Testing for moral hazard in guaranteed contracts – Stiroh (.pptVIP

Testing for moral hazard in guaranteed contracts – Stiroh (Economic Inquiry, 2007) Guaranteed contracts are paid in spite of performance, and indeed despite injury. Question: do players who get them shirk? Arguments against: Employers should be able to anticipate shirking, and adjust contracts accordingly. But: shirking takes place by low effort, and it is difficult to differentiate effort and skill. Future contract value can be negatively affected by shirking during the current one. If players do shirk: A longer-term contract provides more security, hence should yield more shirking. Older players, with less to fear from lost future earnings, should shirk more. Shirking should to a greater extent involve unmeasurable activities. Question 1: Test whether value of free-agent contracts depends on productivity in contract year Regress contract value, length and annual salary (separately) on player’s historical performance, whether he is in contract year, age, position. Results as expected. Question 2: How does performance depend on contract status? Moral-hazard hypothesis predicts rising performance in contract year, declining performance in first year after signing. Problem: perhaps rising performance in year before free-agent contract signed is a selection problem; only those who are improving get these contracts, so of course they would have great performances in prior year. Solution: if this hypothesis is true, they should continue to improve in first year of new contract. Results: performance consistently increase in contract year, and frequently (depending on precise econometric specification) fall in first year of new contract. Question 3: Are teams affected by contract status of all players? Test: Regress team winning percentage (in 2000) on percentage of players in contract year, percentage of players with guaranteed multi-year contract, along with average player age and team payroll. Result: percentage of team with long-term contracts strongly and negativel