I'm (slowly) reading "The Signal and the Noise," Nate Silver's book on predicting. Silver first made his reputation in the field of sabermetrics before garnering greater attention for his analysis of political polling, and the book has a chapter on predicting the future performance of baseball players ... but that's not where this bit on "the winner's curse" is contained.
A basic econ class, and the instructor appears at the front of the lecture hall with a jar of pennies. The students are invited to bid on the jar. Some of the students will bid well under the amount of money contained in the jar; some will come close to the real worth -- but the one who actually gets the jar will always have bid more than he gets back.
This is the "winners curse," and it applies to auctions, whether of a work of art, a free agent pitcher or a jar of coins. The winning bid almost always overpays.
And, by extension, the bidders who come closest to discerning the true value don't get the prize.
This is is why most big-ticket free agent contracts backfire on the signing team. This is the secret advantage of the tightly-budgeted operations, who don't make an offseason splash by signing somebody to an eight-year, $170 million contract that will be mightily regretted three years down the road.
There are teams, to be sure, who operate financially in a manner that defies this basic economic rule. The Yankees. The Dodgers in the brief period (less than a year) since the new ownership took over. The Tigers, at least as long as Mike Illitch is desperate for a World Series parade. It would be foolish to deny that the wasted money brings a competitive advantage -- but that advantage is not a large as popularly believed, and the postseason field is seldom filled with the biggest payrolls.
Which is why there is seldom wailing and gnashing of teeth in this corner when the Twins decline to outbid other teams for this pitcher or that. Free agency, particularly at the highest levels of spending, is a sucker's game -- and a lot more expensive than a jar of pennies.
Acceptable - except when it is a selling point to garner enough support for a new stadium...
ReplyDeleteI would add that the entity placing the winning bid... whether it be the GM, the art collector or the kid in the econ class... can be assumed to be bidding no more money than they can afford. The kid may come out a few bucks behind. The art collector is likely more concerned about the joy of adding to her/his collection than whether s/he might be paying above value and, in any event, will bid no more than what the art is worth to her/him.
ReplyDeleteThe GM, similarly, must base any bid on a FA on what that pitcher's talent means to meeting that specific organization's goals and whether the organization has the financial resources available to "overpay" in order to win the bidding.
A team that never overpays can hold its head high and claim to have never made a bad business decision on a FA... but that's about all they'll be holding high because they're not likely to ever hold up a championship trophy.
It's been more than three decades since the advent of the free agency era in baseball. It's now simply a cost of doing business for those organizations committed to winning. That obviously does not yet include the Twins organization.