Micro Theory vs Reality: Baseball Edition

From James Kwak at Baseline Scenario:

“No, No. It’s Already Priced In. ” That was undoubtedly the response of theoretical law and economics devotees to the premature retirement of Kansas City Royals pitcher Gil Meche a few weeks ago, which we discussed in one of my classes last week. Meche signed a five-year, $55 million, guaranteed contract before the 2007 season, which would have paid him $12 million in 2011 simply for showing up, despite a broken-down shoulder that made him an ineffective pitcher. Yet Meche decided to retire, giving up the $12 million. Meche said this:

“Once I started to realize I wasn’t earning my money, I felt bad. I was making a crazy amount of money for not even pitching. Honestly, I didn’t feel like I deserved it. I didn’t want to have those feelings again.”

One of the topics of the class was non-economic preferences, particularly preferences for fairness, which have been a staple of psychology and behavioral economics over the past decade. Classical theory says that Meche should have kept the $12 million for two reasons. The obvious reason is that $12 million is more than zero, and almost certainly more than the disutility of having to show up to work for another eight months. (Although maybe his marginal utility of money is very low at this point, after four years of his big contract.)

The slightly less obvious reason, which is drilled into law students’ heads in the first semester, is that the risk of career-debilitating injury is already priced into the contract. On this theory, parties are free to bargain for whatever contract terms they wish. In Major League Baseball, the standard for free agent contracts is that they are guaranteed, meaning that they cannot be terminated due to injury (and, I believe, only for cause, where cause includes things like going to jail or getting injured in specifically prohibited activities like dirt-bike racing). So, the argument goes, baseball players chose to bargain for contract guarantees, and in return they are getting less of something else that they want — presumably less money. Put another way, the risk of injury is already priced into the contract. If a player goes through his contract without injury, and remains productive, the team is not going to pay him more money simply because of that. (The player will get more money eventually, either by renegotiating partway through or by getting a bigger contract at the end of the current one, but presumably that’s priced in as well.)

This all may be right. More importantly, it provides a powerful justification for taking the money. It’s hard to stand up and say, “I’m taking the $12 million because it’s in my contract, and I want it, and it’s legally mine.” It’s a lot easier to say, “Teams and players are free to contract however they want, and I accepted less money each year because I got a guarantee, so the $12 million is not only legally but morally mine — it’s just like the payout on an insurance contract, where the reductions in my salary each year were the premiums and the $12 million is the payout.”

So maybe Meche should have taken the money. But at the same time, theoretical law and economics doesn’t dictate our societal norms, at least not yet. As he said, “It’s just me getting back to a point in my life where I’m comfortable. Making that amount of money from a team that’s already given me over $40 million for my life and for my kids, it just wasn’t the right thing to do.” It sounds like he just decided he was happier without the $12 million than he would have been with it.