The Effects of Player Talent, Team Cohesion
and Salary Differences on Team Success:
Evidence from the
National Basketball Association
By Jeroen Leidelmeijer Student Number: 1177079
Thesis Supervisor: Prof. Dr. H. van Ees Second Reader: Prof. Dr. R. H. Koning International Economics & Business Faculty of Economics
Abstract ...4
CHAPTER 1...5
Introduction ...5
The beginning of a sport ...5
Labor difficulties ...6
The Soft Salary Cap of the NBA ...9
Research questions...9
CHAPTER 2...11
Literature Review... 11
Team cohesion: A psychological approach ... 12
Productivity and performance in the NBA... 15
Pay inequality and team cohesion ... 17
Developing the hypotheses... 18
CHAPTER 3...20
Regulations in the NBA... 20
The salary cap ... 20
The Collective Bargaining Agreement (CBA) ... 21
The escrow system... 22
The luxury tax... 23
Allocation of the tax money ... 24
The players' salary restrictions... 25
Salaries for first round draft picks. ... 27
Exceptions to the salary cap ... 28
Larry Bird Exception... 28
Early Bird Exception... 28
Non-Bird Exception ... 29
Mid-Level Exception... 29
$1 Million Exception... 30
Rookie Exception ... 30
Minimum Player Salary Exception... 30
Traded Player Exception... 31
Disabled Player Exception ... 31
Qualifying Offer... 31
Other Salary Cap Loopholes... 32
Restricted free agency ... 32
Base Year Compensation... 34
Exceptions and the salary cap... 35
Salary Cap room and the signing of free agents ... 35
Losing the exceptions ... 35
CHAPTER 4...37
Methodology ... 37
Definitions ... 37
The Gini Coefficient explained... 37
Labor Productivity ... 38 Team cohesion... 39 Individual Performance ... 39 Team Succes ... 40 Data Description ... 40 Sample ... 40 Individual performance ... 40
The ‘Allan Houston Rule’ ... 43
Balancing personal statistics for comparison... 43
Team Cohesion ... 47
(In)equality in the NBA ... 47
League Inequality and Media Coverage ... 47
Pay Inequality ... 48
Gini Coefficient of salaries ... 48
Method Analysis ... 50
CHAPTER 5...52
Data Analysis ... 52
Correlation Coefficients ... 52
Individual pay and team performance ... 52
Team cohesion and team performance ... 53
Individual pay difference and team cohesion... 53
Individual pay difference and team performance ... 54
Regression Analysis ... 55
CHAPTER 6...57
Discussion, Conclusions and Limitations ... 57
REFERENCES...59
Literature References ... 59
Internet References ... 61
APPENDICES ...63
Appendix A: Scale Salary Amounts for First Round Draft Picks ... 63
Appendix B: Summary of all Salary Cap Exceptions... 67
Abstract
The purpose of this study is to investigate the impact of team talent, team cohesion and pay differences on team success based on the data of the 2005-2006 NBA season. The literature suggests a positive relationship between team talent, team cohesion and team success and a possible positive or negative
relationship between pay differences and team success. A statistical significant relationship was found between team success and total team salary, average salary and the Gini of salaries. The relationship with total team salaries was negative, which was not expected and the relationship with average salary and pay differences were both positive. This means that a higher Gini, higher pay differences within a team, is the more successful strategy for achieving team success. Significant results for the relationship between team
Chapter 1
Introduction
The beginning of a sport
Looking at the state of professional basketball today, it is hard to imagine its beginnings. In 1891 a Canadian teacher called James Naismith decided to experiment with a couple of peach baskets and a ball. Though the sport of basketball was born, at that moment, it is doubtful someone would even identify this initial form as basketball at all. Even the playing court was different than the one on which the public saw stars such as Michael Jordan and the Magic Johnson maneuvering up and down. In its beginning, basketball was actually played within the confines of a steel cage. Furthermore the ball was never out of bounds. Players would simply bounce the ball off the sides of the cage. In fact strategic use of these walls was in many ways part of the game. What's more, the game originally had a nine man format. But in 1897 was set at five.
In 1898, just two years after the first documented professional game, the first professional league was created: the National League. This league was quite different from what we see in the NBA today. Players were not on multi-million dollar contracts for a specified number of years. In fact, players were paid on a game-by-game basis and could switch teams if they wanted. Numerous other leagues followed this first league. From the Philadelphia league to the Central league, professional basketball was trying to find itself a secure home.
away from the original cage version. However, problems with localized leagues drawing away talent, persistent financial concerns and the Great Depression led to the demise of the ABL.
From 1946 to 1949 the top players managed to use the leverage of two rival leagues, the Basketball Association of America (BAA) and the National Basketball League (NBL), to carve out a fair existence for themselves. The two leagues, which had been bitter rivals, merged in 1949 to form the National Basketball Association (NBA), which we still know today, leaving the players with two options: play for the salary the NBA offered or play AAU basketball for a company team (such as the Phillips 66ers, Akron Goodyears or Peoria Caterpillers), an option which only a few of the top players chose. The NBA started with 17 teams under the direction of the first commissioner Maurice Podoloff.
The NBA was representative of how far the sport had evolved. No longer was the game played in cages and the scores were no longer in the teens. Basketball had, in its half-century of existence, fundamentally changed itself into something the dollar-spending public wanted to see.
Labor difficulties
Historically, there have been a lot of labor disagreements in professional sports. Many times, the salary cap was the main point of discussion. The salary cap in sports is nothing new. Its origin in basketball can be traced back to the league's $55,000 salary cap for the league's first season, 1946-1947.
Bob Cousy, the league's top player, began to organize the NBPA in 1954, which would become the first team sports player's union. Cousy went to NBA President Maurice Podoloff at the 1955 NBA All-Star Game with a list of concerns: payment of back salaries to the members of the defunct Baltimore Bullets club; establishment of a twenty-game limit on exhibition games, after which the players should share in the profits; abolition of the $15 "whispering fine" which referees could impose on a player during a game; payment of $25 expenses for public appearances other than radio, television or certain charitable functions; establishment of an impartial board of arbitration to settle player-owner disputes; moving expenses for traded players; and payment of player salaries in ten installments rather that twelve, to provide more money to players cut during the season. Podoloff agreed to the payment of two weeks' salary to six players who had played for Baltimore before the franchise folded and committed to meeting with the player representatives within two weeks over their concerns. In 1958, Cousy would resign his position as NBPA President. His replacement as head of the union would be his Boston teammate Tom Heinsohn.
Heinsohn would continue as NBPA President until Oscar Robertson of Cincinnati succeeded him in 1966. Robertson's first major move was to announce at the January 1967 All-Star Game that the players would ask the owners that they be paid for exhibition games, that the limit on the number of exhibitions be reduced from 15 to 10, and that the NBPA hopes to meet with representatives of Major League Baseball and National Football League players concerning more unity among professional athletes. Tensions between the union and owners escalated until the owners announced in March that the playoff would be canceled unless the players gave assurances that they would comply with their contracts and participate in the playoffs as scheduled. The union then responded by threatening to file for certification with the National Labor Relations Board and to strike the playoffs in an effort to upgrade their pension plan.
With the formation of a new rival league, the American Basketball Association (ABA), in 1967, the players' salaries again began to increase. With players such as Rick Barry, Billy Cunningham and Zelmo Beaty jumping to the new league for bigger contracts, and with the new league's success in signing top college talent, the NBA soon opened talks with the ABA about a possible merger of the two leagues. As a merger drew near in 1970, the players filed the "Oscar Robertson Suit", an antitrust suit to block any merger; do away with the option clause which bound a player to a team in perpetuity; the college draft, which limited the player to negotiating with one club; and restrictions on free agent signings; and seeking compensation for damages incurred in the past due to the option clause. The union then received a restraining order to block any merger, and the talks then died. The hostility did not block a new labor agreement however, as the NBPA came to a three-year labor agreement with the NBA in October of 1970 with an increase in minimum salaries, the playoff pool and the per diem allowance.
Following a new three-year collective bargaining agreement, the financial health of the league became a major concern. Numerous franchises suffered from serious financial losses, headed by Cleveland, Denver, Indiana, Kansas City, San Diego and Utah. Some, including Kansas City and San Diego, nearly provoked a player strike in 1982 as they fell behind on their deferred payments to former players, as the league totaled an estimated $80 million to $90 million in deferred money owed to players. With the very real threat of the loss of franchises and player jobs, the union, now led by its new president Bob Lanier, agreed to a new four-year collective bargaining agreement in March of 1983 after strained negotiations and the threat of a player strike.
The 1983 agreement would prove to be a major turning point for the league. An amendment later in the year which implemented the NBA's first league-wide substance abuse policy, proved to be a big step in cleaning up the league's image problems.
Junior Bridgeman of Milwaukee, and the threat of union de-certification, an agreement on a six-year collective bargaining agreement was reached.
Creative accounting would open loopholes in the cap as the restructuring of contracts, early termination clauses, one-year contracts and balloon payments provided means for teams to circumvent the cap in order to sign players. Following the completion of the labor deal in 1994, the league and players managed to reach a no-strike, no-lockout agreement to protect the 1994-1995 season, playing under the previous agreement in hopes of striking a new deal during the season. Talks were unsuccessful, and a lockout was imposed by the owners following the completion of the 1995 NBA Finals in an effort by the owners to put pressure on the players.
When the union reached a highly-secretive agreement with the league which included a luxury tax, rookie salary cap and other provisions designed to tighten the salary cap; a group of players led by Michael Jordan and Patrick Ewing began an effort to decertify the union. Noting the concerns over possible restrictions on player movement, the player representatives chose not to ratify the agreement and sent it back for further negotiation. The contract remained unsigned until June of 1996 when the players and owners finalized the deal. The final agreement included:
• Unrestricted free agency for all players following the conclusion of their contracts
• A guarantee of 48.04% of all Basketball Related Income to the players, which now included luxury suites, international television and arena signage
• Various player exemptions to the cap, with the league keeping the so-called "Larry Bird Exception" which allowed teams to re-sign their own free agents at any price
• A shortening of the college draft to one round, beginning in 1998
• A rookie salary cap with a graduated scale depending on the position a player is drafted, allowing him free agency after his third season.
The Rookie salary cap proved to be a windfall for the players. Draft choices such as Kevin Garnett (six years, $121 million) and Rasheed Wallace (six years, $80 million) and Bryant Reeves (six years, $65 million) all received huge contract extensions, while others like Antionio McDyess, Damon Stoudamire, Joe Smith and Jerry Stackhouse were traded before they could become free agents.
The Soft Salary Cap of the NBA
Basketball had a cap in 1946-1947, gave it up, and then implemented the current version (more or less) in 1984-85. The current NBA cap limits payrolls of NBA teams to 55% of Basketball Related Income for the league. The figure rose to 57% in 2004-2005, the last season of the Collective Bargaining Agreement (CBA), and can be terminated if the average NBA player salary drops below the average NFL, NHL or MLB player salary (among other reasons). Basketball Related Income (BRI) includes revenue from tickets, advertising, local concession and souvenir sales, local media and other league, team and arena income streams.
In 2004-2005 the cap was set at $43.87 million. Three teams, Utah, Atlanta and Charlotte, were under the cap; Utah by $710.000, Atlanta by $3.185 million and Charlotte by $20.49 million. The 27 other teams were all over the cap, 20 teams by more than $10 million, and 3 teams by $40 million or more (Portland (almost), Dallas and the New York Knicks). The reason teams were able to exceed the cap by so much is because many of the exceptions apply to players who do not exercise their free agent rights or who remain with the same team for more than a couple of years. The NBA claims that the basic idea is to try to promote the ability for players to stay with their current team. Nobody likes it when a player plays with a team his entire career, the fans love him, he wants to stay and the team wants to keep him, but he has to leave because the team is unable to offer him a large enough contract.
The NBA also has a "luxury tax" in effect. If average salaries league-wide for a season go over the agreed upper limit (55% of BRI) then there is an escrow fund held back from players' paychecks that is reimbursed equally to franchises until the 55% limit is restored. If the escrow fund is not sufficient, then the highest spending teams are taxed the remaining amount to reimburse the other owners. Player salaries are also capped depending on tenure in the league, but there are so many exceptions to this rule that it rarely has a major impact on the salaries of star players, the ones the true cap on salaries is supposed to affect. Obviously the NBA salary cap and luxury tax structure are not overly constraining and therefore qualify as a soft cap. Chapter three will explain many details of the Collective Bargaining Agreement (CBA) of the NBA including the salary cap, most of the exceptions and the luxury tax.
Research questions
This study tries to answer different questions related to team success, cohesion and player pay. In conjunction with the hypotheses several research questions are formulated:
What is the relationship between individual talent and team success?
Also, cohesion within a team is an important aspect of this thesis. First, the concept and way of measurement is explained with the goal to answer the following research question:
In addition, salary differences between players within a team can have varying effects on team success. Various theories produce different expectations about the outcome of pay differences on team success. Therefore a third research question is formulated:
What is the effect of pay inequality on team success?
Chapter 2
Literature Review
This chapter will introduce economic theory that will be the basis for this thesis. Many economists have researched labor market economics using the professional sports leagues as cases and the basis for their papers. The reason for this is that there is no other research setting other than sports where we know the name, face, and life history of every production worker and supervisor in the industry. Total compensation packages and performance statistics for each individual are widely available, and we have a complete data set of worker-employer matches over the career of each production worker and supervisor in the industry.1 Individual proficiency depends on a variety of factors. A person’s talent along with hard work is crucial. Individual statistics are important and understandable measuring tools of individual proficiency. At first sight, statistics represent on first sight the most important aspects for basketball teams to win games. However, it is not that uncomplicated. Team cohesion might be more important for being a successful team than collecting a group of individually strong players that can not work together as a group. With respect to basketball statistics, having many players averaging many rebounds, assists, blocks and points has never proven to be the most successful way to win the championship.
Inequality is a measure of whether a team is collectively strong or made up of individuals. Inequality demonstrates how a team is arranged in terms of human resources. An example would be a team with one
1
Kahn, Lawrence, M. “The Sports Business as a Labor Market Laboratory.” Journal of Economic Perspectives. Volume 14, Number 3.
or two superstars with much higher salaries than the rest of the team compared to a team with no real superstars but all good “role-players” who all earn comparable salaries.
Team cohesion: A psychological approach
Keeping in mind that this thesis tries in part to investigate the effect of dissimilarity within a team on its performance, to look at psychological theories on group dynamics and group performance and then especially at the relationship between group cohesion and performance can provide much insight.
Brian Mullen and Carolyn Copper (1994) compared various studies and theories and concluded that there is a link between cohesion and performance. They studied a variety of groups such as sports teams, work groups in business settings, military groups and laboratory groups. They investigated whether cohesive groups performed better than less unified groups. They came to the conclusion that the “cohesion-performance effect does, in fact, exist to a highly significant degree” (p. 222).2 The relationship was
stronger in non laboratory groups, such as sports teams, and in small groups rather than large ones. So, this could imply that more homogeneous teams perform better than more heterogeneous teams.
A second important thing is to examine whether cohesion and performance are casually connected by calculating correlations. A very strong relationship between cohesion and performance was found, and, by comparing studies, they even concluded that performance also causes changes in cohesion. Groups that are successful become more cohesive and groups that have to deal with failure tend to become less cohesive.
According to Mullen and Copper three components are very important when it comes to cohesion: attraction, unity (group pride), and commitment to the task. The factor that determines the effectiveness of cohesive groups the most is whether group cohesion is based on commitment to the task rather than attraction or group pride. In addition, cohesion counts more when the group’s task requires high levels of interaction and interdependence.3 This is a very important characteristic of all the great championship teams in the history of the NBA and in team sports in general.
Even though there is a strong relationship between cohesion and performance, not all cohesive groups are productive. The most common reason for this is that the members are not always committed to the group’s performance goals. Mullen and Copper (1994) showed that productivity levels varied less between members of more cohesive groups. Members of cohesive groups produced nearly equivalent amounts, but individuals in non cohesive groups varied considerably more in their productivity. Also, the setting of high performance goals influences the productivity greatly in cohesive groups. The members in groups with high performance
2
Mullen, B., Copper, C. (1994). The relation between group cohesion and performance: An integration. Psychological Bulletin, 115,
210-227.
3
goals all had individually higher productivity levels than the members of cohesive groups with fairly low standards of performance.
This is a model that Mullen and Copper use in their paper for the cohesiveness-performance effect:
Interpersonal Attraction --- Commitment To task + --- Performance Group Pride --- - + Cohesiveness
Interaction Group Size Reality Figure 2.1: Model of the cohesiveness-performance effect.
In summary, as long as groups (teams) encourage high productivity, cohesion and productivity are positively related: The more cohesive the group, the greater its productivity. If group norms encourage low productivity, however, the relationship is negative. Professional sports teams at the highest levels such as NBA teams can be considered as arguably the most competitive groups with the single goal of winning all its games.
Townsend and Scott (2001) conducted a study among 122 self-direct work teams in three plants operated by a large U.S. apparel manufacturer to examine which effect racial composition and member attitudes of teams had on performance. They also investigated whether African-Americans and whites have different perceptions on team cohesion and what the effect of team cohesion was on team performance. They used not only race but also other demographic variables such as age, education level, marital status, number of dependents (i.e. number of persons who they were responsible to care for), and tenure.
An examination of the t-values for the regression coefficients indicates that these demographic variables are significant independent predictors of performance.4 This means that team cohesion is certainly influential on
team performance. They did suspect that the magnitude of difference between races would be substantially greater if they moved to settings more characterized by urban African-Americans and suburban whites.5
4
Townsend, Anthony M. and Scott, K. Dow (2001). Team Racial Composition, Member Attitudes, and Performance: A Field Study.
Industrial Relations, Vol. 40, No. 2 (April 2001).
5
Horwitz (2005) reviewed the literature on the impact of team diversity on performance. He also reviewed demographic attributes as team diversity variables. The two attributes reviewed and of importance for this study are age and race. He states that the literature illuminates the positive aspects of age similarity in team members; age similarity tends to facilitate shared understanding and communication among team members, thereby positively influencing team performance. Quite a few studies have reported age similarity enhances the frequency of communication among members of work teams, whereas dissimilarity in age is often assumed as having a negative influence on team performance (Rhodes, 1983; Tsui, Egan, & O’Reilly, 1992; Zenger & Lawrence, 1989).
Racial and ethnic diversity offer potential opportunities for organizations to improve their competitive positioning. Cox and Blake (1991), for example, made a convincing argument based on the marketing advantages of having a workforce composed of ethnically diverse employees. They assert that organizations can gain a competitive edge by matching the diverse demographic characteristics of the markets they serve with ethnically similar employees. Studies on team interaction in multiracial groups show that such teams have the potential to perform well and often generate more diverse criteria for evaluating alternatives than homogeneous groups.
Other studies, however, report positive effects of variation in ethnicity on team outcomes. In a longitudinal study, Watson et al. (1993) found that variation in race and ethnicity influenced both member-reported team process as well as performance on a team project among teams of college students. Racially homogeneous teams (all White) initially reported better team process and performance than the racially mixed teams; however, the racially heterogeneous teams improved during the period and outperformed the homogeneous teams by the end of the experiment (Watson et al., 1993).
Furthermore, literature on job related attributes was reviewed. The literature states that tenure homogeneity is generally associated with team members’ familiarity of policies, procedures, and political/situational factors in organizations and, thus, potentially offers the advantage of less communication interruptions, power struggles, and conflict. Several studies were conducted regarding the effect of organizational tenure diversity on social integration and turnover in teams.
Xin, and Weiss (2001), for example, reported that tenure diversity was negatively related to both task and emotional conflict in work teams.6
Productivity and performance in the NBA
A very well known phenomenon is that players who are in the final year of their contract play their best basketball and earn a new very lucrative long term contract.
A very interesting paper is that of Stiroh (2000) in which contract related incentive effects are examined using NBA basketball data. The evidence shows that individual performance improves significantly in the year before signing a multi-year contract, but declines after the contract is signed. These incentive effects seem very important as team outcomes improve when more players are competing for new contracts, but decline when more players have recently signed multi-year contracts. Every off-season player contracts will end and all the free agents try to get a new contract. Each wants as much money as possible or have a chance to win as many games as possible. However, the teams with available money and chance to win are limited. Therefore, strong competition exists in the off-season among the free agents. Though this is significant for the research of this thesis, it will not be used due to database limitations and time constraints.
Also, there have been numerous studies that state that post-contract declines may be mitigated by career concerns, i.e., the recognition that current effort will impact not only the current contract but also subsequent contracts (Fama (1980), Holmstrom (1982), and Gibbons and Murphy (1992)).
Superstar pay is a widely examined phenomenon as well. It is based on the facts that a disproportionate part of income goes to a few players. This is very widespread in professional sports and especially NBA basketball. After the introduction of free agency, the phenomenon became even stronger and the concentration and inequality of players’ salaries more distorted. This accumulated to an owner lockout at the beginning of the 1998-1999 season which resulted in 41 missed games and a start of the season following the all-star break in February, but only after an agreement on a new CBA was reached between the team owners and the NBA Players Association (NBPA).
Rosen (2000) examined this superstar phenomenon in his paper. He found that there are two common elements in all of them: first, a close connection between personal reward and the size of one’s own market; and second, a strong tendency for both market size and reward to be skewed toward the most talented people in the activity. True, standard theory suggests that those who sell more generally earn more. But that principle applies as well to shoemakers as to rock musicians, so something more is involved. The elusive quality of “box office appeal,” the ability to attract an audience and generate a large volume of transactions, is the issue that must be confronted.7
6
Horwitz, Sujin K. “The Compositional Impact of Team Diversity on Performance: Theoretical Consideration.” Human Resource
Development Review, Vol. 4, No. 2, June 2005, 219-245.
7
The process that coaches call “surrendering the ‘me’ for the ‘we’ is not easy to convey to superstar (“A”) players who have not participated in team activities before. For these individuals, a more effective means of getting them to play along may be to repeatedly highlight the failures of other superstars, such as those of NBA player Bob McAdoo, who, despite his exceptional talent and many awards, almost ended his sports career with a reputation for not being a team player. This approach exposes your superstar players to the downside of too much self-reliance without making it personal. Never hold a superstar player’s own shortcomings up for inspection in public because that would magnify his insecurities and drive him from the organization. But by carefully exposing a vulnerable star to what is called “sympathetic failure experiences”, you can create enough awareness in most high achievers to have them see the benefits of using, if not fully embracing, members of their team to their advantage.
A final tactic that great sports coaches reliably use to manage their superstars: They co-opt them. Great coaches often make star talent junior coaches to the team. This philosophy of asking stars to coach rather than mentor subordinates is that it does not ask superstar player to come down to the level of a junior; rather, it raises your flawed star to the coach’s level and invites him to perform at a higher status.
In their heart of hearts, narcissistic superstar players just do not want responsibility for advancing the careers of juniors in an organization. No one remembers the names of great mentors, so asking the megastars to become big brothers or big sisters to colleagues will not appear rewarding to them. They want to surround themselves with other superstar players and to be seen as first among them. They also aspire to succeed their bosses. Indeed, an overachiever might view his elevated position as a signal that he is being groomed for the top spot. In fact, he may well be. If he performs well as a coach, that performance may improve his chances of subsequent promotions. When that logic computes into his calculus, he is usually more willing to go along to get along with the rest of the organization. 8
Lazear (2000) examined whether output in firms changed when compensation was changed from an hourly wage to piece rates. This is comparable to whether team owners compensate their players according to team cohesion or individual performance. The results imply that productivity effects associated with the switch from hourly wages to piece rates are quite large.9 Also, more able workers, who shunned the firm under hourly wages, are attracted by piece rates. As a result, average output per worker rises with a 44 percent increase in productivity for the company as a whole. This can be compared to NBA team owners that pay their players according to their individual performance compared to putting together a team with “team-players” with less individual qualities.
8Berglas, Steven. “How to keep A PLAYERS productive” Harvard Business Review; Sep. 2006, Vol. 84 Issue 9, p104-112, 9p, 2c.
9
Pay inequality and team cohesion
In sports, distribution of pay does not follow a general rule that can be formulated in an equation or formula that works for all players. The well-known sports economist Gerald W. Scully (1995) formulated that the distribution of earnings in the economy has been linked to a variety of exogenous and endogenous factors: innate ability, motivation, acquired human capital, skill, occupation, race, sex, unionization, mobility, work/leisure preference, risk preference, luck and so on. In sports the governance structure, or rule space, will be shown to have a large effect on the distribution of player earnings within and across sports. The distribution of player earnings is affected by the distribution of athletic talent, the playing rules of the sport (to the extent that they affect the set of athletic attributes and the substitutability of those attributes), the nature of the production function in the sport, the labor market rules for allocating player talent, and the revenue-sharing rule in the league.10
Berri and Jewell (2004) studied the influence of wage inequality on performance by performing a natural experiment using NBA data. Given that basketball is a team sport where cooperation among workers would appear critical for team success, they asked themselves how increases in wage disparity would impact firm performance. They distinguished two different groups.
On the one hand lies the pay compression school. Proponents from this school argue that relative wage equality will enhance worker cooperation and hence, firm performance.
On the other hand lies the tournament theory which suggests that pay inequality results in higher worker productivity. Workers near the bottom of the firm’s hierarchy are paid a wage less than their marginal revenue product (MRP). The workers accept relatively low wages in the hope of securing a position at the top of the firm’s hierarchy, a position that offers a wage in excess of the worker’s MRP. In essence, significant pay inequality indicates that workers are competing in a tournament, the purpose of which is to elicit higher productivity from labor.
Frick, Prinz and Winkelmann (2003) also examined pay inequalities and team performance in the North American major sports leagues. They found that maintaining harmony within the team by reducing wage disparities below the level required by productivity differences may be most important in team sports where roster sizes are rather large, i.e. where the “rules of the game” (the production technology) require a large number of players to interact. According to their estimates, a higher degree of intra-team wage dispersion is beneficial to the performance of professional basketball teams, i.e. a team is more successful as its pay distribution becomes more “unequal”. In basketball, only a small number of players per team are allowed on the court. This implies that a single star player may be of paramount importance for the team’s
10
performance, which will lead to a highly skewed distribution of player salaries without negatively affecting the performance of those at the lower end of the pay hierarchy.11
The tournament model (Lazear and Rosen, 1981) advances the idea that pay gap between workers (players) in one rank and the next higher rank would be large and greater than their marginal products, thus, providing the incentives for the contestants to do their best. The pay gap is the prize of the tournament, which is expected to increase the higher the level of the tournament (Rosen, 1986).12 This implies that there exists a positive relationship between individual pay differences and team cohesion. Lower ranked (i.e. paid) players always aim for the higher position and hence will work hard to reach that goal. Provided they get the opportunity to prove themselves and ultimately receive the highest salaries, this will improve team success.
Developing the hypotheses
Being able to predict future success of a team would give a lot of power and (monetary) success to the owner and general manager. This is impossible to accomplish though, because of the many factors that influence the success of sports teams. However, a restricted amount of factors can be examined in conjunction with each other. This thesis examines the team success as a function of individual talent and team cohesion: Team success = F (Individual talent, Team cohesion).
The problem with a function like this is the allocation of the talent. A team abound with talent does not mean a successful team. There are players that need an incentive to use their talent to its full potential or else they are not willing to exert all their energy to becoming better players and to the success of the team. The incentive that is used by owners of professional sports teams and companies in general is pay. It is assumed in this thesis that when pay increases the amount of talent that is exerted by, in this case, basketball players, also increases. This assumption leads to a substitution in the function above. Since individual talent is an indistinct concept, it is practical to substitute it with pay. Assuming that players are payed based on talent and not their ability to maximize what talent they have, it leads to the following function: Team success = F (Individual pay, Team cohesion).
Berri and Jewell (2004) noted that a reasonable proxy for team talent is the size of a team’s payroll. Average salary is also looked at to see whether it is important for team success. In addition, it is interesting to investigate what total team statistics in various categories as a factor of talent means for team success. The data was readily available and was also taken into consideration.
11
Frick, Bernd, Prinz, Joachim and Winkelmann, Karina. “Pay inequalities and team performance – Empirical evidence from the North American major leagues” International journal of Manpower, Vol. 24, No. 4, 2003, pp. 472-488.
12
Ang, James S., Hauser, Shmuel, Lauterbach, Beni. “Contestability and pay differential in the executive suites”. European Financial
The first hypothesis relates to the production function and states that:
“Higher salaries lead to higher team success”
The second hypothesis is associated with the relationship between team cohesion and team success. Townsend and Scott (2001) examined the influence of factors such as race, age and tenure on team performance at a firm in the manufacturing industry in the Mid-Atlantic region. This study applies this idea and part of the methods used. The NBA has a drastically different demographic composition but the same ideas can be applied. This leads to the second hypothesis:
“Team cohesion has a positive effect on team success”
In addition, individual compensation leads to greater differences in salaries between players. Available talent determines pay and this leads to inequalities within teams. Some theories state that the people with the lowest salaries become unsatisfied with their salary compared to the people on top and will not exert maximum effort and resort to free-riding which affect team success. Others state that this is not the case and people and pay differences will not influence team cohesion, provided that the lowest paid people get the opportunity to prove themselves and reach the top. Following these different theories these wage disparities have different effects on team success. The third and fourth hypotheses are:
“Higher individual pay difference within teams leads to lower team success”
And
Chapter 3
Regulations in the NBA
The salary cap
A salary cap is a limit on the amount teams are allowed to spend on player contracts, which helps maintain competitive balance in the league. Without a salary cap, teams with more money could simply outspend the remaining teams for top free agents. The basic idea is that a team can only sign a free agent if the total payroll for the team will not exceed the salary cap. For the 2001-2002 NBA season, the correlation between team payroll and regular season wins was about 0.13. In other words, almost no correlation exists between salary and wins. By comparison, Major League Baseball (MLB), which does not have a salary cap, had a much stronger correlation of 0.43 for its 2002 season.13
The NBA has a soft cap. A hard cap does not allow the cap to be exceeded for any reason. A soft cap contains exceptions that allow teams to exceed the cap under certain conditions. In fact, historically very few teams have ever been under the cap during a season.
The basic idea of a soft cap opposed to a hard cap, is to try to promote players' ability to stay with their current teams. Owners and fans do not like it when a popular player has to leave because the team is unable to offer him a large enough contract. The exceptions under a soft cap allow teams to keep players under such circumstances. These exceptions will be explained and discussed below.
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The Collective Bargaining Agreement (CBA)
The Collective Bargaining Agreement is the contract between the league and the Players Association that sets up the rules by which they all operate.
The CBA defines the salary cap, the procedures for determining how it is set, the minimum and maximum salaries, the rules for trades, the procedures for the NBA draft, and all other variables that need to be defined in order for a league like the NBA to function.
The CBA has been in effect since January 1999. It lasted for seven years or until the end of the 2004-2005 season. It was the league's option to continue the agreement for the 2004-2005 season, and this option was exercised in December 2003. In the summer of 2005 they agreed to a new agreement and no games were canceled.
The Players Association has the right to terminate the CBA early if any of the following occur: • Certain types of collusion.
• The average NBA player salary becomes less than the average NFL, NHL or MLB salary.
• Certain provisions of the CBA are struck down in court (the owners can also terminate if this happens).
Two figures control what percentage of revenues the players receive: the salary cap and the escrow tax threshold. Here are both for all years of the agreement (BRI = Basketball Related Income):
Season Defined salary cap Actual salary cap Escrow % 1998-1999 $30 million $30 million None
1999-2000 $34 million $34 million None
2000-2001 48.04% of BRI* (see note below) $35.5 million (see note below) None
2001-2002 48.04% of BRI* $42.5 million 55% of BRI
2002-2003 48.04% of BRI* $40,271,000 55% of BRI
2003-2004 48.04% of BRI* $43,840,000 55% of BRI
2004-2005 48.04% of BRI* $43,870,000** 57% of BRI *From the BRI percentage, they subtract benefits (about $71 million in 1999-2000) and then divide by the number of NBA teams to arrive at the cap. Note that they use projected BRI and benefits when computing the salary cap.
**The 2004-2005 salary cap for the Charlotte Bobcats is $29,250,000.
Basketball Related Income (BRI) includes: • Regular season gate receipts • Broadcast rights
• Novelty, program and concession sales (at the arena and in team-identified stores within a 75-mile radius)
• Parking
• Proceeds from team sponsorships • Proceeds from team promotions • Arena club revenues
• Proceeds from summer camps
• Proceeds from non-NBA basketball tournaments • Proceeds from mascot and dance team appearances • Proceeds from beverage sale rights
• 40% of proceeds from arena signage • 40% of proceeds from luxury suites
• Proceeds received by Properties, including international television, sponsorships, revenues from NBA Entertainment, the All-Star Game, the McDonald's Championship and other NBA special events.
The NBA and Players Union are also working to replace BRI with a new definition of revenues, called Core Basketball Revenues (CBR).
The escrow system is a guarantee that total salaries will not exceed the designated percentage. At the other end of the spectrum there is a minimum team salary, which is defined as 75% of the salary cap. Any team that does not spend at least that much is charged at the end of the season, and that money is given to the players. In practice, most teams' salaries will be higher than the salary cap amount.
The escrow system
The biggest factor behind the 1998 lockout was the amount of revenue that went to player salaries. The owners did not want salaries to exceed 53% of BRI, but by the 1997-1998 season salaries had risen to 58%, which triggered an "out" clause allowing the owners to terminate the previous CBA. With the new agreement, they put in the escrow system to ensure that salaries & benefits did not exceed a designated percentage of BRI. As described above, the designated percentage of BRI that salaries & benefits cannot exceed is as follows:
Season Designated Percentage 2001-2002* 55% of BRI
2002-2003 55% of BRI
2003-2004 55% of BRI
In order to keep salaries and benefits at or below the designated percentage, beginning in 2001-2002, money is withheld from players' paychecks and deposited into an escrow account. At the end of each season the league-wide salaries to the designated percentage of BRI are compared to see if there is an excess. If there was not an excess, then all of the money in escrow is given to the players. But if there was an excess, then the excess amount is returned to the owners (which lowers salaries back to the designated percentage), and the players get the rest. The amount withheld is the projected overage amount, not to exceed 10% of salaries & benefits.
The luxury tax
If player salaries rise to the point that the maximum escrow withholding isn't enough to lower the league-wide salaries to the designated percentage, then some teams pay a tax. This is often referred to as a "luxury tax", but the CBA simply calls it a "tax" or a "team payment."
The tax is triggered when the league-wide salaries and benefits exceed approximately 61.1% of BRI. If the league-wide salaries & benefits are less than this amount, then no team pays a tax, no matter how high their payroll. If the tax is triggered, then it is paid by all teams that are over the luxury tax, in the amount by which their team salary exceeds the tax threshold (see below).
In 2001-2002, salaries and benefits were approximately 59.8% of BRI (and the escrow withholding was sufficient to return salaries to 55% of BRI), so the team tax was not triggered. The salaries and benefits were 65.5% in 2002-2003 and 63.4% in 2003-2004, and the tax was triggered in those years.
Season: 2002-2003 2003-2004 BRI: $2.662 billion $2.756 billion
Salaries + Benefits $1.744 billion $1.748 billion
Percentage of BRI 65.5% 63.4%
In 2002-2003 there was a $2.662 billion BRI and the designated percentage (55%) was $1.464 billion, so the overage (salaries and benefits minus the designated percentage) was $280 million. However, the maximum that can be withheld in escrow is 10% of salaries and benefits, or $174.4 million. This confirms the idea that the tax is triggered when the maximum escrow withholding isn't enough to lower the league-wide salaries to the designated percentage. So the entire $174.4 million escrow withholding was returned to the teams, and the teams over the tax threshold paid the tax. The idea was that since the high-spending teams are the ones most responsible for the players' salaries being so high, they should be the ones making up the difference.
over the tax threshold pay a tax equal to the amount they are over. So a team with a $60.0 million team salary paid a tax of $7.12 million. Teams with payrolls below the tax threshold do not pay any tax.
The league decided to credit teams that pay luxury tax for players who have been ruled permanently disabled. There is a one-year waiting period following the player's injury or illness. The credit is in the amount of the Disabled Player Exception (half the player's salary, or the average salary, whichever is less) and is subtracted from the team's luxury tax payment. This prevents a form of double jeopardy, where a team would otherwise have to pay tax on an injured player's salary, and also on his replacement's. Interestingly, if the injured player is traded before he is deemed permanently disabled, then neither team receives the credit. This credit is subject to re-adoption on a year-to-year basis.
Allocation of the tax money
Escrow money that is returned to the teams is not distributed evenly. As described above, if the salaries and benefits exceed a designated percentage of income for that season, then some of the players' salary is returned to the teams. Also, if the salaries and benefits are sufficiently high, then some teams will pay additional money to the league, which is the luxury tax.
A "cliff provision" was established to protect teams that end up slightly over the tax threshold. This is important because the tax threshold isn't determined until many months after teams make their personnel decisions. A "cliff threshold" is designated at 65% of BRI. Teams above the tax threshold (approximately 61.1% of BRI) but below the cliff threshold (65% of BRI) are penalized less severely than teams above the cliff threshold.
Also note that every team receives at least some of the escrow & tax money. In many cases, the money received more than offsets any luxury tax they pay. In addition, all teams benefit from a reduction in the amount of benefits they are required to pay. The following rules govern the distribution of the tax and escrow money:
Tax money:
• Teams under the tax threshold receive a full share (1/30) of the tax money. • Teams over the cliff threshold do not receive any of the tax money.
• Teams between the tax threshold and cliff threshold receive a pro-rated amount between $0 and a full share, based on where they are between the two thresholds. For example, a team midway between the tax threshold and cliff threshold in 2002-2003 received 50% of a share of tax money. • Not all tax money is distributed under this formula. See Surplus, below.
Escrow money:
this minimum share, or their tax share, whichever is greater. For example, in 2002-2003 a team that gets an 80% tax share also gets an 80% escrow share, and a team that gets a 50% tax share gets a (minimum) 70% escrow share.
• Not all escrow money is distributed under this formula. See Surplus, below. Surplus:
• The above formulas do not result in all of the tax and escrow money being distributed. Some of this money goes to the Toronto Raptors to help account for currency differences. Some goes to teams with permanently disabled players. The rest is divided evenly among all NBA teams.
So once teams cross the tax threshold, they start forfeiting both luxury tax and escrow distributions. They stop losing escrow distributions 30% of the way to the cliff threshold. They lose tax distributions in the entire range between the tax threshold and cliff threshold.
The players' salary restrictions
There are both minimum and maximum salaries, and both are based on how long the player has been in the league. The minimum salaries scale upward each season. Here are the minimum salaries:
And here are the maximum salaries: Years in NBA Defined maximum salary 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005 0 $9,000,000 or 25%* $9,658,000 $10,625,000 $10,067,750 $10,960,000 $10,968,000 1 $9,000,000 or 25%* $9,658,000 $10,625,000 $10,067,750 $10,960,000 $10,968,000 2 $9,000,000 or 25%* $9,658,000 $10,625,000 $10,067,750 $10,960,000 $10,968,000 3 $9,000,000 or 25%* $9,658,000 $10,625,000 $10,067,750 $10,960,000 $10,968,000 4 $9,000,000 or 25%* $9,658,000 $10,625,000 $10,067,750 $10,960,000 $10,968,000 5 $9,000,000 or 25%* $9,658,000 $10,625,000 $10,067,750 $10,960,000 $10,968,000 6 $9,000,000 or 25%* $9,658,000 $10,625,000 $10,067,750 $10,960,000 $10,968,000 7 $11,000,000 or 30%* $11,589,000 $12,750,000 $12,081,300 $13,152,000 $13,161,000 8 $11,000,000 or 30%* $11,589,000 $12,750,000 $12,081,300 $13,152,000 $13,161,000 9 $11,000,000 or 30%* $11,589,000 $12,750,000 $12,081,300 $13,152,000 $13,161,000 10+ $14,000,000 or 35%* $14,000,000 $14,875,000 $14,094,850 $15,344,000 $15,355,000 Source: NBA Collective Bargaining Agreement
* Whichever is greater. The percentage refers to the percentage of the team's salary cap.
First round draft picks have a more restrictive salary scale, based on their draft position.
Salaries for first round draft picks.
First round draft picks operate under a different set of rules. There is actually a very strict salary scale for first round draft picks and their first contracts. They do this because it was previously common for rookies to hold out, not signing with their team until they got the contract they wanted. In addition, there was backlash from the veteran players who saw rookies with no NBA experience getting contracts that were bigger than theirs. The last year without a salary scale was 1994, when it was rumored that first overall pick Glenn Robinson was going to hold out for a $100 million contract. He eventually signed a 10-year, $68.15 million contract.
Beginning in 1995, salaries for first round picks were set according to a very strict scale, determined by their exact draft position. In the previous CBA, this was calculated using a weighted average of the first year salary of the same pick in the previous seven drafts. In the first year of the CBA (1998-1999), salaries were computed using this same weighted average. In subsequent years of the CBA (1999-2000 through 2004-2005), it increased by 5% each year (a simple 5% of the 1998-1999 figure, not a compounded percentage). For example, the following chart lists the salary figure for the #1 overall draft pick in each season from 1998-1999 through 2004-2005, along with the raise allowed in the 4th (option) year.
Season 1st year salary 2nd year salary 3rd year salary 4th year option (% raise over 3rd year salary) 1998-1999 $2,679,300 $2,880,200 $3,081,200 26,1% 1999-2000 $2,813,300 $3,024,300 $3,235,300 26,1% 2000-2001 $2,947,200 $3,168,300 $3,389,300 26,1% 2001-2002 $3,081,200 $3,312,300 $3,543,400 26,1% 2002-2003 $3,215,200 $3,456,300 $3,697,400 26,1% 2003-2004 $3,349,100 $3,600,300 $3,851,500 26,1% 2004-2005 $3,483,100 $3,744,300 $4,005,600 26,1%
By comparison, the 29th and last pick in the draft has a first-year salary figure of $535,600 in 1998-1999 and $696,300 in 2004-2005. A listing of the salary figures for all draft picks and all years can be found in Appendix A.
The exact percentage increase for the fourth (option) year varies by the player's draft position. It is 26.1% for the first pick, scaling up (almost evenly) to 80.5% for the 30th pick.
There are also restrictions to the contract length. Under the CBA, contracts were three years with a team option for a fourth year. After the fourth year, players become restricted free agents rather than unrestricted (provided the team picked up the fourth-year option). These contracts can also be extended between August 1 and October 31 after the player's third season.
Since the rule for first round picks was implemented, there has never been a holdout. There has also been less grumbling from veterans about rookies who make more than they do. In that respect, the rookie salary scale has proven to be a great success.
Exceptions to the salary cap
There are many exceptions to the signing of players that teams can use to make deals with other teams assuring them of not having to pay the luxury tax that comes with exceeding the salary cap. Below are the most commonly used exceptions to the salary cap.
Larry Bird Exception
This is the best known exception. Players who qualify for this exception are called "Qualifying Veteran Free Agents" in the CBA. This exception allows teams to exceed the salary cap to re-sign their own free agents, up to the player's maximum salary. The free agent in question must have played for three seasons without being waived or changing teams as a free agent. This means a player can obtain "Bird rights" by playing under three one-year contracts, a single contract of at least three years, or any combination. It also means that when a player is traded, his Bird rights are traded with him, and his new team can use the Bird exception to re-sign him. These contracts can be up to seven years in length. A player can receive 12.5% raises using this exception. This exception is known as the Larry Bird exception because the Celtics were the first team allowed to exceed the cap to keep their own free agent, and the player happened to be basketball icon Larry Bird.
There is one more limit to the maximum salary that can be given using the Larry Bird exception. If the player was a first round draft pick and just completed his three-year rookie scale contract, but his team did not exercise their option to extend the contract for the fourth season, then this exception cannot be used to give him a salary greater than he would have received had the team exercised their fourth year option.
Early Bird Exception
without being waived or changing teams as a free agent. Using this exception, a team may re-sign its own free agent for 175% of his salary the previous season or the average player salary, whichever is greater.
Early Bird contracts must be for at least two seasons (which limits this exception's usefulness; it is often better to take a lower salary for one more season and then have the full Bird exception available the next season) and no longer than six seasons. A player can receive 12.5% raises using this exception.
The league computes the average salary by taking the total salaries paid during the previous season, dividing by 362.5 (29 teams, times 12.5 players per team) and then adding eight percent. This average salary figure is used when determining the salaries payable using the Early Bird, Disabled Player and Mid-Level exceptions. The figure is also used when determining an unsigned free agent's affect on team salary. The NBA does not count expansion teams in their first two seasons when computing the average salary. So when a 30th team was added in 2003-2004 (the Charlotte Bobcats), the divisor was still 362.5. It changed to 375 in the 2005-2006 season.
Non-Bird Exception
Players who qualify for the Non-Bird Exception are called "Non-Qualifying Veteran Free Agents" in the CBA. They are defined as veteran free agents who are neither Qualifying Veteran Free Agents nor Early Qualifying Veteran Free Agents. This exception allows a team to re-sign its own free agent to a salary starting at 120% of the player's salary in the previous season or 120% of the minimum salary, whichever is greater, even if they are over the cap. Raises are limited to 10% and contracts are limited to six years when this exception is used.
Mid-Level Exception
This exception is also called the "Middle Class Exception". It says that a team can offer any player a contract equal to the average NBA salary every year, even if they are over the cap. This exception is new to the current CBA, and was "ramped up" to the average salary over a period of four years. Here is the value of the mid-level salary exception for each year of the CBA:
This exception may be split and given to multiple players. It may be used for contracts of up to six years in length. Signing a player to a multi-year contract does not affect a team's ability to use this exception every year.
$1 Million Exception
This exception carries over from the previous CBA. Like the mid-level salary exception, it ramps up over several years:
Season $1 Million Exception 1998-1999 $1,000,000 1999-2000 $1,100,000 2000-2001 $1,200,000 2001-2002 $1,300,000 2002-2003 $1,400,000 2003-2004 $1,500,000 2004-2005 $1,600,000
This exception may not be used two years in a row. It may also be split and given to more than one player, and can be used to sign players for up to two years.
Rookie Exception
Teams may sign their first round draft picks to rookie "scale" contracts even if they will be over the cap as a result.
Minimum Player Salary Exception
Teams can offer players minimum-salary contracts even if they are over the cap. Contracts can be up to two years in length. For two year contracts, the second season salary is the minimum salary for that season. The "minimum salary exception" allows teams to acquire minimum-salary players without regard to salary matching under the assigned player exception.
Traded Player Exception
This is a "credit" that teams can use to replace the salary of a player traded to another team. This credit cannot be used to sign free agents; it is only available for trades. Any trade which results in the team ending up over the salary cap requires an exception. This is true even if the team is moving downward in salary.
The Traded Player exception is the primary means used by teams over the cap for completing trades. It allows teams to make trades that leave them over the cap, but it places several restrictions on those trades. Trades using the Traded Player exception are classified into two categories: simultaneous and non-simultaneous. As its name suggests, a simultaneous trade takes place all at once. Teams can acquire up to 125% plus $100,000 of the salaries they are trading in a simultaneous trade.
In some cases, teams have up to one year to acquire the replacement player(s) to complete a trade. These trades are considered non-simultaneous trades. In a non-simultaneous trade, a team can only acquire up to 100% plus $100,000 of the salary it gives up (as opposed to the 125% plus $100,000 in a simultaneous trade). A trade in which more than one player is traded away can only be simultaneous; non-simultaneous trades are allowed only when a single player is traded away.
Disabled Player Exception
This exception allows a team that is over the cap to acquire a replacement for a disabled player who will be out for the remainder of the season. This exception can also be granted in the event of a player's death. This exception can only be used to acquire one player. The maximum salary for the replacement player is 50% of the injured player's salary or the average salary, whichever is less. Approval from the league (based on a determination by an NBA-designated physician) is required for this exception to be used. This exception can be used to sign a free agent, or to create room to accept a salary in trade. When used for trade, it is treated in a similar fashion to the traded player exception. If a team is under the salary cap by more than the combined amount of their exceptions, or drops below the cap by more than the combined amount of their exceptions after receiving this exception, then they lose this exception. If a team is under the salary cap and has this exception available, then it is included in their team salary.
Teams have had occasional difficulty getting the NBA to approve an injury exception. A vote of the NBA Board of Governors is actually required for this exception to be granted.
This exception is not to be confused with the salary cap relief that teams can apply for up to two years after losing a player to a career-ending injury or death. This exception allows a team to acquire a replacement player. The salary cap relief removes a contract from the books.
Qualifying Offer
qualifying offer must be for 125% of the player's previous salary, or the player's minimum salary plus $150,000, whichever is greater. Teams are given an exception in this amount for the purpose of making a qualifying offer. This exception is not necessary for players finishing the fourth year of their rookie scale contracts, because teams may use the Larry Bird exception for these players. Restricted free agency and the concept of the qualifying order will be further explained below.
A summary of all salary cap exceptions can be found in Appendix B.
Other Salary Cap Loopholes
Restricted free agencyTwo types of free agency exist; unrestricted and restricted. An unrestricted free agent is free to sign with any other team, and the player's original team can do nothing to prevent it. Restricted free agency gives the player's original team the right to match an offer sheet the player signs with another team and keep the player.
The CBA of 1999 provided restricted free agency on a limited basis. It is allowed following the fourth year of rookie "scale" contracts for first-round draft picks. It is also allowed for all veteran free agents who entered the NBA in 1998-1999 or later, who have been in the league three or fewer seasons. However, first round draft picks are unrestricted free agents following their third season if their team does not exercise their option to extend their rookie scale contract for the fourth season. All other free agency is limited to unrestricted free agency.
In order to make their free agent a restricted free agent, a team must submit a qualifying offer to the player by June 30. The amount of the qualifying offer for players on rookie "scale" contracts is based on the player's draft position. The qualifying offer for all other players must be for 125% of the player's previous salary, or the player's minimum salary plus $150,000, whichever is greater. The qualifying offer may be for one season only. The team automatically gets an exception in the amount necessary to make this qualifying offer if they are over the salary cap.
A player can elect to accept his qualifying offer and play the following season under its terms. This is sometimes done in order to become an unrestricted free agent the following summer.
When another team wants to sign a restricted free agent, it signs the player to an offer sheet, the principal terms of which the original team is given seven days to match. The offer sheet must be for at least two seasons (not including option years). If the player's prior team also submitted a maximum qualifying offer, then the offer sheet must be for at least three seasons (not including option years). If the player's original team exercises its right of first refusal by matching the principal terms of the offer sheet, the player is then under contract to his original team. If the player's original team does not exercise its right of first refusal within seven days, the offer sheet becomes an official contract with the new team.
To summarize, a restricted free agent essentially has four options:
• He can accept his prior team's qualifying offer, play for one season, and become a free agent again the following summer.
• He can accept his prior team's maximum qualifying offer (if one has been submitted) and play under a long-term contract at the maximum salary.
• He can sign an offer sheet with another team, which his prior team is given the opportunity to match.
• He can negotiate a new contract with his prior team that is independent of the qualifying offer or maximum qualifying offer.
A signed offer sheet can be rescinded within the seven day waiting period if all three parties (the player and the two teams) agree.
Free agents continue to be included in team salary. By renouncing a player, a team gives up its right until the following June 30 to use the Larry Bird, Early Bird, or Non-Bird exceptions to re-sign that player. A renounced player no longer counts toward team salary, so teams use renouncement to gain additional cap room. After renouncing a player, the team is still permitted to re-sign that player. However, they must either have enough cap room to fit the salary, or sign the player without using one of the three "Bird" exceptions.
After renouncing a player, a team can still trade the player in a sign-and-trade agreement. Under no circumstances can a team sign and then trade another team's free agent. But there is a special rule that allows teams to re-sign their own free agents for trading purposes, called the sign-and-trade rule. Under the sign-and-trade rule, the player is re-signed and immediately traded to another team. This is done by adding a clause to the contract that specifies that the contract is invalid if the player's rights are not traded to the specific team within 48 hours.
