman (2003) provide the simplest solution we are aware of to
obtain the optimal allocation vector, being
Y S 1 ( E ( R) C ) , (6)
1
where S is the inverse of matrix S, C is a constant and Y is a vector of non-normalized weights.
Once the vector Y is normalized by calculating xi yi / yi , we obtain the optimal proportional

i
solution which guarantees xi 1 . An example of the actual calculation is given in Section 3.

i
Another important result, which we develop in Section 3, provides a formal linkage
between the expected rate of return of a specific player and his/her contribution to the team’s
performance, hence determining his/her fair pay. This latter linkage also serves as an empirically
measurable implication of the model.
It should be emphasized that in the context of our model, an optimal vector of proportional
budget allocation is defined as one that yields the lowest attainable standard deviation from a
given set of positions by choosing players in those positions, such that a required mean return
A is earned on the investment. By changing the required return constraint A to some other
required return, say B , we obtain a different allocation of the team budget among (possibly
different) players in the predetermined positions. This is where our assumption of a continuum of
players is needed: a change in budget allocation from xi (1) to xi ( 2) where xi ( 2) xi (1) implies
that the owner is allocating more funds to position i , thereby recruiting a "better" player, which
we assume exists in the market of talent. The term "better" is measurable by the player's ability
to reduce team risk for the given required return, B , through its expected return, variance and
covariances with all other team players.
By repeating the exercise and solving the optimal budget allocation for different required
returns, the collection of optimal allocations yields a horizontal hyperbola, as in Figure 1. The
hyperbola represents all allocations, feasible and non-feasible. Non-feasible allocations are those
in which at least one player receives a non-positive (zero or negative) share of the budget. Such
allocations are ignored since they represent an irrelevant solution (player compensation is strictly
positive). The feasible parts of the hyperbola can be constructed numerically for a particular
dataset based on the derivation presented above. A numerical example of the calculation
procedure of an optimal allocation is presented in Section 3 with respect to example 2, which we
discuss in the next section.
[insert Figure 1 about here]
Figure 1 shows that with a given budget, all optimal allocations among team players are
represented by a quadratic functional relationship between the required expected return and its
standard deviation. Each point on the hyperbola represents a different allocation of the same
budget among the team players, i.e., a different compensation plan. This implies that if a team
owner desires higher rates of return, s/he will have to bear higher financial risk in terms of the
variance of rates of return earned by the entire team. Rational investors will never allocate their
budget according to allocation schedules represented by points residing on the hyperbola, lower
(vertically) than point A, e.g., point B. The reason for this is that a rational team owner who is
willing to undertake risk level B will require the highest possible return for bearing this risk,
i.e., will choose to allocate the budget such that it will earn expected return C, on the upward
sloping part of the hyperbola, rather than B, on the downward sloping segment of the hyperbola.
For this reason, the downward sloping segment of the hyperbola is presented as a dashed line,
indicating its inefficiency. Moreover, although allocations inside the hyperbola (between points
B and C) are feasible, they are ignored for being inferior to the “optimal choices” located on the
upward sloping segment of the hyperbola.
Once all optimal allocations that make the risk-return tradeoffs have been calculated for a
team, the next question to be addressed is the specific budget allocation the team owner will
choose on the hyperbola. That is, out of the entire “optimal investment opportunity set,” the
upward sloping segment of the hyperbola (out of which a few segments might not be feasible,
and hence disregarded), the owner should choose one risk-return combination that suits his/her
preferences. The normative modeling tool is the “indifference curve” economists use in order to
represent the tradeoff a “rational agent” would make between two goods, or attributes. In our
case, the team owner is asked to specify the compensation s/he requires in terms of additional
(marginal) expected return, if being asked to undertake an additional unit of risk (over some
benchmark). It can be shown that if team owners satisfy a number of “rationality axioms,” their
tradeoff between risk and return would result in a convex set of indifference curves on the plane
expected-return – standard-deviation, as illustrated in Figure 2. Such investors are referred to as
“risk averse” investors. The higher the curve (following the arrow), the higher the utility the
owner draws from the choice being made. Hence, the tangency point between the hyperbola and
the highest possible indifference curve will determine the optimal choice. This notion is
illustrated in Figure 2, where the team owner’s optimal allocation is determined by the tangency
point A between his/her highest indifference curve, I (Max), and the hyperbola. All other
allocation possibilities, illustrated by the intercept of dashed indifference curves with the
hyperbola are inferior to point A. Hence, this specific team owner will find it optimal to tolerate
the risk, and expect the return associated with the tangency point A.
The main message of this model is that the optimal budget allocation among team players
is determined both by objective team attributes that determine the shape and location of the
hyperbola on one hand, and the subjective risk preferences of the team owner on the other hand.
The shape of the hyperbola is determined by the expected profitability of each player and its
uncertainty, but mostly by the interdependency and mutual performance of each pair of players
in the team, measured by the pair-wise covariance terms. This latter notion gives rise to the role
of the coach – a good coach will make the interactions among players “constructive,” in the
sense of increasing expected returns for a given variability, and/or decreasing return variability
of the entire team for a given expected return.
In order to facilitate this discussion, the instrumental meaning of the covariance terms (or
equivalently, the correlation coefficients) in the model must be defined. The covariance i, j
measures the linear association between the returns generated by player i versus those generated
by player j through the correlation coefficient i, j . If the correlation coefficient i, j is zero,
there is no linear association between returns earned by those players, i.e., if player i performs
badly in a specific game, we cannot draw any conclusion from a linear statistical model about the
performance of player j in the same game. We denote such players as neutral players.
Alternatively, we say that player i is a compensating player of player j if on average s/he plays
above his/her average performance when player j performs below his/her performance, and vice
versa. Finally, player i is said to be a dragging player of player j if s/he performs badly when j
plays badly and plays well when j also plays well. To exemplify the terminology one can think of
the performance of the goalkeeper in soccer as neutral with respect to most other players in the
team, but dragging with respect to the stopper – if the stopper under-performs, the goalkeeper is
likely to under-perform as well. In summary, there is a negative correlation coefficient between
the performances of compensating players, zero correlation between neutral players, and positive
correlation between dragging players. Evidently, some positions imply compensating or dragging
relationships by their very nature, regardless of the specific players occupying the position.
Therefore, empirical measures of correlations will account for both the positions' effect and the
specific players' effect turning specific numerical values of correlations non-informative.
Correlations will be meaningful through a cross-sectional (same sport field, different players
occupying given positions) or time-series (same player playing in different teams) comparison of
pairs of positions in the same type of sport, when players' performance in these positions varies.
Returning to the overall team perspective and the role of the coach, we define a
synchronized team as one where compensating interactions dominate the other interactions
among pairs of players. Equivalently, the team is defined as not-synchronized when dragging
interactions dominate, and as neutral when neutral interactions dominate. That is, the notion of
synchronization applies to the team as a whole, while the terms compensating-, dragging-, and
neutral-players refer to specific pairs of players/positions. Thus, the role of the coach can be
operationally defined as that of increasing the synchronization of the team as much as possible.
Note that we do not require all pair-wise interactions to be compensating; this case cannot yield,
in general, a consistent covariance matrix, but we do expect the coach to train the athletes to be
synchronized. Lastly, note that synchronization is more important in some sports such as soccer,
field hockey, and basketball, and less in others such as golf or archery (Bar-Eli & Schack, 2005).
2. Simulated Examples
In this section we exemplify how the model can be used to convey better insights for
decision makers when pricing athletes. We discuss and illustrate the operational meaning and
implications of the assumptions we make with respect to different variables in the model, using
four numerical examples in a five-players/positions team.
The Benchmark: A Team of Homogenous Players
We start with a simplistic example that will serve as a benchmark for other examples,
whereby all players are homogenous in terms of their expected return and expected return
variability. We further assume in this example that all correlation coefficient terms, i, j , among
all pairs of players/positions (i,j) are equal to zero (a neutral team). We summarize the input data
in Table 1.
[insert Table 1 about here]
Intuitively, since all expected returns, standard deviations of the expected returns, and all
paired correlations are identical, there should be no justification for differential payments.
Indeed, the right panel of Figure 3 shows that all players are equally valued with each receiving
1/5th of the payroll budget. The left panel shows that since all players are identical, the hyperbola
reduces to a singular point at 10% expected return and 20% standard deviation.
Based on this simplistic benchmark, we turn to exploring the reasoning for differential
compensation schedules when above-average players join the team.
Example 1. Star Players
The above example will be more realistic if we introduce heterogeneity among players. As
a first attribute of heterogeneity, assume that Player 1 is expected to earn higher returns for the
team owner; the question is how this advantage will translate toward Player 1's value in the
market. After increasing the expected return for Player 1 by 10%, from 10% to 11%, and leaving
all other parameters as in the benchmark example, we obtain a new optimal solution, presented in
Figure 4. Now that there is a slight difference in expected return from Player 1, the construction
of endless efficient combinations is possible, i.e., the hyperbola comes into existence.
Additionally, we see that the budget is not equally allocated among all players, since Player 1
receives 21.57% of the budget, while all other players receive 19.61% each.

The question now is what determines the magnitude of the difference between Player 1’s
compensation versus his/her team members: 21.57%-19.61%=1.06%? The answer is that the
choice of the risk-return combination the team owner prefers to obtain will determine not only
his/her expected risk-return outcome, but also the budget allocation. As discussed in the previous
section, the specific risk-return combination the team owner would prefer, among all available
possibilities on the upward sloping part of the hyperbola, can be found by equating the marginal
rate of substitution of the specific team owner between risk and return to the slope of the
hyperbola. The slope of the investor’s indifference curve is given by the upward sloping straight
line, and its tangency point with the hyperbola represents the optimal choice of the specific
owner. In order to obtain his/her optimal risk-return combination at the tangency portfolio, the
owner must allocate the budget among team players according to the schedule presented in
Figure 4. This tangency point represents equilibrium in the sense that it satisfies the owner’s risk
preferences, determines the expected risk-return profile of the team, and determines the optimal
allocation of the payroll budget among all players. In the case presented, the marginal rate of
substitution is very steep, indicating that the owner is extremely risk averse.
The importance of the owner’s risk-return preferences deserves a closer look. Under the
assumption of competitive markets for athletes, i.e., when team owners freely bid for athletes,
the preferences of the marginal team owner will set equilibrium prices. Intuitively, this implies
that when all players are identical except for a star player, defined as such due to his/her ability
to generate higher expected return vs. his/her peers, then in a competitive market the price of
such star players must increase. Hence, if the preferences of the marginal team owner had been
different, the team mentioned above would have received a different compensation schedule.
In order to demonstrate the sensitivity of the compensation scheme to different risk-return
combinations, we reconstruct Example 1 by changing the risk aversion of the team owner. The
numerical example of Figure 4 yielded a rate of return of 10.2% and a standard deviation of 9%.
If the owner’s required rate of return increases to 10.4%, which is associated with 10% standard
deviation. The compensation schedule changes such that 40% of the (constant) budget is now
allocated to Player 1 while all other team players receive 15% each. This change in allocation
implies that a team owner desiring a higher return will replace a player in position 1 with a more
expensive player who yields a higher expected return. These results are presented in Figure 5.
It is important to note that this example demonstrates an extremely high sensitivity of the
compensation schedule to the owner’s risk preferences. The reason for this sensitivity is that the
difference between Player 1’s expected return and that of other team members is very small (one
percentage point 11%-10%), representing severe scarcity.
Taking this line of logic further, we would expect that the percentage of the payroll
budget allocated to star players would decline as they become more common (less scarce) in the
market. To see this effect (Figure 6), we assume that Player 2 is also believed to earn 11%, like
Player 1. All other parameters, specifically the risk preferences of the team owner, remain
similar to those of the last example.
The introduction of an additional star player, who is assumed to be identical to the first
one, has two effects: first, both star players receive equal payments, both of which are higher
than that of the non-star players; second, the hyperbola turns wider, indicating that the team
owner now has better risk-return alternatives. This means that the owner can earn a higher return
for the same risk, or, looking at it from the opposite angle s/he can earn the same return but be
exposed to lower risk. Quirk and Fort (1999) demonstrated that in a free market for athletes,
significant compensation differences between star players and regular players can only arise
when a star player’s MRP is higher than that of regular players, not only in his/her own team but
in other teams as well. That is, a star player whose MRP is high in a given team but whose
advantage cannot be translated to financial success in other teams, will be paid an amount
between his/her performance in the home team and his/her second best alternative. Our model
suggests that one of the reasons why a star player is more effective in some teams but less in
others is his/her synchronization with other teams and with their coaches. Hence, synchronizing
star players with regular players appears to be most important for the star players themselves,
and for the team owners.
Two pertinent examples that come to mind in this context are FC Bayern Munich in the
early 1980s and the Chicago Bulls in the 1990s – one clearly dominating the German Soccer
Bundesliga and the other the U.S. National Basketball Association (NBA), respectively. In the
early 1980s, Bayern was led by two superstars, namely Paul Breitner and Karl-Heinz
Rummernigge, who were even nicknamed "the 'Breitnigge'-Duo" (Schulze-Marmeling, 1997).
Breitner played in Bayern between 1970-74, left to play in Spain and returned to Bayern between
1978-83. Rummernigge played in Bayern between 1974-84, and was sold to Inter Milano for a
record of 11.4 million DM. Likewise, the Chicago Bulls in the 1990's were led by Michael
Jordan and Scottie Pippen, with specific roles being assigned to other players, such as rebounder
Dennis Rodman, defensive specialist Ron Harper and shooter Steve Kerr (Weinberg & Gould,
2003). Both Jordan and Pippen played with the Bulls at the height of their careers; the fact that
these star players did not migrate to other teams throughout the height of their careers may imply
that their alternative MRP would have been lower than their MRP at their home teams; hence,
their equilibrium pay would be lower as well. It is probable that the difference in a player’s MRP
across teams is related to different synchronization with other teams and/or coaches, thus players
in general, and particularly star players unwilling to take a synchronization risk, will strive to
avoid migration. Obviously, a player who finds it difficult to synchronize with his/her current
team will seek migration opportunities. Note, however, that this analysis applies to player
migration across teams in iso-wealth leagues; it is reasonable to assume that a star player in a
low-wealth league would take the synchronization risk and migrate to higher-wealth leagues, as
the level change in his anticipated pay may be sufficient to compensate for this risk.
Example 2. Compensating, Neutral, and Dragging Players
In this section, we address the relationship patterns that can take place between pairs of
players in a team, i.e., the effects of compensating, dragging, and neutral players on
compensation schedules and the value of synchronized versus non-synchronized teams to the
owner. In essence, we discuss here the crucial part of task cohesion in successful team
performance (Paskevich, Estabrooks, Brawley & Carron, 2001). The extent to which player i
compensates (or not) for the weak performance of j is measurable by the covariance of their
contribution to the team profitability rate. It is beneficial to replace the covariance and represent
the covariability by the linear correlation coefficient i, j , because the latter is normalized, and
therefore comparable across players and teams. The correlation coefficient is bounded between -
1 and +1, where i, j 0 indicates independence (neutrality) of the performances of players i vs.
the performance of player j. If i, j is positive, good performance of i will be statistically
correlated with good performance of j, and vice versa. From the owner’s perspective, the higher
the value i, j obtains, the less attractive will be the specific pair of players, and consequently,
the entire team. As mentioned in the previous section, high correlation coefficients within a team
represent many dragging pairs of players, and hence a non-synchronized team. Therefore, the
team might play very well at certain times, but very weak at other times, resulting in a volatile
(risky) total rate of return – not a desirable outcome for the owner. A better team is one where
many pairs of players can compensate for each other, hence producing more stable, less risky
returns. If we compared two teams, one with many compensating players and one with many
dragging players, with both earning similar expected returns, the owner would prefer the
synchronized team – the one with more compensating players – since it generates the same
average return in a more predictable way; the volatility of the overall team return is less risky.
The important implications of enhanced task cohesion for sport management are discussed in
detail in Bar-Eli and Schack (2005).
While our first two examples assumed that all paired correlation coefficients are zero, we
now exemplify the effects of compensating and dragging players on the compensation schedule
among team players. Starting with an illustration of the effect of compensating players, Table 2
and Figure 7 show that while all expected returns and variances are identical among all players, a
negative correlation of 1, 2 2,1 0.3 between players 1 and 2 increases their relative
compensation to 24.39% of the budget, while all other players receive 17.07%.
Alternatively, if players 1 and 2 were dragging with a correlation coefficient of
1, 2 2,1 0.3 , their respective compensation would decline to 16.95% of the budget each,
while the other team members would have received 22.03% of the budget each, as illustrated in
Figure 8. Note that a problem of two dragging players can be solved by replacing one of them, if
there are alternative players in the market, but it cannot be solved if the position itself is dragging
in the specific sport; thus, any player in the specific position will be paid less than other
positions.
Obviously, the effects illustrated in these examples can be combined, such that players
who earn high potential returns are also dragging players. For example, if two star players are
hired, each potentially yields 11% while all others yield a standard 10% return, all correlation
coefficients are 0, and the owner is willing to accept 10% risk, then our model predicts that they
would have to receive 32.0% each, leaving 12.0% for each one of the other players. But if these
two players were also dragging players with a correlation coefficient of 1, 2 0.3 , their share
of the payroll budget would decline to 28.88% while the others receive 14.08%. Alternatively, if
they were compensating at 1, 2 0.3 in addition to being more profitable, their share of the
budget would have increased to 35.87% while the other players receive 9.42% each. It should be
noted that the value of any player would increase more when s/he is better synchronized with the
most valuable players in the team.
Example 3. The Value of the Coach
If compensating pairs of players are valuable to the team owner because they stabilize the
rate of return of the entire team, and dragging pairs of players are not desirable, it would be
rational for the owner to hire a coach who would orchestrate the team such that most of the
interactions would be compensating, rather than dragging. For example, the highly successful
(and very well-paid) NBA coach Pat Riley bases his philosophy of success on the principle of
"success through unselfishment," according to which team-oriented behaviors are encouraged,

with each player being asked to put aside his or her unique interests and personal considerations
and work primarily towards the good of the team as a whole (Riley, 1993).
The performance of a coach can be measured in our model by the amount of return
earned at a given level of risk, for a given benchmark degree of synchronization. For example,
given the expected risk-return and correlations schedule of the team as seen in Table 3, and
assuming the owner is willing to tolerate 10.6% standard deviation, then s/he will earn an
expected rate of return of 10.6% with the existing coach. Let us assume that this coach is capable
of generating zero correlations among all pairs of players, and therefore is denoted a “neutral”
coach. The performance and compensation schedules of this team are illustrated in Table 3 and
Figure 9.
Now assume that a new coach is hired and the owner is still willing to accept 10.6%
standard deviation of return, but the new, “synchronizing” coach makes the expected correlations
mostly negative. The correlations, potential risk-return schedule of the team (the hyperbola), and
the proportional compensation for all players are given in Table 4 and Figure 10.
A few implications stem from the new data. The most important one is that the new
coach made it possible for the team owner to earn an 11.1% rate of return for the same level of
risk, 10.6%. The additional return of 11.1%-10.6%=0.5% is earned thanks to the coach’s
capabilities in synchronizing the players so that they can compensate for an occasional weak
performance of their colleagues. This return differential is the net contribution of the latter coach
over and above the achievements of the former coach, thus his/her salary should be higher by (at
most) the product of 0.5% times the payroll budget. Nevertheless, it should be noted that the risk
minimization role of the coach should not be taken as a stand-alone task: the coach must exert
great effort in improving the overall play level of all players in the team, in addition to his/her
synchronizing efforts. To see why this aspect of the coach's role also contributes to his/her value,
note that the difference between the two roles has different effects on the shape and location of
the hyperbola. Generally speaking, the synchronization role shifts the hyperbola to the left and
turns it wider, while the individual player-improvement role shifts the hyperbola upward, and
opens it wider if return differences across players increase. In both cases a successful coach
either earns more return for the team owner, or earns the same return at a lower risk. Since the
functional relationship between risk and return is well defined, the incremental value of the
coach can be easily assessed.
The right-hand side panel of Figure 10 reveals an outcome we did not encounter in earlier
examples; it shows that Player 5 should receive a negative proportion of the budget. We have
deliberately introduced this notion in order to discuss its implications. This result implies that
Player 5 is overpriced – his/her current price is too high given his/her expected return, standard
deviation, and correlation coefficients with his/her teammates. Recall that we defined E (d i ) the
net profit that a player generates. This net profit, in a single period model, includes the difference
between his/her current price and his/her future price in the athlete market. If Player 5 is paid p 0
today and sold for p1 at the end of the period, then, if p1 p 0 , and this difference is greater than
the additional revenues the player generates for the team (e.g., through the sales of collectible
items, fashion, gadgets, tickets, etc.) the owner must conclude that p 0 is too high. Either Player
5 will negotiate and be willing to receive a lower price, or s/he should not stay with the team. In
a multi-period model, the player must have demonstrated that s/he can perform better in any of
the relevant measures: earn more income, and/or earn this income at lower standard deviations,
and/or s/he plays in a more compensating way with the other players. As long as the information
set which includes p 0 implies a negative proportional compensation for a player, p 0 must
decline, and thus the result presented in the last example does not reflect a feasible solution.
3. Empirical Implications and Calculation Examples
Two main empirical implications stem from our model. First, that a player who is well
synchronized with other team members deserves a higher share of the available payroll budget.
Second, the model can be used to determine whether a player is fairly-, over- or under-paid,
given the expected rate of return s/he earns for the team, the correlation between his/her
performance and the team performance, and the preferences of the team owner. In this section
we elaborate on these two implications and demonstrate the derivation and the estimation
technique.
3.1. Calculating the optimal budget allocation
In order to calculate the optimal budget allocation across team players one need to obtain
the following data:
1. A vector of expected returns for all players. Recall that as seen in Section 1, returns are
calculated based on the expected marginal revenue product and price of each player,
E ( MRPi ) and pi , such that E (ri ) E ( MRPi ) pi / pi ; thus an estimate of E ( MRPi )
must precede this analysis, possibly through a modified Scully estimate such as in Hall et
al. (2002), Krautmann (1999), or Zimbalist (1992b).

2. A variance-covariance matrix of expected returns should be calculated. If one assumes
stationary return distributions, this matrix can be estimated based on a time series of past
returns.
Apparently, the simplest solution technique of the optimal proportions has been
developed by Feldman and Reisman (2003). Feldman and Reisman show that if S is the n n
variance-covariance matrix and E ( R ) is an n vector of expected returns, then the optimal non-
normalized vector of budget allocation Y is given by equation (6), Y S 1 ( E ( R ) C ) . We recall
1
that S is the inverse of matrix S and the constant C is the intercept of the linear line tangent to
both the hyperbola and the (invisible) indifference curve, as presented in Figure 2. Obviously,
since the indifference curves are not observable, the realization of returns can be taken as a proxy
for the owner’s revealed preference. We shall turn to estimate the intercept C next. Once the
vector Y has been solved for, the normalization xi yi / yi where xi 1 yields the vector
i i
of optimal proportional allocation.
Let us demonstrate this calculation with respect to example 1 in the text. Matrix S and its
1
inverse matrix S stem from the correlations matrix (since Cov(ri , r j ) i, j i j ), and the
vectors of standard deviations and expected returns are taken from the example. Table 5 shows
the data and resulting optimal proportions:
[Insert Table 5 about here]
We assumed in the example that the constant C is zero, thus the vector E ( R ) is similar to
the vector of expected returns (otherwise, we would have subtracted it from each expected
return). Multiplying S 1 E ( R) yields the non-normalized allocation vector Y, and, upon
normalization, we obtain the vector X.

3.2. Estimating fair player’s value
In order to estimate empirically the value of a specific player in a given team, an
extension of the model is required. The idea is to construct a sub-portfolio, made by combining
the return on player i with the return on the entire team at some proportional allocation. Then, the
marginal change of the expected return of the sub-portfolio is evaluated as a partial derivative
with respect to a marginal change in its risk. The resulting functional relationship is
E (ri ) C E ( RP ) C i (7)
Cov(ri , rP )
where i 2
. That is, the “fair” expected rate of return of player i positively depends
P
on C, E ( RP ) and i with the following interpretations:
1. The expected return must exceed the intercept C since E ( RP ) C normally holds; the
intercept C represents the required rate of return when the owner bears no risk at all.
2. The value of i is determined by the covariability of the rate of return on player i and the
rate of return of the team. One may express the covariance in terms of the correlation
coefficient to deduce that a player with a high correlation coefficient with the team
(dragging player) is required to earn a higher return (i.e., paid less today), and vice-versa.
3. The effect of a marginal change in i on the rate of return E (ri ) is the slope of (7),
E ( RP ) C .
The positive slope of the required rate of return vs. i yields probably the most important
implication of the model: the higher i is, the higher the required rate of return from player
i, E (ri ) . This result implies that a player that is playing well when the team plays well, or badly
when the team plays badly (i.e., high, positive covariance), should yield a high rate of return,
since s/he is not a compensating player but a dragging one. Recall that the rate of return is given
by E (ri ) ( E ( MRPi ) pi ) / pi , which implies that for a given E ( MRPi ) a dragging player should
be paid less than a compensating player. Put differently, for a given pay, a dragging player
should generate higher E ( MRPi ) than a compensating player.
The empirical estimation of (7) can be conducted in a two-step procedure known in
financial economics as the Fama and MacBeth (1973) procedure: first, regress a time series of
player’s (actual) returns rit on the overall team return, rPt , rit i r
i Pt it , where we
hypothesize: E ( ˆi ) 0 , and E ( ˆit ) 0 . Second, regress a cross-section of the resulting i ’s on
average returns: ri i i , where ri is the time series average of the returns of player i.
Hence, we would expect the regression intercept E ( ) to be equal to C and its slope to
E ( ) (rP C ) . Normally, we would expect the observations to scatter about the upward
sloping pay-performance line, as presented in Figure 11.
In this figure a team of five players is plotted, from which a few insights stem regarding
over payment, under-payment, and fair payment. In equilibrium, a player’s rate of return should
plot on the upward sloping pay-performance line, representing fair pay for the MRP s/he yields,
when this return is justified for his/her co-variability with the aggregate team performance.
Player 1 in this example is paid fairly. Yet Players 2 and 3, who plot above the line (assuming
high statistical significance), are paid unfairly lower than their co-variability and MRP would
justify. The reason why plotting above the pay-performance line implies under-payment stems
from the way the return is calculated: E (ri ) ( E ( MRPi ) pi ) / pi . For any benchmark point of
fair compensation that lies on the pay-performance line, a reduction in pi increases E (ri ) , which
means that the point increases vertically above the line. Correspondingly, over-payment implies
that the point that represents the player lies under the pay-performance line, such as Players 4
and 5 in this example. Note that deviations from the line can result from indivisibility issues,
which are more severe in teams with a small number of players than in stock portfolios, yet they
are ignored in this analysis. To summarize this subject, we indicate that the weighted average of
all players’ Betas in the team (weighted by their proportional budget allocation, xi ) yields a unit
Beta for the team, and it always plots against the overall rate of return of the team. Hence, if we
know C and the overall expected return of the team, we can plot the pay-performance line.
Lastly, a relevant implication from (7) is a direct calculation of player i's pay (portion of
the budget), pi . By replacing E (ri ) ( E ( MRPi ) pi ) / pi in the covariance term in i and on the
left hand side of (7), and reorganizing the equation, we obtain
E ( RP ) C Cov( MRPi , RP )
E ( MRPi )
P P
pi . (8)
1 C
If, for example, player i is expected to generate a MRP of $100,000, and the other
variables are valued as indicated in the following equation, the pay for player i will be
0.16 0.07 5,250

$100,000
0.14 0.14
pi $70,928 .
1.07
Discussion
This paper presents a formal model for an equilibrium valuation of professional players
in a competitive market, based on the core theory of portfolio selection in financial economics as
pioneered by Sharpe (1964), Lintner (1965), and Mossin (1966). Our key point is that payments
made for professional players and coaches represent a financial investment by the team owner,
for which the rate of return is uncertain. The major valuation properties of a sport player,
according to this model, are the player’s potential to earn direct and indirect returns for the team,
the uncertainty (standard deviation) of these returns, and the degree of synchronization of the
specific player with his/her teammates (measured by the covariance of all paired performances).
As stated previously, the model provides a number of predictions concerning athlete and
coach compensation schedules. We summarize these predictions in Table 6.
The predictions presented in the Table can be summarized as follows: The value (budget
allocation at present) of player i is positively related to the player’s expected contribution to the
teams' profits (cell 1). The expected rate of return from player i has no effect on the
compensation offered to the coach (cell 2), as the budget is assumed exogenous. The value of
player i is negatively related to the variance (uncertainty) of the player’s expected contribution to
the team's profits (cell 3), and is unrelated to the coach’s compensation (cell 4). The value of
player i is negatively related to the correlation between his/her performance and the performance
of other players in the team (cell 5).
The value of the coach declines when the correlation coefficient of the performance
among pairs of players in a team increases (cell 6). Such a team will perform well at times, but
weak at other times, making the overall return to the owner more volatile (risky). To put it
another way, a coach that better synchronizes the team should be paid more. The value of all
team players (cell 7) and the coach (cell 8) in a specific sector (geographical region, league, sport
field, etc.) should increase with the total wealth (budget) available for the sector (assuming that it
operates in a distinct, competitive environment).

Two additional implications of the model, not present in Table 6, should be mentioned.
First, the question of whether a team made of many star players, playing in an unsynchronized
way with each other, is preferable over a synchronized team with fewer or no star players at all.
Our model provides a framework to empirically assess these alternatives. Generally, the effect of
better synchronization among team players contributes to the overall risk-return alternatives
available for the owner, through the reduction of risk. Alternatively, the incorporation of
unsynchronized star players in a team increases the expected return, thanks to the stars’
performance, but the risk imposed on overall team performance counterweighs the benefits. The
specific “optimal” combination depends on the risk-return preferences of the owner, the
magnitude of excess return star players provide, and the degree of team synchronization.
Generally, it appears reasonable to hire a few star players in a team of regular players, and
devote resources (a good coach) to synchronize the stars with the team, rather than to invest
heavily in an unsynchronized team of many stars.
Second, all other elements being equal, successful players will minimize migration in
order to avoid synchronization risk, but if their current synchronization is not optimal, players
will strive to migrate to teams where they can best synchronize with the rest of the team. Such a
move will increase their pay in two ways: first, their higher synchronization will increase their
proportional budget allocation, and second, their better performance may increase their MRP by
attracting more fans, the sale of branded goods, etc.
Needless to say, in order to empirically examine these predictions, appropriate
performance measures are required. In the organizational behavior literature, performance is
defined as “a summary measure of the quantity and quality of task contributions made by an
individual or group to the work unit and organization” (Wood et al., 2004, p. 117), with
performance evaluation (appraisal) being a central issue in management (Robbins, 2005),
including sport management (Byers, 2004). When appropriately used, adequate performance
evaluation measures should be applied in order to empirically test the abovementioned
predictions. Specifically, our model requires as inputs the MRPs of all players, as well as their
total pay per period, which together serve to estimate their rate of return. This estimation can be
made by applying modified Scully measures, such as Krautmann (1999), Zimbalist (1992b) or
Hall et al. (2002). Using a time series of rates of return to calculate the covariances of all players’
pair-wise returns and their standard deviations, we elaborate in Section 3 how to estimate the
value of an individual player in a specific team.
From a more general perspective, our model can be used to convey some important
insights for decision makers in sports finance. It is well known that managerial decisions are
often biased, and therefore sometimes irrational (Bazerman, 2003). The problem of making
optimal managerial decisions has concerned researchers in organizational behavior for many
years (for review, see Buchanan & Huczynski, 2004), with the area of sport management being
no exception (Chelladurai, 2001; Slack, 1997). Thus, our model can be applied in reducing the
probability of making “foolish financial decisions” (DeSchriver & Mahoney, 2003, p. 250) and
some of their possible fatal consequences (Gerrard, 2004).

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Table 1
Expected Returns, Standard Deviations, and Correlations of a Team of Neutral Homogeneous
Players (the Benchmark Team)
Expectations Correlations
E(r) 1 2 3 4 5
Player 1 10.0% 20.0% 1 100.0% 0.0% 0.0% 0.0% 0.0%
Player 2 10.0% 20.0% 2 0.0% 100.0% 0.0% 0.0% 0.0%
Player 3 10.0% 20.0% 3 0.0% 0.0% 100.0% 0.0% 0.0%
Player 4 10.0% 20.0% 4 0.0% 0.0% 0.0% 100.0% 0.0%
Player 5 10.0% 20.0% 5 0.0% 0.0% 0.0% 0.0% 100.0%
Table 2
The Benchmark Team, with One Pair of Compensating Players
E(r) 1 2 3 4 5
Player 1 10.0% 20.0% 1 100.0% -30.0% 0.0% 0.0% 0.0%
Player 2 10.0% 20.0% 2 -30.0% 100.0% 0.0% 0.0% 0.0%
Player 3 10.0% 20.0% 3 0.0% 0.0% 100.0% 0.0% 0.0%
Player 4 10.0% 20.0% 4 0.0% 0.0% 0.0% 100.0% 0.0%
Player 5 10.0% 20.0% 5 0.0% 0.0% 0.0% 0.0% 100.0%
Table 3
A Team of Heterogeneous Players with a “Neutral” Coach: Zero Pair-wise Correlations
E(r) 1 2 3 4 5
Player 1 12.0% 24.0% 1 100.0% 0.0% 0.0% 0.0% 0.0%

Player 2 11.0% 22.0% 2 0.0% 100.0% 0.0% 0.0% 0.0%
Player 3 10.0% 20.0% 3 0.0% 0.0% 100.0% 0.0% 0.0%
Player 4 9.0% 18.0% 4 0.0% 0.0% 0.0% 100.0% 0.0%
Player 5 8.0% 16.0% 5 0.0% 0.0% 0.0% 0.0% 100.0%
Table 4
A Team of Heterogeneous Players with a “Good” Coach: Mostly Negative Pair-wise
Correlations
E(r) 1 2 3 4 5
Player 1 12.0% 24.0% 1 100.0% -10.0% -20.0% -20.0% -30.0%
Player 2 11.0% 22.0% 2 -10.0% 100.0% -10.0% -10.0% -10.0%
Player 3 10.0% 20.0% 3 -20.0% -10.0% 100.0% -30.0% 0.0%
Player 4 9.0% 18.0% 4 -20.0% -10.0% -30.0% 100.0% -20.0%
Player 5 8.0% 16.0% 5 -30.0% -10.0% 0.0% -20.0% 100.0%
Table 5
Calculation of Optimal Budget Allocation
Expectations Variances and Covariances

E(r) 1 2 3 4 5
Player 1 11.0% 20.0% 1 4.00% 0.00% 0.00% 0.00% 0.00%
Player 2 10.0% 20.0% 2 0.00% 4.00% 0.00% 0.00% 0.00%
Player 3 10.0% 20.0% 3 0.00% 0.00% 4.00% 0.00% 0.00%
Player 4 10.0% 20.0% 4 0.00% 0.00% 0.00% 4.00% 0.00%
Player 5 10.0% 20.0% 5 0.00% 0.00% 0.00% 0.00% 4.00%
1
Inverse matrix S
1 2 3 4 5 Non-normalized (Y) and

normalized (X) allocations
1 25 0 0 0 0
Y X
2 0 25 0 0 0 2.75 21.57%
3 0 0 25 0 0 2.50 19.61%
2.50 19.61%
4 0 0 0 25 0 2.50 19.61%
5 0 0 0 0 25 2.50 19.61%
Table 6
Summary Results and Predictions of the Model
Valuation
Effects
Value of Player i Value of the Coach
Model Parameters
Expected return from player i, (1) (2)
E (ri ) (+) (0)
Riskiness of the return from (3) (4)
player i, 2 (-) (0)

i
Correlation of performance (5) (6)
between players i and j,

(-) (-)
i, j
Budget available for the team (7) (8)
players and coach (+) (+)

Figure Captions
Figure 1: Risk-return combinations for alternative budget allocations
Figure 2: Specific allocation for a given team owner
Figure 3: Budget allocation among identical players (no “star players”)
Figure 4: Budget allocation when one star player earns higher expected return
Figure 5: Team where one star player earns higher expected return and owner desires higher
return
Figure 6: Budget allocation when two star players earn higher expected return
Figure 7: Team with two “compensating” star players (identical expected returns)
Figure 8: Team with two “dragging” star players (identical expected returns)
Figure 9: Budget allocation with heterogeneous players and a “neutral” coach
Figure 10: Budget allocation with heterogeneous players and a “synchronizing” coach
Figure 11: Pay-performance line: Player return versus player Beta

E(R)
Expected Return
A B
B
Standard Deviation of Rate of Return
P
Figure 1: Risk-return combinations for alternative budget allocations

I (Max)
Increasing utility Tangency line

E (R )
Expected Return
Standard Deviation of Rate of Return

P
Figure 2: Specific allocation for a given team owner

Combinations of Optimal Allocations Optimal Weights of Budget for Each

Player
16%
40%
14%
12%
30%
Expected Return
10%
Weights
8%
20%
6%
4% 10%
2%
0% 0%
0% 5% 10% 15% 20% 25% 1 2 3 4 5
Standard Deviation Player Number
Figure 3: Budget allocation among identical players (no “star players”)


14%
Player
40%
13%
12%
Expected Return
30%
21.57%
Weights
11% 11.0% 19.61% 19.61% 19.61% 19.61%
20%
10% 10.0%
10%
9%
8% 0%
0% 5% 10% 15% 20% 25% 30% 1 2 3 4 5
Standard Deviation (s) Player Number
Figure 4: Budget allocation when one star player earns higher expected return

14%
40.00% Player
40%
13%
12%
Expected Return
30%
Weights
11% 11.0%
20%
15.00% 15.00% 15.00% 15.00%
10% 10.0%
10%
9%
8% 0%
0% 5% 10% 15% 20% 25% 30% 1 2 3 4 5
Figure 5: Team where one star player earns higher expected return and owner desires higher
return

14%
Player
40%
13%
32.00% 32.00%
12%
Expected Return
30%
Weights
11% 11.0%
20%
10% 10.0% 12.00% 12.00% 12.00%
10%
9%
8% 0%
0% 5% 10% 15% 20% 25% 30% 1 2 3 4 5
Figure 6: Budget allocation when two star players earn higher expected return.

14%
Player
40%
13%
12%
Expected Return
30%
24.39% 24.39%
Weights
11%
20% 17.07% 17.07% 17.07%
10% 10.0%
10%
9%
8% 0%
0% 5% 10% 15% 20% 25% 30% 1 2 3 4 5
Figure 7: Team with two “compensating” star players (identical expected returns).

14%
Player
40%
13%
12%
Expected Return
30%
22.03% 22.03% 22.03%
Weights
11%
20% 16.95% 16.95%
10% 10.0%
10%
9%
8% 0%
0% 5% 10% 15% 20% 25% 30% 1 2 3 4 5
Figure 8: Team with two “dragging” star players (identical expected returns).

14%
Player
13%
40%
12% 12.0%
11% 11.0% 28.77%
26.46%
Expected Return
10% 10.0% 22.60%
9% 9.0% 16.28%
Weights
8% 8.0% 15%
7%
5.89%
6%
5%
1 2 3 4 5
4%
0% 5% 10% 15% 20% 25% 30% -10%
Figure 9: Budget allocation with heterogeneous players and a “neutral” coach.


14%
Player
37.55%
13% 40%
29.43%
12% 12.0% 27.15%
Expected Return
11% 11.0% 14.74%

15%
10% 10.0%
Weights
9% 9.0%
1 2 3 4 5
8% 8.0% -10% -8.87%
7%
6%
0% 5% 10% 15% 20% 25% 30%
-35%
Figure 10: Budget allocation with heterogeneous players and a “synchronizing” coach.
E (R )
Predicted (equilibrium) player
Player 3 return vs. player Beta
3
Return
Team 2 5
Return
1 4
C
Beta=1.0 Player 3 Beta

Beta
Figure 11: Pay-performance line: Player return vs. player Beta.
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The Valuation of Athletes as Risky Investments: A Theoretical Model

Article in Journal of Sport Management · December 2007

Haim Kedar-Levy Michael Bar-Eli

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Running head: THE VALUATION OF ATHLETES AS RISKY INVESTMENTS

The Valuation of Athletes as Risky Investments: A Theoretical Model

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owner is earned at the lowest possible risk.

The Valuation of Athletes as Risky Investments: A Theoretical Model

period salary is a function of current period salary and performance.

“reasonable” appears to be relevant.

assess the role and value of the coach.

1. The Formal Model

transaction costs. Player i is expected to generate a team-specific Marginal Revenue Product

personalities, style, and the like.

represents a pool of risky investments, is the linear function

E (rP ) x1 E (r1 ) x2 E (r2 ) ... xn E (rn )

calculated by multiplying each covariance between i and j by xi and x j , respectively, the

variance of a portfolio of n assets can be written in matrix notation as

Applying the Lagrange technique, we define the Lagrangean

obtain the optimal allocation vector, being

Once the vector Y is normalized by calculating xi yi / yi , we obtain the optimal proportional

solution which guarantees xi 1 . An example of the actual calculation is given in Section 3.

Another important result, which we develop in Section 3, provides a formal linkage

measurable implication of the model.

covariances with all other team players.

procedure of an optimal allocation is presented in Section 3 with respect to example 2, which we

discuss in the next section.

[insert Figure 1 about here]

upward sloping segment of the hyperbola.

expected-return – standard-deviation, as illustrated in Figure 2. Such investors are referred to as

[insert Figure 2 about here]

of the entire team for a given expected return.

by player j through the correlation coefficient i, j . If the correlation coefficient i, j is zero,

likely to under-perform as well. In summary, there is a negative correlation coefficient between

specific players' effect turning specific numerical values of correlations non-informative.

four numerical examples in a five-players/positions team.

The Benchmark: A Team of Homogenous Players

[insert Table 1 about here]

[insert Figure 3 about here]

compensation schedules when above-average players join the team.

Example 1. Star Players

[insert Figure 4 about here]

In order to demonstrate the sensitivity of the compensation scheme to different risk-return

[insert Figure 5 about here]

percentage point 11%-10%), representing severe scarcity.

similar to those of the last example.

[insert Figure 6 about here]

and for the team owners.

Rummernigge, who were even nicknamed "the 'Breitnigge'-Duo" (Schulze-Marmeling, 1997).

Example 2. Compensating, Neutral, and Dragging Players

the performance of player j. If i, j is positive, good performance of i will be statistically

detail in Bar-Eli and Schack (2005).

[insert Table 2 about here]

[insert Figure 7 about here]

Alternatively, if players 1 and 2 were dragging with a correlation coefficient of

[insert Figure 8 about here]

most valuable players in the team.