In this article by Michael J. Enz, Jonathan Murphy, and James E. Tienery, the three professors apply George Akerlof’s market for lemons theory to baseball, and specifically the free agency market. Just like Akerlof’s study of the used car markets, MLB free agency is one with plenty of uncertainty surrounding a player’s future production quality combined with asymmetric information. According to their research, free agents were actually outperformed by the rest of the league in three of the four statistical categories they focused on for position players, despite the fact that “free agents are supposed to represent the top 40% of the players” in the league. For pitchers, the league average was better when measured in DICE ERA (a statistic that reduces the “luck” factor when measuring a pitcher’s quality and efficiency) than by free agents.
What is the market for lemons theory? It’s a economics/networks/game theory that examines the used car market to explain other market interactions and relationships. The hypothetical used car market is one with only lower quality cars, or “lemons,” available as the high quality used cars aren’t available. 1/3 of all used cars are good cars, 1/3 are bad cars, and 1/3 are lemons. When a used car seller and used car buyer meet, only the seller knows the true quality of the car. Therefore, the buyer will offer a price that reflects the random possibility that they receive any of the three quality of cars.
Let’s say the buyer is willing to pay $12 for a good car, $6 for a bad car, and $0 for a lemon.
Let’s say the seller is willing to accept $10 for a good car, $4 for a bad car, and $0 for a lemon.
The buyer’s offered price that reflects the randomness of the car’s quality = (1/3 * 12) + (1/3 * 6) + (1/3 * 0) = $7
This offering price of $7 eliminates the possibility of buying a good car however, because the seller would not accept any offer for a good car less than $10. So now suddenly, the market has devolved into a market for strictly bad cars and lemons, which also now changes the buyer’s offering price since the probabilities have changed.
The buyer’s new offering price = (1/2 * 6) + (1/2 * 0) = 3. But again, their new offering price of $3 is less than the seller’s willingness to accept for a bad car, so the buyer will only be able to make a deal with someone selling a lemon and can only have the expectation that the car they’re buying is a lemon, and the buyer does not want a lemon. Therefore, the market has completely collapsed so nothing of value is traded. So no buyers and no sellers are going to end up happy. This is why sellers use market signals as an incentive to distinguish their car over other cars (like a certified pre-owned guarantee or insurance, etc).
Want a recent example of this in the MLB? Notorious baseball agent Scott Boras has recently advocated on free agent centerfielder Jackie Bradley Jr.’s value by telling reporters “JBJ is kind of the PBJ of the Major Leagues. He’s sweet, smooth and spreads it all over, covers it well.” Whatever that means, it was done with the intention of garnering attention for his free agent client and distinguishing JBJ over other free agent centerfielders.
Applying this to the MLB free agency market, especially with the data used by the three gentlemen in the article, it is quite easy to see how MLB free agency can also be described as a market for lemons. MLB teams and their front offices are becoming more and more hesitant to sign free agents to huge deals given the risk and uncertainty that is associated with the market as a whole. The 2018 offseason market was particularly interesting, as even some of the largest free agents remained unsigned prior to the start of spring training. There were so many free agents leading up to the spring training season that the MLB actually created an additional spring training camp exclusively for free agents to begin training at the same time as the rest of the 30 MLB teams.
I wrote this article in 2018, unaware at the time that I was pretty much describing a market for lemons, and much of my frustrations as a baseball fan were shared by agents, players, and the MLBPA. The MLBPA actually even considered a collusion lawsuit against team owners for the sheer amount of free agents that remained unsigned into the start of the regular MLB season. A number of factors may have contributed to the quantity of unsigned free agents, but as players have recently increased their demand for larger contracts for longer durations, teams have become more and more reluctant to spend big during free agency like in the past. It may be because teams themselves are noticing that the free agency market truly is a market for lemons.
In recent years, it makes sense that the free agent market is underperforming compared to the rest of the league, according to the articles data, as teams are opting towards extending a superstar’s contract before it expires rather than allow their team’s superstar to hit free agency and be pursued by other teams. Free agent players also want longer contracts for more money, but teams are not willing to offer that (with rare exceptions for superstar players, however with plenty of examples of superstars falling off a cliff performance-wise after signing a huge free agency contract, even those super contracts are becoming more and more rare). So each side of the market is nowhere near equilibrium, and players, whether good or bad, are not willing to accept below a certain level of pay and duration, while teams are not willing to risk the uncertainty of a low quality market with large pay and multi-year contracts – or essentially the definition of a market for lemons. The market equilibrium is unobtainable and only superstars with consistent MVP-level performance acting as their market signal are able to reach deals with teams. Instead, other free agents are forced to accept contracts that may undervalue them because the free agency market isn’t balanced.
Looking beyond simply the free agency market, Major League Baseball is constantly filled with asymmetrical information that drives front offices to spend countless hours analyzing prospects, big name players, and even high schoolers. In 2019 alone (the last 162 regular game season for the MLB), there were 1,410 players that made an appearance in an MLB game, and that does not include the various players called up throughout the season but who never played any innings (an MLB team has a roster limit of 25 individuals). MLB General managers and front offices have probably some of the most difficult jobs in terms of talent evaluation of any “job recruiters.”
For example, the MLB has the largest draft of any major American sports league by far, with 40 rounds including supplemental/compensation picks within each round that are awarded based on regular season transactions. In the 2011 MLB draft, the Tampa Bay Rays had 60 draft picks throughout the 40 rounds. To complicate things even more, an individual can be drafted right out of high school, out of college, or from an international draft as well even. The level of attention required for the draft is unfathomable and the amount of scouts each team has can range from 40 to 50 individuals, roughly the size of the rest of their front office. Plus, specifically within the draft, the talent that a prospect goes up against is extremely difficult to quantify and compare with other prospects. How does one compare the talent pool in high school baseball in Maine for a top draft prospect against a similar draft prospect playing against SEC college pitchers? The draft market is not necessarily a market for lemons, but the amount of asymmetrical information that scouts and front offices must sift through when ranking their draft prospects is unbelievable. Especially as the push towards advanced analytics is reducing the amount of traditional talent scouts and instead pushing more towards the talent scouts demonstrated in the film Moneyball. Scouts are no longer former baseball players, but instead are young tech and data analysts that applying high level mathematics and statistics to even the most obscure baseball prospect. Does it always work however? No, not at all. Having numbers to back up decisions is definitely more comforting, but when those numbers are predictive analysis for players that have limited market signals, it is not increasing the confidence of the entire market for lemons but instead increasing the confidence of specific buyers (teams) while simultaneously reducing the power of sellers (the players/prospects).
This reversal of power within the prospect market is causing teams to make assumptions about cars based on often immeasurable statistics. Referring back to the market for lemon cars, if a buyer decided to study used cars and find their own anecdotal evidence that Toyota Camrys perform best on highways, then the value for Toyota Camrys would artificially inflate while all other used cars are given reduced valuations in comparison. So in the search for more market parity, instead the buyer actually increased the distance from equilibrium of the overall market. Back to baseball – drafting a high school pitcher from California first overall because of an MLB’s teams recent analysis can increase market imperfections, especially when that player is completely unproven against college level hitters, minor league hitters, and especially major league hitters. California baseball hitters could be deceivingly awful, but the amount of market imperfections just greatly increased because of the anecdotal analysis that a team just performed and acted on.
MLB general managers and front offices have objectively extremely difficult jobs, and the various markets in which they operate makes their jobs even more difficult because they can be very easily described as markets for lemons. Plenty of good cars do exist, but given the presence of bad cars and lemons, the market is unbalanced and all actors except the lemons suffer as a result of the uncertainty and risk. Market signals like past performance, past injuries, advanced statistics, and demand from other suitor teams can help reduce the noise within the market, but the overall free agency market and draft prospect market for professional baseball is most definitely an example of a market for lemons.