The Valuation of Athletes as Risky Investments: A Theoretical Model

Abstract

The desire to hire the best athletes and coaches in order to maximize team performance necessitates generous compensation contracts, which in turn increase the risk of financial distress or even bankruptcy for team owners. Indeed, one of the largest expense items in the budget of professional sport teams is the remuneration of players and coaches. Yet an investment made today in a given team yields an uncertain income in the future because team profitability depends on the uncertain performance of each player and the synchronization among players—both influenced by the coach. We present a formal theoretical model that assesses athletes’ valuation and accounts for the aforementioned factors. The optimal compensation schedule is determined empirically by regressing expected performance measures of each player with the aggregate team performance. Once the optimal schedule has been determined, the expected rate of return for the owner is earned at the lowest possible risk.