Market Power

Musings by an academic economist on the power of markets and the power over markets.

Friday, March 18, 2005

Mariner's Accounting Income

From the Seattle Post-Intelligencer:

Despite posting their worst won-loss record since 1983, the Mariners reported net income last season of $8.74 million -- up from $2.85 million in 2003 -- further reducing the ownership's group cumulative losses to $108 million.

It's important to realize that this only reports accounting income, not economic profits. Economic profit is the difference between the total revenues that flow into the firm and the total costs that flow out, including the opportunity costs of the resources owned by the firm. According to the article, the M's made $18.5 million in adjustments to depreciation and amortization of debt. Depreciation does not represent a cash outflow from the firm. Instead, it represents an adjustment to an income statement in which the team writes off the cost of its fixed resources over a period of time.

Why is the accounting income so important?
The 2004 net income figure is significant because in five years of operating at Safeco Field, Mariners owners have seen their previous cumulative losses in the team nearly cut in half. A profit-sharing clause is triggered once those losses are wiped off the books.
Although they sound good, these clauses produce perverse incentives. For example:
Hale said the owners intend to put that money back into payroll this year, with estimates the team will spend more than $90 million this season and possibly operate in the red. The team has seen season attendance at Safeco Field drop more than 600,000 since 2002, with 2.9 million fans last season, down from 3.2 million in 2003.
Without such clauses, a profit-maximizing team will pay a player a salary that is no greater than his expected contribution to revenue. With the clauses, teams have an incentive to pay players salaries above their expected contribution to revenue in order to keep the clauses from going into effect. By "operating in the red", the owners of the Mariners put off the date when they must share their profits.