Risk Aversion

Risk Aversion in Baseball?

People are risk averse. For example, we buy insurance plans so we’re not stressed too much about paying for car accidents or breaking a laptop. It’s a pretty big human characteristic; people like decreasing risks even though the probability of bad events occurring is relatively low. The high costs of paying for medical bills or paying for fire damage on a house is just too much for people to fathom, and thus that’s essentially how insurance companies make their money off us.

In baseball you see the exact opposite behavior from General Managers (GM’s). Instead of a consumer’s tendency to pay for insurance coverage, managers generously give to players in return for something never guaranteed: production on the field. I’ve listed and summarized below three main components of risk in the development, and signing of baseball players.

Signing free agents.

All teams need to sign free agents every off season to keep competitive, yet there are always contract agreements that baffle the typical fan. In many ways, you can’t fault the team for giving a player too much money; it’s the bidding war market and the suave talk of agents that inflate a player’s worth to a team. Many players find an incentive to increase their productivity in seasons heading into free agency, attempting to legitimize a hefty raise. This leads to an over-dramatization by ┬ásports agents to paint a picture of exponential increases in production in all stat categories. What teams fail to see is that not even last year’s production numbers are insured. Barry Zito was given the insurance of making on average $18 million for the next 8 years, while the true ace of the Giants, Tim Lincecum, is making $650,000 this year. Obviously, Lincecum will get his payday in due time, but in pure production numbers, it’s evident Zito is not even worth half his salary. Last year, Zito won his first game two months into the season.

Addition of prospects to a ballclub.

Prospects signing through the MLB draft are often given huge bonuses (especially those drafted in the first round) despite never playing a single professional game. Sound familiar to the likes of free agents? Once again managers are willing to take risks on high school, college players who might not even get a chance to play in the majors for at least another year. ┬áMore interesting, is when managers are willing to trade their elite players for a batch of young prospects. It’s essentially trading in your money for a bond that will become liquid in four or five years. Except that it might or might not be there in most cases. Prospects are always desirable. Except that they have never proven themselves in the highest levels.

Baseball players are injury prone.

You never know what will happen. A lot of players have made fortunes while going through injuries for years. These players are paid millions while frustrating both management and themselves for chronic back spasms or elbow surgeries. Carl Pavano signed a 4 year $40 million contract with the Yankees while in return, gave them back 21 starts, less than two-thirds of a season.

All in all, it’s obvious managers must take these risks in order to keep their business running. Fans love to see their newest acquisition. Big names bring out the richest of fans, go to lavish yankee stadium and see their $200 million payroll play against the likes of $50 million Cleveland ballclub. In fact, it could be argued that these risks show how players are risk averse. They won’t play a game until they are guaranteed a salary they deem as the market price for their services.

What would it look like if businesses ran by the likes of baseball teams? Every worker would be given guaranteed money while never having to worry about getting the next expense report out, or the next project.