ABSTRACT

For a league to succeed financially in the long run, it must have a semblance of even competition among teams, but teams’ aversion to losing causes them to prefer lopsided wins to unexpected losses. Given that the value of a win is much greater in large cities, it is unlikely that leagues would maximize revenue from perfect parity across teams.

Fans and owners both have an interest in competitive balance. The perception that fans are less likely to follow a league in which a few teams win most of the games or championships gives owners a financial stake in maintaining competitive balance. Policies aimed at increasing competitive balance are generated by the central league office as individual teams always prefer winning to losing.

A popular measure of within-season balance is the ratio of the standard deviation of winning percentages to the “ideal” standard deviation that would prevail if all teams were equally talented. A popular measure of cross-season balance is the Herfindahl-Hirschman index, which shows how concentrated championships are. Economic theory predicts that free agency will not affect the distribution of talent in a sport as long as the team owners maximize profit, players maximize income, and transaction costs are low. Sports leagues have implemented policies such as revenue sharing, salary caps, luxury taxes, and the reverse-order draft to increase transaction costs and limit the movement of players from small-market to big-market teams. These measures have met with uneven success.