Implicit Leverage in the NBA

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"Implicit Leverage in the NBA"

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Arturo Galletti explains an under-understood element of NBA contract structure: “a typical NBA contract is structured around a base year salary and an 8% increase by Year. This means for example that a five year contract for $25 million (like the rumored Miller deal) only counts for 25 divided 5.8 or 4.3 million against the cap.”

One question to ask yourself is what underlying model of the economy justifies the idea that annual guaranteed 8 percent raises should be should be “typical”? It would make sense if you thought there was reason to project 8 percent nominal revenue increases for every franchise, but that doesn’t really make sense. Or if the players being signed consistently got better with every passing year. But that’s not the case. NBA player performance peaks, on average, at age 25 which means that with the exception of rookies signing their first contract extension you’re normally talking about purchasing a depreciating asset. The result is that teams time and again find themselves signing contracts that are fine for now, but turn into millstones within a few years.

Part of the issue, pretty clearly, is an agency problem. General Managers are likely to get fired now if their teams fail to improve. Consequently, dealmaking in both the free agent market and the trade market discounts the future at an irrationally high rate.

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