The Economics of Free Agency: Is it Economically Sound?

Many fans are hoping for big free agent signings this offseason–like Yasmani Grandal and Manny Machado–but is that the best team-building strategy? Photo by Richard Mackson/USA TODAY Sports

With the World Series now behind us, the baseball world officially turns to the offseason. After the Pirates finished the season above .500 for the first time since 2015, many fans are anxiously awaiting offseason moves—signings and trades that will push the team over the cusp of fringe competitor to true contender.

However, some fans are once bitten-twice shy after what many consider a disastrous prior offseason. The merits of those claims are debatable, but the sentiment persists nonetheless.

The negative attitudes mainly started after the Pirates traded two of their best players—Gerrit Cole and Andrew McCutchen—then continued through the rest of the offseason, as the narrative all winter long was that the Pirates were the only team that didn’t sign a major league free agent.  This trope persisted some throughout the season as well. This inactivity even spurred an extraneous grievance from the MLBPA against the Pirates and three other teams (including two of the best in the league in 2018), alleging misappropriation of revenue sharing funds. However, consider the actions of the some of the other 26 teams in free agency:

• Several teams only signed two players—the Astros, White Sox, Yankees, Dodgers, and Rays. Or one—the Indians and Marlins.
• The Braves—until mere days before the season started—had only signed two players to non-guaranteed major league deals, which for whatever reason pundits were counting as signing major league free agents.
• Three teams committed less than $5 million in total salary to major league free agents, including the World Series finalist Dodgers ($4 million), who also trimmed roughly $54 million in payroll season-over-season in an effort to get under the tax for 2018.

Now, consider the myriad of other failed free agent experiments that litter the league every offseason.

Just ask the Phillies, Mets, Orioles, or Rockies bullpen how free agency ended up working for them this past season; or the Padres and White Sox in 2015; or the Marlins in 2012; or the Angels about Albert Pujols, Josh Hamilton, and C.J. Wilson. Is there some selection bias there? Of course, it’s my article; however, there are probably ten examples of negative free agent experiences for every Brewers example I’m bound to hear—who did it mainly through trades, by the way.

Why do I bring all this up? Well, some may think I’m trying to defend the Pirates, but I’m not. I’m merely explaining that free agency isn’t some foolproof plan, and that other teams treated free agency similarly to what the Pirates did this past offseason—with hesitation.

Obviously, this is all behind us, and we have a new offseason to look forward to, with hopes that the Pirates will finally become players in the free agent market, supplementing a strong, young core to help get the team over the top and back to the playoffs. Well, sorry, but I’d like to rain on the fan’s parade for a while.

In my opinion, the Pirates were right to sit out free agency last offseason—and would be wise to proceed with caution yet again this winter—because free agency is an extremely poor way to build a team. In general, I am a proponent of the small-market strategy; burn it all down only to slowly build it back up with prudent moves and not haphazard ones—which free agency is more often than not. This statement has nothing to do with a defense of the Pirates, Bob Nutting, Neal Huntington, or anyone else; rather, it’s a defense of economics.

Why do I feel this way? I feel any worthwhile opinion needs backed up with facts, theory, and data, so here it is. If you break down free agency to cold hard economics—and what is free agency if not a market?—you’ll see that it is bad business, inefficient, and just not the best way to build your favorite team.

Efficient Market Hypothesis

In the investing world, some subscribe to what is known as the Efficient Market Hypothesis, which basically claims that it is very hard for an investor—if not impossible—to beat the market, as the market is so efficient and information so available that stock prices are exactly as they should be, so there are no real deals to be had.

Well, in my opinion, the MLB Free Agent Market is anything but efficient, making it easier to beat, but obviously still worthy of treating with caution. So, what kind of problems present themselves when a market isn’t as efficient as a buyer may like?

The Lemons Problem

A market where buyers and sellers are on unequal ground regarding available information is sometimes referred to as “A Market of Lemons,” coined after a paper by economist George Akerlof from 1970. The theory basically states that the seller always has the upper hand, as they know the exact condition of the asset they are selling, and the buyer is left to hope that the seller isn’t pushing them a “lemon,” as Akerlof used the market of used-cars as the example in his paper. So, what does this have to do with MLB Free Agency?

In this scenario, the player/former team is the seller and new teams are the buyers. Free agency is inefficient—or a Market of Lemons—because these parties are not operating equally with available information.

Consider any job interview environment—the job seeker almost always puts on their best face, wears their nicest outfit, and says all the right things, but it all changes after they start the job. It’s not any different in baseball. After often producing like he never has before in his final season before free agency, a player will visit perspective teams and put on the best he’s got, but what happens after he signs? Does he actually want to be there? Did he just sign for the money? Will he not work as hard now that he’s signed? Will he fit the team well? These are all factors teams can’t foresee and have to hope for the best after signing a big-ticket free agent, and more often than not it seems to backfire.

Also, consider this—if the player if so worthwhile, why is he available in the first place? The player’s old team has information the new team doesn’t. Sure, prospective teams can conduct interviews and physicals, but a complete picture of the player will never be available until it’s often too late.

Despite all this, a team dives in and feels they’ve found a perfect fit, but what happens when it turns out they’ve made the wrong choice?

Winner’s Curse

Eventually, most big money and mid-tier free agents will sign, which means the signing team beat out other competitors for the rights to the player’s services, typically because they offered the most money. This will often result in what’s known as Winner’s Curse.  As has been discussed, teams don’t have all the necessary information they need to make correct valuations, so they often end up paying more than what the asset is truly worth, as they have no way of knowing what it’s true value actually is.

If a buyer pays more than what something is worth, or feels they didn’t get what they paid for, this can result in buyer’s remorse. As was seen this past offseason, it’s clear that some teams have become cautious regarding free agency and don’t want to experience these feelings of remorse, so they pivot and try other avenues.

Could alternatives to free agency result in the same kind of trouble though?

Endowment Effect & Loss Aversion

If a team doesn’t want to make a foray into Free Agency, one of the only other options can be to stick with what they have—through building up their own system or resigning pending free agents—but history shows this isn’t always the best, most logical strategy either.

I’ve touched on these principles in the past, and while they speak well to how it may be a bad team building strategy to hold on too long to and/or build around too many prospects who may never actually live up to their potential, how to handle long-time members of an organization approaching free agency fit the category as well. A perfect example lies with the Pirates and Andrew McCutchen.

Fans saw a former MVP, franchise player, and an all-time Pirate on and off the field and couldn’t cope with the fact that McCutchen was no longer worth the price he was being paid on the field or what they expected he would be worth on the trade market. This emotional attachment is what’s known as the Endowment Effect—the idea that the owner of an asset is more emotionally tied to that asset simply because they own it and don’t want to consider any potential replacements because the replacement isn’t “theirs.” This theory is tied to and can lead to what’s known as Loss Aversion, which concludes that owners are so afraid of losing value that they will make decisions based on avoiding that loss, even in the face of equal—or greater—gain.

Kyle Crick ended up being a good return for McCutchen—not to mention the possibilities of Bryan Reynolds and Ji-Hwan Bae (signed with international space acquired in the deal, but his future is even more cloudy now than a regular prospect’s would be) down the road—and will hopefully serve as a main cog in the bullpen for many seasons to come. If fans had their way, McCutchen would have received a lifetime contract and a blank check, which looking back now is a laughable notion—as it was then if we’re being honest. Similar situations have played out poorly for other teams—Miguel Cabrera, Alex Gordon, and Joe Mauer come to mind immediately—and I believe the Pirates made the right choice. Any decision must be made with the best interests of the team in mind, not the emotional stance that often accompanies many transactions.

In my opinion, it is a positive attribute of the Pirates’—or any—front office that they are able to avoid these emotional motivators and view it as simply what’s best for the team’s present and future. It’s why I was slightly dismayed by the Chris Archer trade, but that’s a story for another day.

So, if free agency isn’t the most economical, and remaining static can be wrong too, what’s the best way to build a team?

Substitution Effect

When prices rise, smart consumers will often look for cheaper alternatives; this is where the Substitution Effect comes in. The key to being successful in using this tactic is to find substitutes that produce near, at, or above the production of the player that is being substituted for at a fraction of the price.

Whether it’s a prudent trade (Corey Dickerson, J.A. Happ, or a long line of closers), waiver claim (Richard Rodriguez, Travis Ishikawa, A.J. Schugel), reasonable free agent signing (Francisco Liriano the first time around, Edinson Volquez, Jung Ho Kang), or using home grown talent to fill holes (too many examples to list), there are much more judicious ways to build a team than just spend a bunch of money.

*****

If logical decision making in a perfect market existed, there would be no such thing as Behavioral Economics.

In my opinion, there’s a logical, reasonable way to approach team building. Sure, simply saying “make smart moves” is easier said than done, but with all the evidence, it’s hard to argue that splurging in free agency is the best, most efficient answer.