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The winner's curse: expensive mistakes in free agency

Posted by Andrew Mooney  December 5, 2011 02:59 AM

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With their managerial search finally concluded, the Red Sox’ focus now shifts to filling holes in the roster through free agency, shoring up the pitching staff and adding a right fielder, ideally. Their limited needs suggest that the team will be relatively minor players this offseason, out of the market for free agency’s biggest prizes -- Albert Pujols and Prince Fielder, namely, now that shortstop Jose Reyes has signed with Miami. That may be a good thing; the teams that do ultimately land these players could very well be afflicted with the winner’s curse.

The winner’s curse is derived from a piece of auction theory, which states that, in a sealed-bid auction -- when each party knows only his or her own bid -- the winner will almost always overpay. The term originated in the 1950s, when competing oil companies placed bids on offshore drilling properties, according to their own independent appraisals. The only way the winning bidder -- the party that valued the oil field the highest -- received fair value on his investment was if every other bidder underestimated the oil field’s value. And as, in most cases, the median bids were closer to the property’s true value than bids at either extreme, companies virtually had to overpay if they were to own the oil field.

When wading into the free agent market, baseball teams are particularly vulnerable to the winner’s curse for a couple of reasons. First, the market for baseball players works much like the market in the oil example: each team must make its own independent assessment of a player’s future worth, something that’s incredibly difficult to predict with any certainty. Teams also have limited access to the estimates of their fellow bidders. To be sure of signing a player, they must make an offer that they anticipate will top anything tendered by the competition. And with many other prospective buyers contending for the same scarce supply of players, teams know they may have to venture outside their price range and pay a premium to stay in the race for these players’ services.

Secondly, and more dangerously, teams mistakenly pay for players’ pasts, and not their futures. Many top-notch baseball players’ best years are already behind them by the time they sign lucrative free-agent contracts. The average age of the 2011 free agent class is 33.8; by contrast, the average MLB player hits the peak of his prime at age 27. Even first-time free agents are required to have logged six seasons of big-league service -- generally, that includes the crucial 26-29 year-old period, in which a ballplayer realizes his potential to the fullest extent.

Exacerbating the problem is that, for a team to place the winning bid on a coveted free agent, it has to make a long-term commitment: four to six years, in many cases. Even if a player’s production exceeds expectations during the first couple years of his contract, it’s very difficult to obtain good value over the duration of the deal. Just ask Yankees management whether A-Rod’s been worth $65 million the last two seasons.

The way to beat the winner’s curse is, first of all, to acknowledge its existence. When teams recognize how often these bad contracts are given out, they should -- assuming they are rational actors -- fine-tune their methods of player evaluation and steer clear of long term deals to aging players. Eventually, free agent contracts would begin to more accurately reflect the underlying value of the signing players. Yet the winner’s curse is not a totally foreign idea; Baseball Prospectus covered the phenomenon as far back as 2002. And, as recent history indicates, MLB teams have learned just about zilch.

A look at free agent contracts soon to be or just recently completed can provide some insight into the pitfalls of the winner’s curse. From 2006 to 2009, 20 players signed deals worth over $50 million -- an arbitrarily chosen threshold, admittedly, but one that, in all cases, represents an expensive, multi-year agreement. (Note: included among these were contract extensions, which, as a form of long-term commitment to an established star, work essentially the same as free agent contracts for my purposes.)

The list below is enough to make any GM entering this week’s winter meetings think twice about opening his wallet. As measured by WAR, only seven players of those 20 ever recorded even one season as productive as the one immediately preceding their new deal: Cliff Lee, Manny Ramirez, J.D. Drew, Gil Meche, Daisuke Matsuzaka, Torii Hunter, and Matt Holliday; and only four -- Lee, Ramirez, Meche, and Hunter -- had more than one such season. On the other hand, flops like Barry Zito, Gary Matthews, John Lackey, and Aaron Rowand testify both to the difficulties inherent in projecting players’ futures and the dangerously large financial commitments necessary to sign them.

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The next few weeks may well provide a few additional candidates for this list. José Reyes can’t stay healthy for a full season at age 28; imagine what his legs will be like at 33. Prince Fielder compares all too favorably with a certain other doughy, salary-guzzling slugger with whom you might be familiar. And even if Albert Pujols is the next Hank Aaron, it’s hard to justify committing $20-25 million to any 38-year-old.

It’s probably for the best that these players aren’t on the Sox’ wish list. Instead, Ben Cherington, Larry Lucchino, and crew will be content to remain secondary buyers, filling the few weaknesses in a still potent roster and avoiding the potential hex of the winner’s curse. After all, the Red Sox don’t need any reminding just how quickly this curse can strike.

This blog is not written or edited by Boston.com or the Boston Globe.
The author is solely responsible for the content.

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Stats Driven is powered by David Sabino, who over the last two decades has been a source of statistical analysis on the pages of Sports Illustrated, New York Times, and Chicago Tribune. David has written about all seven recent Boston-area championships for Sports Illustrated Presents commemorative issues, was the creator of such long time features as SI’s Player Value Ranking, NBA Player Rating and long running fantasy football and baseball columns.

He has also authored or made contributions to many books, including the Sports Illustrated’s 100 Fenway: A Fascinating First Century.

Now living in Marblehead, he’s focusing his attention on the Boston sports scene, specifically delving into the numbers affecting the Red Sox, Patriots, Celtics and Bruins, with the goal of informing and entertaining real fans. You can follow him on Twitter at @SabinoSports.

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