Analyzing the 2016 NBA Free Agency from an Economic Principle Viewpoint

Many NBA fans would describe the 2016 NBA Free-Agency period as one of the craziest free-agency periods in NBA history. The NBA Finals runner-up Golden State Warriors, who set the NBA record for the most wins during the regular season with 73 wins during the 2015-2016 season, made the biggest transaction when they signed superstar Kevin Durant away from the Oklahoma City Thunder.

However, the 2016 free-agency period was more well-known for numerous free-agents receiving very lucrative contracts, which included players receiving max contract offers based on the number of years the team and player agreed to. A max contract in the NBA means players can receive up to 25%, 30%, or 35% of the team’s salary cap, based on the player’s respective NBA playing experience.

The soft salary cap for all 30 NBA teams sharply increased from $70 million to $94.143 million, a 34.49% increase, which resulted in the highest increase in total salary cap and percentage in NBA history. As a result of the sudden increase in available money teams now possessed to sign players, most free agents got a huge increase in their salary. ESPN.com’s NBA Inside Reporter Marc Stein shocked many NBA fans when he reported that Memphis and Mike Conley agreed in principle on a five-year, $153 million deal, league sources say. Although Conley has developed into a very respectable above-average point guard for the Memphis Grizzlies, nobody considers him a household name by any means; he has never made an All-Star team, All-NBA team, or USA Olympic basketball team. Therefore, many fans and even some players wondered why teams were willing to pay players like Conley the same amount they would have had to pay superstars like LeBron James, Kevin Durant, or Stephen Curry anyways.

The sudden salary cap increase created an illusion that teams overpaid for many free agents this off-season. I will analyze the sole external factor that explains the sudden increase in player’s contracts during the 2016 NBA free-agency period by utilizing basic economic principles. The analysis will also show how players, who were considered to be overpaid, actually received equilibrium market value salary, while NBA superstars were the ones who did not receive their equilibrium market value salary.

The main external factor that led to the sudden increase in salary cap and players’ salary was the new television contract. On October 7, 2014, the National Basketball Association agreed with both ESPN/ABC and TNT Sports to by far the most lucrative television contract in NBA history; they agreed to a 9-year, $24 billion contract, an average of $2.66 billion per year, beginning from the 2016-2017 NBA Season, for ESPN/ABC and TNT Sports to have exclusive rights to broadcast nationally televised NBA games. To put it in perspective, the previous television contract the NBA agreed to with ESPN/ABC and TNT sports totaled $7.5 billion over 8 years, or an average of $940 million per year. The new TV contract increased NBA’s annual revenue from television contract by 283% from its previous television contract.

As a result of the sudden increase the NBA received from the new television contract, it was more than certain that team salary cap would significantly increase, leading to NBA players receiving a share of that TV revenue. Although the NBA proposed a “cap-smoothing” proposal, which would have artificially lowered the salary cap for it to increase at a more gradual rate, the NBA players union unanimously rejected the proposal. As a result, a sudden increase occurred.

Before the 2016 free-agency period, the salary cap for NBA teams increased only steadily from 2012-2016. Therefore, only minimal change occurred on the supply and demand curve and its market equilibrium level. The supply curve represents the number of players who can provide the same or greater level of productivity in comparison to the given player. However, the demand curve, represented by the amount teams are willing to spend on a player based on the number of players who can replace that respective player’s productivity, could shift by various factors, such as the new television contract, Meanwhile, the price ceiling represents a limit on how much each individual team can sign a player for, known as the max contract.

During the 2016 free-agency period, superstars like Kevin Durant and NBA Champion LeBron James signed new contracts. However, their annual salary is well below their equilibrium market level because the new salary cap increase shocked the NBA economy. The demand curve for most free agents shifted significantly to the right, since more teams had more money available to spend on individual players.

Analyzing Memphis Grizzlies’ PG, Mike Conley, and new Warriors Kevin Durant’s contracts will explain, in economic context, how so many more players received max contracts. Conley, as previously mentioned, re-signed with the Memphis Grizzlies for five years and $153 million, which is $30.6 million annually. Meanwhile, Durant signed a two-year contract for $54 million, which is $27 annually. Although Durant is worth more than Conley at an equilibrium market level, Conley received the same level of salary as Durant.

Let’s analyze Mike Conley’s supply and demand curve (Figure 1). During the 2015-2016 NBA season, Conley received $9.56 million. Although Conley’s supply curve marginally shifted left due to his increased productivity in comparison to his peers from previous years, we will not shift his supply curve for this explanation. The new TV contract shocked the NBA economy, and significantly shifted the demand curve to the right since owners suddenly had significant amount of additional money to spend on players. As a result of the increase in demand due to the increase in salary cap, Conley’s market equilibrium value equaled approximately $30 million, which was the maximum amount of salary he could receive based on the number of years he signed for.

Meanwhile, Durant’s supply and demand curve graph will explain how the new television contract and the individual player’s salary restriction (maximum contract) economically compromised him significantly. Durant signed with the Warriors for 2 years and $54.3 million, which is comparable to Conley’s salary on an annual basis. Since Durant produces more on the court compared to Conley, Durant’s supply curve is displayed significantly further to the left; a significantly few number of players can replace Durant’s productivity. If you look at Figure 2, Durant’s equilibrium market value is significantly higher than the price ceiling. Therefore, Durant was not able to receive his market value from the Warriors.

The basic economic principle of supply, demand, and price ceiling (max contract) should help fans and some players understand why teams had no choice but to pay a lot of players the same salary they would have had to towards superstar players. Even role players and bench players received a significant salary that would have been equivalent to what an NBA superstar would have received during the 2014 Free-Agency period.

For those who became furious that Kevin Durant would sign during this off-season, they should understand why the Warriors were so economically incentivized to replace former starting SF Harrison Barnes, a fantastic role player for the Warriors. While Durant signed for 2 years, $54 million, a salary significantly below his market equilibrium value this off-season, Barnes signed with the Dallas Mavericks for 4 years $94 million, his market equilibrium value, which is relatively close to Durant’s annual salary. From an economic standpoint, the Warriors will definitely receive much more production from Durant for what they paid him, compared to the production they would have received from signing Barnes. Economically, the significant increase in salary cap explains why the Warriors had to sign Durant, while simultaneously considering many other factors to build this team.

During 2016 free-agency period, NBA teams spent approximately $3.5 billion to sign free-agent players to contracts. In comparison, teams spent approximately $1.2 billion to sign free-agent players to contracts before the NBA agreed to the new television contract with ESPN/ABC and TNT Sports. The result of the increase in money teams had to spend on free agents resulted in a 291% increase this free-agency period compared to 2014 free-agency period.

Overall, many teams had to spend the over-abundance of salary to acquire or keep their own free agents. As a result, a lot of average and above-average players received very hefty contracts. Although NBA superstars received a raise in salary on new contracts, they were unable to receive their market equilibrium value, relative to many players below their skill level. As teams will have less available capital to spend on free-agents during future free-agency periods, player’s economic value should decrease back to a more reasonable equilibrium where all players would receive a market equilibrium salary in respective to their production. It will be very interesting to predict which other main factors would make a significant impact from an economic principle.

 

One Reply to “Analyzing the 2016 NBA Free Agency from an Economic Principle Viewpoint”

  1. Good stuff! It would be interesting to see how Durant and Conley would be paid if there were no price ceiling. You could say max salaries take money from the LeBrons and Durants of the world and distribute it to the rest of the league.

Comments are closed.