Risk Aversion and Sports Securities Markets (Or, How is Randy Newsom Like a Lemon?)
posted by Dave Hoffman
Larry Ribstein and Christine Hurt have highlighted a new investment opportunity: buying a share in a professional baseball player. (Slate follows the herd.)
The idea is the brainchild of minor-leaguer Randy Newsom, to date the only player who has offered his future earnings up for sale. (RSI is currently offering 4% of his future major league salary at the price of $50,00, $20/Share. 2,500 total shares.) As Newsom explains, the concept is a hedge for athletes:
“Minor leaguers can make as little as seven or eight thousand dollars a year. Some have families to take care of, some have to take jobs right away once the season is over to pay bills, and many of those that are a little better off still can’t afford some of the things that could help them reach the big leagues, like hiring a nutritionist or going to some of those expensive training institutes. With that in mind, I wanted to come up with a way that players could use their own upside earning potential to try to help their financial situation in the present and kind of lock in some of that earning potential, like insurance.”
I doubt that the company Newsom formed (RSI, L.L.C.) will be able to successfully assert that these “shares” aren’t securities due to be registered with the SEC. It looks like they are going to argue that even though they are advertising their wares to the public as tradable shares, what’s really being sold is two separate contracts. The first, between RSI and the player, gives RSI an assignable right to the player’s future income in return for some money down, and a right to sue the player for not working under limited circumstances. The second contract, between RSI and the “investor,” transfers that payment right and itself then may be traded as an option (?) on the “market” the RSI will create on its webpage. The result sounds like a mix between a prediction and a securities market. I have no clear idea how the SEC will treat it, though I’m pretty sure that simply warranting that buyers “agree that purchasing shares in a player is in no way considered a public offering as defined by the Securities Exchange Commission (SEC)” won’t be enough!
But who cares about the law. The question is whether these contracts are good investments? Steven Levitt says no. He thinks Newsom is identifying himself as a lemon by advertising his future major league earnings as $1.25 million or less (where the average annual salary exceeds $400 K). On this view, perhaps major league teams should use these kinds of “shares” to excavate private knowledge about player health and performance – players who sold themselves might know about a nagging elbow problem they didn’t want to tell the team trainer about; players who did would know that they had recently discovered an untraceable Andean fruit known for turning Juan Samuels into Ryan Howards. (Push past manipulation problems! Abramowicz does!). Of course, this suggests that the entire minor league trading market would go down the lemon-hole, as Jeff Na argued here.
But I’m not sure that this analysis is accurate. Why does Levitt so quickly discount risk-aversion as an explanation for Newsom’s desire to hedge himself? The five-year odds of a career-ending injury for a 25-year-old professional pitcher (even a submariner like Newsom) are high – I’d bet above 40%.* And the lifetime expected earnings of a 25-year old pitcher promoted to the majors are probably not much north of $2M. A rational player, under these circumstances, will accept only contracts that would provide him more than $1.2 M. But players, like all of us, are risk averse with respect to future gains, taking money now more often than not. It doesn’t seem crazy (to me) to a severely discount on a slice of your future profits if the payback is $50,000 today – especially if that $50,000 goes toward necessities like the mortgage. Risk aversion is a powerful bias!
* I actually have a buddy who probably knows this number like the back of his hand, and who right now, reading this, is shouting out “Nooo! It’s 28.3%!!! You weren’t thinking about the advances in Tommy John repair, you fool!!!” Sorry, friend, but you should go back to work.
January 30, 2008 at 1:50 pm
Posted in: Securities
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