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The Economics of Free Agency: Is it Economically Sound?

Image result for manny machado dodgers

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.

Ethan is a Pirates contributor to The Point of Pittsburgh. An Accountant by trade, Ethan is passionate about the business of sports and won't apologize for enjoying it more than the actual games. He's a believer in analytics, hasn't played a game since little league, and can be contacted via Twitter @EthanHullihen

9 Comments on The Economics of Free Agency: Is it Economically Sound?

  1. I would also note that teams such as the Dodgers and Yankees have more “wiggle room” than a team like the Pirates in terms of free agent signings–if the Yanks or Dodgers miss on a significant free agent signing, that doesn’t necessarily cripple them for the next offseason. If the Pirates jump into the deep end of the FA pool and it doesn’t work out, that’s the kind of mistake that has implications for two, three or more years going forward.

  2. Adam Yarkovsky // October 29, 2018 at 11:07 AM //

    Yes. The key to big markets is being able to make those mistakes and supplement them with more and more $. For as much as people want the pirates to spend more and theres some merit to it . The level to which they can spend will NEVER get to that level. Making any and every high dollar addition must win. Injury or poor play from these assets kills the current 25 as well any trade value.

    • Ethan Hullihen // October 29, 2018 at 11:17 AM //

      I agree with both of you. I believe that the distinct big market advantage is not being able to sign big money FAs, it’s being able to cover up big money FA mistakes.

      All the talk about the WS was the two big payrolls, which was true, but no mention of a lot of it being dead weight salary (Ramirez, Sandoval, etc.)

      Sure, the Pirates may be able to make those big acquisitions, but it’s not being able to eat it when it goes wrong (ie Liriano) that is the true problem.

  3. Bob Stover // October 29, 2018 at 12:08 PM //

    Very interesting article today. It confirms what I already believed, namely that trading and development are the only true way to go for a small market franchise such as the Pirates. The only free agents that are likely not to be lemons are beyond the price range the Pirates can or are willing to spend. I’m not against a limited use of signing free agents, particularly those which you can get for a one or two year deal at a modest price. Even if you get a lemon in that market, it won’t destroy the franchise for 5-10 years like some teams have had happen by indiscriminate free agent signings.

    I look at this year’s World Series champion, the Boston Red Sox. Although it has only been five years since they last won a World Series in 2013, only two players remain from the 2013 squad n the team that won it all last night; and both were rookies in 2013. Most of the team is homegrown or acquired in trades with other teams. David Price and Rick Porcello being the lone exceptions that came from the high-priced free agent market. Chris Sale, Brock Holt, Ian Kinsler, Mitch Moreland, Brandon Phillips, Joe Kelly and Steve Perace were all obtained via trades. Some low to mid-priced free agents include Sandy Leon, Nathan Eovaldi, Craig Kimbrel and Eduardo Nunez.

    The main reason that Boston has so much home grown talent is that they draft better than the Pirates and most teams. The reason that they have acquired nice pieces via trade is that they had minor league pieces to sell and didn’t hold them too long.

    • Ethan Hullihen // October 29, 2018 at 1:26 PM //

      While some of your facts are off–Porcello, Eovaldi, Kimbrel, and Nunez (then resigned) were all acquired via trade, while Moreland was a FA and you forgot JD Martinez–you’re overall point is sound. Boston is successful because they have great value from draft and international FA, which have been used to fill holes or trade for top talent.

      That’s another distinct advantage for big markets though. Then can afford to trade top prospects because they can pay the cost to replace, while small markets have to rely on them because they are more affordable. The Pirates lack luster performance in developing such players doesn’t help matters either. Big markets can also afford to retain such talent when prudent as well.

  4. Adam Yarkovsky // October 29, 2018 at 12:18 PM //

    Wait a second how are we a few responses in and are still using logic. This is crazy talk. Someone has to scream nuttings cheap right lol. Great points guys.

    • Someone has to scream Nuttings cheap right

      That would be like screaming “Hey, we all breathe air !!!”

      It’s just something that everyone now just takes for granted.

  5. Daquido Bazzini // October 31, 2018 at 5:15 PM //

    In case you missed it, the 2018 MLB playoffs and World Series have concluded.
    It ended up with the #1 and #3 clubs on the team salary chart.
    Once again, that is the hard cruel reality of MLB.
    If you don’t get (at least) in the middle of the pack, you can forget it.

  6. Adam Yarkovsky // October 31, 2018 at 7:17 PM //

    Or if you aren’t in the the top 8 you need to have the luckiest of runs or you have no shot. In a way the middle are real dumb

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