NFL Labor Peace Brings Employment Chaos: Business Class

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By Tobias J. Moskowitz

Now that labor peace is at hand in the National Football League, the real chaos is beginning.

There is an unusually narrow timeframe for teams to sign (or pass on) the hundreds of free-agent players who remain on the market. Thus, the next few weeks promise to be a caffeine-fueled free-for-all.

How can teams assign value on the fly to make informed decisions about acquiring and retaining talent? By Aug. 3, more than 460 free agents had already been signed or resigned, with many more still searching for teams.

In short, it's difficult,  as anyone who has ever had to quickly make hiring and firing decisions, or any sort of valuation, could attest. In  my book "Scorecasting: The Hidden Influences Behind How Sports Are Played and Games Are Won," which I co-authored with Jon Wertheim of Sports Illustrated, we described a study that examines how NFL teams fare on draft day. Without a doubt, draft day is the ultimate microcosm for assessing value quickly. The authors of the study, Cade Massey, a Yale University professor, now at the University of Pennsylvania, and Richard Thaler, a professor of behavioral economics at the University of Chicago, found systematic evidence that NFL teams overpay for high draft picks -- both in terms of salary and the opportunity cost of the other players they could have acquired for the pick.

Consider the 2004 draft: The San Diego Chargers chose Eli Manning with the first overall pick. The New York Giants, who held the fourth overall pick and were in the market for a quarterback, were faced with two very different options in the 15 minutes they had to make their selection.

Option one: Make a trade with San Diego –- a deal  in which the Giants would first draft Philip Rivers, swap him for Manning, and then surrender their third-round pick that year as well as their first- and fifth-round picks in the 2005 draft. Option 2: Trade their pick to the Cleveland Browns, who held the seventh pick (before they swapped their pick with Detroit). Then,draft Ben Roethlisberger with that pick, and receive Cleveland’s second-round pick in addition to drafting Roethlisberger.

The Giants chose the first option, which meant they effectively considered Manning to be worth more than Roethlisberger plus four additional players.

This struck the two economists as an extraordinarily steep price. After collecting data from the NFL draft over the previous 13 years -- looking in particular at the trades made on draft day and the compensation paid to top picks -- they found that the Manning trade was anything but unusual. As a matter of routine, teams paid huge prices in terms of current and future picks to move up in the draft. They also paid dearly for contracts with those players.

Not only did Manning cost the Giants four other players -- one of whom turned out to be the Pro Bowl linebacker Shawne Merriman -- but he was also given a six-year, $54-million contract. Compare that with Roethlisberger’s $22.26 million contract over the same span that he received from the Steelers for being the 11th overall pick. Thaler and Massey found that historically, the No. 1 pick in the draft is paid about 80 percent more than the 11th pick over the course of each player’s initial contract.

Do the values match performance? The researchers compared the values teams placed on picks with the actual performance of the players. They then compared those numbers with the performance of the players given up to get those picks. For example, in the case of Manning, how did his performance over the next five years compare with the aggregate performance of Rivers and the players chosen with the picks the Giants gave San Diego? Likewise, how did those numbers stack up against Roethlisberger’s stats and those of the players the Giants could have had with the additional picks they would have received from Cleveland?

Certainly, higher picks are better than lower picks on average. But the problem is that they aren’t that much better. For instance, how much better is the first quarterback taken than the second or third quarterback? Not much. Looking position by position, they concluded that the probability that the first player drafted at a given position is better than

-- the second player drafted at the same position is only 53 percent;

-- the third player drafted at the same position is only 55 percent;

-- the fourth player drafted at the same position is only 56 percent.

Yet teams will end up paying, in terms of both players and dollars, as much as four or five times more to get that first player relative to the fourth player. And, this pattern persists year after year.

The problem is that teams (and humans, really) aren't very good at valuing talent. We tend to be overconfident in our ability to do so, especially when value is uncertain, and even more so when in a bidding war. We're sure that athlete is a "once in a lifetime player," a phrase invoked multiple times in every single draft. The reality: It's hard to know whether you're getting a franchise player or a bust. What is certain is that you will pay through the nose for a top pick.

Eli Manning's older brother, Peyton, provides one of the best examples. In the 1998 draft, opinion was split as to who was the better quarterback, Peyton Manning or Ryan Leaf, but there was wide agreement that they would each transform the franchise that obtained their rights. While Peyton is currently on pace to break every conceivable passing record, Leaf is out on bond for burglary and drug charges and hasn't played in the NFL since 2001. Or, put differently, ask anyone under the age of 25 who Ryan Leaf is.

So, how do teams know when they're getting the next Peyton Manning or the next Ryan Leaf? They don't. Consider that of the last 13 No. 1 picks, 10 have been QBs. Now look at the names and judge for yourself whether teams are better than a coin flip at picking the top player: Tim Couch (1999), Michael Vick (2001), David Carr (2002), Carson Palmer (2003), Eli Manning (2004), Alex Smith (2005), JaMarcus Russell (2007), Matthew Stafford (2009), Sam Bradford (2010), and Cameron Newtown (2011). All were expensive.

So, what should teams do? Thaler and Massey advocate trading down. If teams are willing to overpay for high draft picks, you can find tremendous value trading those picks for more second- and third-rounders. (Two teams that have done so consistently: the Philadelphia Eagles and the New England Patriots. They also seem to be the clear big winners in this off-season frenzy so far. Coincidence?)

With the new Collective Bargaining Agreement in place, will this trend persist? It will probably intensify. The new bargaining agreement limits the amount teams can spend on first-round picks, making them even more attractive (for example, compare Cam Newton's four-year, $22 million deal to Sam Bradford's 6-year, $78 million contract). While teams will be able to get top picks at lower prices, those same picks as a result will almost surely be worth more players. Thus, trading down should be even more effective.

While the NFL draft is over, the shortened free-agent market and frenzied bidding period can be expected to exhibit some of the same tendencies. Even more so when it comes to re-signing players, since we tend to covet what we have more than what we don't have. Exhibit A: The Carolina Panthers re-signing most of their free agents -- a team that went 2-14 last year -- to overpaid contracts. On the flip side, the Eagles and Patriots have cut more players than most teams, avoiding the tendency to overpay. There will be opportunities to find underpriced talent but, with the added time pressure, likely many more traps to overpay. How else can you explain the eighth-best punter, Michael Koenan, getting $19.5 million?

(Tobias J. Moskowitz is professor of finance at the University of Chicago Booth School of Business and a contributor to Business Class. The opinions expressed are his own.)

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-0- Aug/05/2011 02:16 GMT