Player Compensation and Team Success in the National Hockey League Stephanie Hao March 11, 2016 Econ 191A-B Prof. Ross Starr Abstract: This paper examines the relationship between inequalities in player compensation in the NHL and two measures of team performance: season winning percentage and team revenue. I find that, for seasons before the salary cap, taking a “superstar” approach to player compensation for centers, left wingers, and defensemen is insignificantly related to winning percentage, while compensating right wingers more equally may yield an increase in wins. Taking a superstar approach to signing centers and right wingers and a more egalitarian approach to signing left wingers may yield an increase in team revenue. For seasons after the implementation of the salary cap, there is an insignificant relationship between inequalities in player compensation and season winning percentage for all forward positions, while allocating cap space more equally among defensemen is related to higher winning percentages. Finally, higher inequality in compensation for right wingers is associated with increases in revenue after the salary cap. 1 I. Introduction and Literature Review Before the introduction of a salary cap, wealthy franchises in the National Hockey League had the resources to offer the best players incredibly lucrative contracts. Thus, teams such as the Toronto Maple Leafs, Montreal Canadiens, and Edmonton Oilers were able to dominate the NHL for years at a time. However, NHL franchise owners sought to restrict growing player salaries; in doing so, they hoped to increase the NHL’s popularity among wider audiences by promoting parity within the league. The 1994-1995 lockout, which resulted in a 48-game season, attempted to address the issue of player salaries, but ended without the adoption of a salary cap or a luxury tax. Finally, after a full-season lockout from 2004-2005, the NHL collective bargaining agreement (CBA) implemented a hard salary cap in 2005 that limited the total amount of money a team can spend to pay its players each season. The salary cap ceiling is set as a percentage of previous years’ revenues, while the cap floor is set at $16 million less than the cap ceiling. Teams cannot spend more than the cap ceiling or less than the cap floor and may spend at most 20% of the cap ceiling on a single player. A player’s cap hit is the average annual value of his contract—that is, the total dollar amount of his contract, including signing and performance bonuses, divided by the number of years on the contract. The NHL and the NHLPA renegotiated the CBA in 2013 after a lockout during the 2012-2013 season, which resulted in a lower cap ceiling and limitations on the variation of a player’s salary within a contract. A team’s general manager must now find a way to allocate a limited amount of resources among players under the restrictions of the salary cap. Some franchises use a “superstar” approach in compensating players; that is, they spend a large portion of their 2 cap space on a few stars and must fill in remaining positions with lower-paid players. This approach may lead to a team with large disparities in both player compensation and player performance. Other franchises may instead fill their roster with more evenly compensated, mid-tier players, resulting in a team with relatively little disparity. Using panel data from the 1994-1995 season to the 2014-2015 season, I would like to determine the relationship between player compensation allocation for each position (center, left wing, right wing, and defense) and two measures of success: team performance and team revenue. This paper proceeds as follows. In the remainder of this section, I present a brief introduction to the structure of an NHL team and a review of current theoretical and empirical literature. I present two models in Part II and the data I use in Part III. Part IV contains my estimation results, and I conclude in Part V. a. Structure of Teams in the NHL In regular five-on-five play in the NHL, there are six players on the ice at a time: one goaltender, two defensemen, and one line of three forwards. The role of a forward is primarily to score goals, while the role of a defenseman is primarily to keep the opposing team from scoring. However, due to the speed of the game, many forwards are defensively responsible and many defensemen can produce offensively; thus, unlike in baseball and football, it is difficult to measure offensive and defensive performance separately. An NHL team’s roster usually consists of twenty players: two goalies, three pairs of defensemen, and four lines of forwards with three forwards (a center, a left winger, and a right winger) in each line, although some teams may substitute a forward with a seventh defenseman. The defensive pairs and offensive lines play in shifts of 3 around 45 seconds each, while a goalie usually stays on the ice for the duration of a 60- minute game. Additionally, because hockey is a full contact sport, teams may use “enforcers” or “goons,” usually on the fourth line, to retaliate against hits on more skilled players by the opposing team. Although these enforcers may not produce as well offensively, they deliver hits or start fights and may be a significant appeal for spectators. Thus, a player’s salary may depend not only on the number of points scored but also on the number of hits delivered or penalty minutes taken. b. Theoretical Literature The effects of wage dispersion have been explored by Lazear and Rosen (1981), Akerloff and Yellen (1990), and Levine (1991). Lazear and Rosen introduce a rank-order tournament in which compensation depends on a worker’s ordinal rank, rather than production, when compared to his peers. In this tournament, the “winner” with the highest ordinal rank receives a payment much higher than that of the “losers.” Thus, workers are incentivized to invest more effort into increasing their rank and consequently their payment, and as the difference between the payment of winners and losers increases, so too does this investment. However, investment comes at a cost to workers. Firms must therefore find an optimal spread of payments that not only encourages workers to invest but also sets the workers’ cost of investment low enough to prevent them from seeking better opportunities elsewhere. In this light, it is possible to view the National Hockey League as a tournament in which players compete with each other for recognition, cap space, and positions on the starting lineup and special teams. General managers may recognize this and offer the best-ranked players of a team much larger 4 contracts in order to increase each individual team member’s investment, thereby increasing the production of the team overall. On the other hand, Akerlof, Yellen, and Levine argue that large differentials in salary may decrease team performance. According to Akerlof and Yellen’s fair wage- effort hypothesis, workers will invest effort into their work relative to their wage; thus, if workers are paid below what they perceive to be the “fair” wage, they will not produce as much as workers who are paid fairly. Introducing high salaries for “superstar” players in the NHL may therefore lead to feelings of antipathy among lesser-paid teammates, a reduction of effort by these lesser-paid players, and a lack of team cohesion. Similarly, Levine argues that firms whose production depends on cooperation between workers should reduce the disparity between wages. He presents a model in which both cohesion and production among high-skilled workers and low-skilled workers are greater when wage differential is smaller. An increase in wage disparity will therefore negatively impact a firm’s performance. Levine acknowledges that it may be difficult to sustain high levels of cohesion between workers in firms with competitive environments, because “star” workers may leave in search of higher salaries. However, such movement is limited in the NHL because only players who are free agents may continuously seek higher pay. c. Empirical Literature Empirical studies of the relationship between player compensation and team performance have been primarily on data from the NFL, NBA, and MLB. Borghesi (2008) estimates the effects of “justified” and “unjustified” player compensation in the NFL on team performance using data from 1994 to 2004; he finds that while unjustified 5 dispersions in defensive base pay negatively impact defensive performance, spending more on defensive bonuses overall positively impacts performance. Both the Gini coefficient and the mean of unjustified base pay have a negative impact on offensive performance. Thus, Borghesi’s findings suggest that teams taking a “superstar” approach perform worse than teams with a more egalitarian pay structure. Katayama and Nuch (2011), using not only season-level but also game-level data from the 2002 to 2006 NBA seasons, measure salary inequality three ways: the Herfindahl-Hirschman Index (HHI), the Gini coefficient, and a coefficient of variation adjusted for number of minutes played by each player per game. They regress these measures on team performance, proxied by a ratio of the points scored by the player’s team to the points scored by the opposing team, and find that salary inequality has no significant impact on team performance on the game- and the season-level for any of the three measures used. Thus, Katayama and Nuch find no evidence in favor of either the rank-order tournament theory proposed by Lazear or the fair wage-effort hypothesis proposed by Akerlof and Yellen. However, they do find that the coefficients for measures of salary inequality were negative, indicating that they could be significant when estimated using a larger set of data.