Academic journal article
By Jane, Wen-Jhan; San, Gee; Ou, Yi-Pey
International Journal of Sport Finance , Vol. 4, No. 2
This paper provides a comprehensive study of the causality between pay and performance for professional sports teams. By using the total salary payment, as well as the dispersion of salary payment of the baseball teams in Taiwan, we engage in a simultaneous regression of a Granger Causality Test for each team's salary structures and their corresponding performance. Our empirical results show that the causality only runs from the dispersion of salary payment to team performance, and not vice versa. As such, both the tournament hypothesis, which emphasizes the effect of salary dispersion, and the Yankee paradox, which proposes the negative externality for a team with high payroll, are thus confirmed. The one-way causality results suggest that teams must rely more on internal wage adjustments, especially on the dispersion of salary, under the league with strict restrictions on the mobility of players.
Keywords: Equity Theory, panel Granger Causality test, salary regulation, Tournament Theory, Yankee Paradox
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Economists usually pay more attention to the relationship, rather than the direction, of the linkage between salary structures and team performance. Studies of professional baseball teams (Depken, 2000; DeBrock et al., 2004; Wiseman & Chatterjee, 2003; Scully, 1974; Sommers & Quinton, 1982), soccer teams (Garcia-del-Barrio & Pujol, 2007; Lucifora & Simmons, 2003), and hockey teams (Idson & Kahane, 2000; Jones & Walsh, 1988) normally treat team performance as the dependent variable, and then search for relevant factors that shape it. Recently, Horowitz (2007) provided a detailed literature review looking into various measures of performance in sport. This paper is one of the few research studies focused on the direction of the linkage between salary structures and team performance.1 The direction of the linkage (e.g., the causality between salary structures and team performance) is unclear and has rarely been rigorously investigated in the literature. Hall et al. (2002) stressed that such a link "plays a central role in the theory of team sports but is seldom investigated empirically" (p. 149). Therefore, we focus on two important concepts of salary structures, the total payroll and the dispersion of salary, to investigate the causality between them and team performance.
Total payroll and the dispersion of salary are important for understanding both the relationship and the causal link between salary structures and team performance in labor market theory. Since total payroll for a sports team is more likely to be affected by its talented players, a causality test between total payroll and team performance will enable us to understand whether expenditure on playing talent, as measured by the team's total payroll, will translate effectively into performance (or success). In other words, the question we want to answer is not whether a team with the highest total payroll, or an owner with very deep pockets, as in the case of the New York Yankees in baseball or Manchester United in soccer, is more likely to win a championship, but whether a causal link between them exists or not.
While the possible relationships between salary dispersion and organizational performance asserted by Tournament Theory (Lazear & Rosen, 1981) and the Fair Wage- Effort Hypothesis (Akerlof & Yellen, 1990) have been investigated for decades, almost none of the studies in the literature have focused on the issue of the direction of causality between salary dispersion and organizational performance. The causal link between salary dispersion and performance can help us to understand why a team with high performance also has a high degree of internal salary dispersion. One explanation would be that the team performs well because salary dispersion creates incentives. Another explanation is that the team performs well and shares rents with its workforce in such a way that it increases salary dispersion. …