On Thursday, August 6th, Indians team President Paul Dolan met with the press to discuss a variety of issues relating to the financial health of the franchise and the impact of their recent trades. During that meeting, Dolan projected that, due to a variety of factors, the Indians’ franchise would lose $16M this season.
The problem is that if sports economics has any credence, this statement is almost certainly garbage of the highest order.
In order to understand how that can be, we have to once again enter the labyrinth of sports finance - and in particular, the shady things that any pro franchises can legally do with their books.
Chapter 1: Paul Beeston and the Magical Loss Conversion
Earlier this decade, then-VP of the Toronto Blue Jays, Paul Beeston, made a statement that has since become the centerpiece of practically every serious discussion of baseball economics:
“Under generally accepted accounting principles, I can turn a $4 million profit into a $2 million loss, and I can get every nation’s accounting firm to agree with me.”
This is the primary problem with the Dolans’ claim. The accounting practices in professional sports - specifically, Major League Baseball - are so serpentine and two-faced that owners can make statements that are technically true while simultaneously running completely counter to The Big Truth.
This is not quite the same as Bill Clinton inventing a new way to smoke marijuana, but it’s close.
The core enabler of this problem is the following absurd reality: Major League Baseball is exempt from all US anti-trust laws. In other words, they have been given a green light to operate as a monopoly.
I won’t go into the whole legal history that established this exemption. Suffice it to say that in the early 1920s, Congress claimed that baseball did not qualify as interstate commerce. A 1922 US Supreme Court ruling upheld this protection. In the decades since, the Supreme Court has shot down all lawsuits aimed at unshielding MLB…on the basis that because Congress granted the original exemption, Congress has to be the body that overturns it.
Of course, Congress is too concerned with the BCS to worry about professional sports. And in true recent Congressional fashion, they’re even managing to miss the big point there - but that’s another column.
The anti-trust exemption and a variety of other tax and accounting loopholes create a plethora of options for MLB ownership to distort their earnings. Below is a greatest hits list, which I will have to continue tomorrow.
1) Salary Depreciation
(Note: An advance thank you to Robert Whiting, the first writer I was able to find who could explain this concept simply but without sacrificing the details. Whiting primarily writes about Japanese baseball and its intersection with American baseball. I’ve read his book The Meaning of Ichiro and highly recommend it for any modern baseball fan.)
If you’re employed right now, I can guarantee you that your boss is looking at every possible loophole that will allow him to reduce his company’s tax bill this year - especially “in this new economy.” One of the best ways to reduce his corporate taxes - especially if he’s actually heading an extremely profitable company - is to use accounting tricks to show that the company is “actually” running in the red. Your state and federal government can’t tax your profits if they don’t exist.
But while they may be desperate, one thing that your boss will not and cannot do is to write off his employees’ salaries as losses cutting into revenue. If he tried this, within a matter of seconds the IRS would be jumping out of trees on the guy like it was a kung fu movie.
However, there are 30 business owners in the US who were exempt from these rules for a limited time. Who were they? The owners of the 30 MLB franchises.
Here’s something Bud Selig doesn’t want you to know: when an ownership group buys an MLB franchise, they get to take advantage of something called salary depreciation. From what I can tell, the basic reasoning is that a baseball owner’s most skilled employees - the players on their roster - are being paid for skills that can only decline over time. As a result, the owners are getting a fundamentally bad deal on the contracts to which they’re signing these employees and are thus entitled to a subsidy.
I’m not saying for a moment that I agree with this rationale, mind you. I’m just saying that this seems to be the justification.
The size of the subsidy ownership receives is staggering. For the first 5 years after purchasing an MLB team, ownership is allowed to amortize up to 50% of the purchase price on the basis of salary depreciation. What does that mean? When the Dolans bought the Tribe before the start of the 2000 season for a record $320 million, they already knew they were going to be getting a hefty savings over the long run. Specifically, they knew that from 2000-2004, they were going to be able to credit a $32M annual loss on their books, which would almost certainly be enough to show the organization operating in the red (more on this later). In the process, the Dolans would save millions in tax money, making the business of owning the Indians more profitable than it should be.
Obviously, the Dolans’ salary depreciation honeymoon is now over. But the point is that it was in place for 50% of the time that they’ve held the franchise. And the great trick of this whole franchise valuation / accounting game is that because the economy is so jacked up right now, owners only want fans to look at the short term. The last thing they want is for people like me to dig back and start looking at their cumulative earnings since they took over the team - but that’s exactly what I’m going to try to do later in this post.
That said, because this whole expose is growing at the same rate as the federal deficit, you’ll have to wait until tomorrow for that portion.
2) Ownership salary
D. Stanley Eitzen notes that another economist named Richard Sheehan has revealed that franchise owners have another unique little tool to misrepresent the financial state of their teams. Each owner normally pays himself an annual salary which, as with most other heads of corporations, is not small. There is no cap on this number - owners can pay themselves whatever they want.
The kicker, though, is that whatever the salary, it appears on ownership’s balance sheet as a “business expense” that cuts into the team’s profits. Much like the fraudulence of revenue sharing (which I discussed in my lengthy “Mythbusters: Franchise Ownership Editoin” post a few weeks back), these ownership salaries are just another means for the owner to pocket cash for personal gain.
But in this case, the salary provides a double bonus: not only does the owner get to keep the money, but he can also use that huge “business expense” to save himself serious tax dollars and to endear himself to the fans by showing that he’s basically a philanthropist. Who else would be so willing to take a major financial hit in order to help the deserving fans of the home city fight for a championship?
Eitzen references a point in the early ’80s where George Steinbrenner paid himself a “consulting fee” of $25M for - I kid you not - negotiating the Yankees’ cable contract. That figure appeared on the Yankees’ balance sheet as a $25M loss.
This, ladies and gentlemen, is why you hire accountants.
3) “Non-Cash” Charges
The third and final trick concerns another accounting term that I will try to distill into layman’s terms.
A ”non-cash” charge is an accounting expense only. That is, ownership doesn’t actually pay any money out to cover the expense. In layman’s terms, I believe it’s OK to think about it as an “assumed loss.” You as the owner estimate the devaluation of your goods and deduct that estimated amount from your revenue stream…even if it’s completely divorced from reality.
There are two main areas that MLB owners use this clause. The first is the minor leagues. The second is their ballparks.
According to Forbes, MLB teams have a tendency to tilt the lens in a favorable direction by factoring in the losses incurred by their minor league affiliates.
The trick? They don’t factor in minor league revenue.
It’s not immediately clear to me why they’re allowed to factor in the negatives without also applying the positives, but considering the source, I’m OK with assuming truth on this one.
As a reference point, the average MLB team claimed a $14M operating loss for associated with their minor league affiliate. But Forbes’ independent analysis concluded that the real number was something more like $8M - in other words, a 40% difference between what ownership wants their fans to believe and what’s true.
The other highly popular non-cash charge for MLB owners is ”stadium depreciation.” The basic idea is that (like those declining players) the ballpark they’re using gets crappier every year. The owners estimate a depreciation value and claim that value as yet another loss on their books. On average, that number ends up being more than $5M per team.
Is anyone sensing a theme here? You’ve got a day to think about it before I come back with Part 2.
On to Part 2
On to Part 3
-T
