The Reserve Clause

A few weeks back, Milwaukee Brewers first baseman Prince Fielder expressed his unhappiness with his current contract. Fielder, who followed up an impressive rookie campaign in 2006 by leading the NL with 50 home runs in 2007, is one of the sport’s best young power hitters. But he renewed his deal for only $670,000 US, relatively little for a player of his calibre. Fielder is understandably frustrated with his contract situation. Should he be?

Here’s a primer for Fielder and others who are ill-informed about the structure of MLB’s labour market. All players with fewer than six years of experience are subject to what is called a “reserve clause”. The rights to these players are retained by the team to which he was drafted and originally signed. However, once a player completes three full years of major league experience, he is eligible for salary arbitration, giving the player some leverage in salary negotiations. Note that 17% of players become arbitration eligible after just two years of service; they are known as “Super Twos”. After six years of experience, a player is no longer constrained by the reserve clause and becomes a free agent. He can then make his services available to the highest bidder.

There is a small but significant economic literature on this topic. The findings of these studies are unsurprising. Briefly:

· The reserve clause creates significant monopsony power, especially for players who are ineligible for arbitration

· Once players achieve arbitration eligibility, their salaries continue to be suppressed below competitive market levels, but rapidly approach free agent salaries as experience increases. For example, see Ryan Howard’s latest contract.

· Free agents enjoy considerable market power and can command salaries in excess of their marginal revenue products (winner’s curse?)

So I say to Fielder, there is no reason to be unhappy with your contract. His current contract seems to be about right according to MLB’s collective bargaining agreement. In fact, he is probably earning about as much as anyone would in his circumstances. And with just one more year until arbitration, he can expect to be earning a lot of money very soon.

This is probably a good place to comment on the NHL’s CBA. This functions very much like MLB’s agreement, except that arbitration eligibles (often called restricted free agents) can be poached by other teams through the use of offer sheets, e.g. the Dustin Penner signing. A restricted free agent’s current organization can either match the offer or accept draft picks as compensation for losing a player. As a result, teams have less control over their young players than they did before. To correct for this, a club may want to sign its young players to long contracts earlier in their careers. The riskiness of such deals is offset by the risk of losing the player to an offer sheet. And in fact, this is exactly what we see happening in the NHL. Alexander Ovechkin, Rick Dipietro, Mike Richards, and many others have signed long term contracts that would have seemed absurd in previous years. But this is simply the natural consequence of the new market structure.

Combined with a reasonable salary cap, this is actually a fairly sensible way to ensure that players receive compensation in line with their true value while maintaining a high degree of competitiveness. That’s not to say there won’t be growing pains as teams and agents adjust to the new rules. And of course not everybody wins. The beneficiaries of this system are the game’s most talented players; they reach their peak earning years faster than before. And the salary cap ensures that the richest clubs will not be able to abuse their position by indiscriminately stripping the rosters of small market clubs. Thus, we should see increased parity across the league. The losers in this agreement are aging veterans. In the past a team could overspend on a past-his-prime free agent. But teams must now contend with a salary cap while paying more to their young players. They can no longer afford to over-compensate veterans. And in this fan’s eyes that’s not much of a problem.