One question that has perplexed basketball fans since before the current NBA labor strife commenced is why do so many teams consistently overplay players? Washington Wizards forward Rashard Lewis is often cited as the quintessential example of this problem, but he has plenty of company. From Eddie Curry to Rudy Gay to Joe Johnson, NBA owners and general managers have made a habit of offering astronomical salaries to players whose abilities simply don’t justify that level of compensation.
Given that teams consistently mismanage their payrolls, it’s easy to understand why fans feel little remorse when NBA owners claim the league’s current economic structure is causing them to lose money.
It may be impossible to fully understand why the practice of overplaying players has become so prevalent, but a fascinating Washington Post article about a different subject may shed some insight into why it continues to occur.
The article, titled “Cozy relationships and ‘peer benchmarking send CEOs’ pay soaring,” is not about the NBA. It examines one theory behind why executive compensation in America continues to rise at exponential rates. I won’t regurgitate the entire article, but the primary argument made by the author is that boards of directors for many large, publicly traded companies determine executives' salaries using a practice known as “peer benchmarking.” This practice does not consider how a company performed under a CEO’s leadership, but rather, sets the pay level “at or above the median of their peer group.”
The logic behind this approach is that the best way to retain supposedly talented executives is to put them in a pay class with the best of their peers. Even if a CEO's accomplishments do not rival those of his most successful peers, raising his or her level of compensation is viewed as a way to ensure retention. As the article states, “A chief executive’s pay is more influenced by what his or her “peers” earn than by the company’s recent performance.”
The connection between this issue and NBA franchises overpaying players may not seem immediately apparent, but take that sentence and replace the words “chief executive” and “company” with “player” and then consider the situation of the Atlanta Hawks when they offered Joe Johnson a max contract after the 2009-10 season.
Johnson joined the Hawks in 2005, signing a five-year contract worth $70 million—an average of $14 million per year. His productivity peaked in the 2006-07 season, when he averaged 25.0 ppg. At that time, he rightly acquired a reputation as one of the league’s premier shooting guards, putting him in a peer group with players like Kobe Bryant, Ray Allen and Dwyane Wade.
Johnson’s productivity declined for the next three seasons before he became a free agent after the 2009-10 season. Many basketball pundits and analysts named him as one of that summer’s most coveted free agents and predicted he would receive the maximum amount of money allowed under the NBA’s collective bargaining agreement.
This is where conventional logic for determining someone’s pay and the peer benchmarking method start to diverge and where it becomes reasonable to surmise that NBA owners and general managers are copying the practices of their colleagues in corporate America.
Conventional logic would have led the Hawks management to conclude that Johnson did not merit a max contract. He was 30 years old and his productivity had been on the decline. With Johnson as their best player, the Hawks had never advanced past the second round of the playoffs. Maximum contracts take up a significant portion of a team’s designated salary cap and should, in theory, be reserved for superstar players like LeBron James or Dwight Howard.
Superstar players are like the top-notch CEOs of a basketball team because they possess the ability to almost single handedly turn a team into a championship contender. There are only a handful of legitimate NBA superstars—just like there are only a handful of truly great CEOs (think Eric Schmidt and the late Steve Jobs)—and teams that cannot sign such a player would be better served using their money to retain lots of very good players, a model used by the 2004 NBA Champion Detroit Pistons.
Johnson was never a superstar. During his time in Atlanta, the Hawks were never championship contenders despite the fact that Johnson had a talented supporting cast. His level of play did not warrant a max contract offer, and some pundits understood this.
If, however, the Hawks were determining Johnson’s salary using a system similar to peer benchmarking, then it becomes easier to understand why he received such a sweet deal. As I already mentioned, Johnson had, for some years, been considered one of the NBA’s best shooting guards. Many of the other top shooting guards, like Kobe Bryant, were already earning top dollar.
During the 2010 offseason, two other guards in that peer group, LeBron James and Dwyane Wade, were also free agents, and both were expected to command max deals. So if the Hawks management believed, or at least accepted, the fact that Johnson was considered an elite guard, and if they were determined to retain his services with as little hassle as possible—which seems obvious considering there were never any credible stories suggesting Atlanta’s management was looking to replace Johnson or initiate a sign-and-trade with another team—than raising his level of compensation to that of his best peers, like Wade and Bryant, was a reasonable approach.
I say reasonable not because I agree with the Hawks strategy—I’m mortified every time a franchise overpays a player by tens of millions of dollars—but it falls in line with the type of thinking that permeates the business community. Talk to any business consultant, and he or she will tell you that retention, especially at the top levels of a company, is viewed by most experts as critical to a company's continued profitability. This is especially true in publicly traded companies, where CEO turnover can rock stockholder’s confidence.
Whether or not corporate America overvalues retention is a debate for another day, but it seems as if NBA teams, most of which are owned by individuals who started their careers in the business world, also value retention and use a method similar to peer benchmarking to retain their players. They may think this is the best way to proceed, but the reality is that this type of decision making is crippling NBA franchises.
Anyone who has rooted for a franchise that has significantly overpaid players knows that one bad contract can spell doom. Take the Washington Wizards, for example, who have not made the playoffs since they gave Antawn Jamison and Gilbert Arenas bloated contracts during the 2008 offseason. Jamison was a player on the decline, much like Johnson, and while Arenas had yet to bring guns into the locker room, he was recovering from knee surgery and facing an uncertain prognosis.
Offering Jamison and Arenas huge contracts put the two players at the top of their peer groups and gave them an incentive to stay in Washington. It also crippled the Wizards finances by taking away the franchise's ability to add the role players necessary for continued success.
The primary difference between businesses and NBA franchises is that businesses don’t operate under a salary cap structure. If a CEO underperforms at a level that cripples a company, the board of directors can negotiate a severance package and move on.
It’s not as simple in the NBA. Since players’ contracts are guaranteed, teams have to honor the full amount of the original contact even if they cut a player, and those salaries stay on the books and count against the salary cap. A team can go over the cap and pay the luxury tax, but all these factors add up to such an array of financial disincentives that cutting overpaid players rarely happens.
As a result, fans of franchises that commit the sin of overpaying are forced to watch a team of overcompensated, underperforming players, and the NBA offseason is often treated as a fire sale to get rid of bad contracts rather than an opportunity to improve rosters.
Peer benchmarking, or any type of related method for determining compensation, does not work in professional sports.
The Washington Post article argues, peer benchmarking in the business community has contributed to the exponential increase in executive compensation, when every company tries to raise their CEO’s pay to a higher level the average level of pay climbs. This has happened in the NBA. It started when a then 21-year-old Kevin Garnett received an unprecedented $126 million in 1997, and the results continue to manifest themselves, e.g. Mike Conley Jr. receiving $45 million in 2010.
Now it has to stop. Owners need to find their common sense and stop overpaying players. Basketball teams are not an interchangeable kits of parts, but overpaying players just to ensure retention is contributing to NBA franchises’ supposed insolvency. If owners stopped this practice, they could pocket some of that cash and stop from sinking further into the red, and the NBA might even be able to proceed with the 2011-12 season.