Moral hazard in long-term guaranteed contracts: theory and evidence from the NBA

In sports literature and reporting the ‘contract-year effect’ has been treated as anything ranging from an old wives tale to a well-established fact. We note many instances of players’ play falling off after landing a huge contract. In this paper we analyze the effect of being in the final year of the contract on player performance (as measured by the NBA efficiency index and using PER rating for a robustness check). Using the set of all NBA players from 1999 onwards we use a fixed effects regression model to determine that being in the last year of a contract causes a player to perform significantly better than in the year prior and that this effect is non-linear over the duration of the contract. We find that this effect is reduced for more experienced playersas players get further into their careers the change in performance level tends to flatten. We postulate a simple game theoretic model that forms the basis for and is consistent with the empirical results. This paper makes a contribution to the economics literature on career concerns and long-term contracts and should be of interest to sports agents, teams and athletes. MIT Sloan Sports Analytics Conference 2011 March 4-5, 2011, Boston, MA, USA