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Governance and vertical integration in team sports.
Abstract:
Antitrust law distinguishes vertical and horizontal restraints. A horizontal restraint is one which exists between competing firms supplying rival products in a market, and a vertical restraint is one which exists between firms that jointly contribute to supplying a particular product in a market. Horizontal agreements receive much closer antitrust scrutiny because they often enable firms to limit competition at the expense of consumers, while vertical restraints may be legal or illegal depending on whether they tend to enhance or reduce competition or the exploitation of market power. This paper argues that there are important vertical restraints that operate in sports leagues which have been mostly neglected in the literature but have a significant impact. We focus on intraleague restraints, where member clubs of a league agree to control the organization of league competition, and interleague restraints, where horizontal agreement such as the Reserve Clause relies on agreements not to compete for players competing in senior or junior leagues. (JEL L83, L42, L44)

Article Type:
Report
Subject:
Sports associations (Management)
Sports associations (Economic aspects)
Antitrust law (Interpretation and construction)
Vertical integration (Management)
Market power (Evaluation)
Teamwork (Sports) (Management)
Sports (United Kingdom)
Sports (Laws, regulations and rules)
Sports (Economic aspects)
Sports (Social aspects)
Authors:
Szymanski, Stefan
Ross, Stephen F.
Pub Date:
10/01/2007
Publication:
Name: Contemporary Economic Policy Publisher: Western Economic Association International Audience: Academic; Trade Format: Magazine/Journal Subject: Business; Economics Copyright: COPYRIGHT 2007 Western Economic Association International ISSN: 1074-3529
Issue:
Date: Oct, 2007 Source Volume: 25 Source Issue: 4
Topic:
Event Code: 200 Management dynamics; 930 Government regulation; 940 Government regulation (cont); 980 Legal issues & crime; 290 Public affairs Advertising Code: 94 Legal/Government Regulation Computer Subject: Antitrust issue; Company business management; Government regulation
Product:
Product Code: 8691000 Athletic Associations; 9108640 Antitrust Law NAICS Code: 81399 Other Similar Organizations (except Business, Professional, Labor, and Political Organizations); 92615 Regulation, Licensing, and Inspection of Miscellaneous Commercial Sectors SIC Code: 8699 Membership organizations, not elsewhere classified
Geographic:
Geographic Scope: United Kingdom Geographic Code: 4EUUK United Kingdom
Accession Number:
180372672
Full Text:
1. INTRODUCTION

A fundamental characteristic of modern sports is the adherence to a fixed set of rules. Rules imply governance, and the structure of governance in modern sports implies a set of relationships between those who devise and administer the rules and those who are governed by them. These relationships can be analyzed using the methods of political science, using concepts such as power, legitimacy, constitutionality, and so on. They can also be analyzed in economic terms as a set of vertical agreements whose precise terms and conditions influence both the efficiency of sporting competition (according to some agreed welfare criterion) and the distribution of rents between the participants. The scope for economic analysis along these lines is clear if we consider the world of professional team sports, where clubs are constituted as business units with costs and revenues, so that we can talk about whether arrangements maximize joint profits and how the profits are distributed. When we consider team sports where participants may have not-for-profit objectives, economic analysis is sometimes deemed controversial. However, even if we acknowledge not-for-profit objectives, it is still possible to use economic principles to analyze vertical agreements within sporting to analyze vertical agreements with sporting organizations.

Both in the United States and in Europe, the governance of sports leagues and organizations has been a subject of public policy debate. In the United States, the debate has largely focused on the role of the antitrust law in regulating competition and whether the contractual arrangements entered into by professional clubs operated in the public interest. In Europe, the debate has tended to focus on the relationship between governing bodies and the competition law. Baseball's notorious antitrust exemption originally rested on the premise that its business was "giving exhibitions of base ball" and that "the exhibition, although made for money would not be called trade or commerce in the commonly accepted use of those words. "(1) However, as the meaning of commerce applied in the U.S. antitrust law has broadened, (2) few in America now doubt that baseball and the other major league sports are businesses and that the antitrust law applies. (The special exemption for baseball continues because of the Supreme Court's view that baseball's "unique characteristics and needs" require Congress to specifically legislate on the matter.) Moreover, it is accepted that its rule extends into commercial restraints agreed to by avowedly not-for-profit organizations such as the National Collegiate Athletic Association. In Europe, however, the governing bodies of the major sports have continued to press for distinctive treatment within the European Union's Treaty of Rome.

Antitrust law, both in Europe and in the United States, is built around a prohibition of the improper development or maintenance of monopoly power and a prohibition of cartel-like behavior. When applied to the world of sports, legal analysis has dwelt largely upon the issue of cartels. If sports leagues are textbook cartels,(3) the question has been whether horizontal agreements among the participants, such as exclusive territories, are legitimate ancillary restraints which form part of the league joint venture or means to capture economic rents from consumers and players (see, e.g., Flynn and Gilbert, 2001). However, Ross and Szymanski (2006) argue that it is important to consider the vertical aspect of sporting organizations. In both theory and practice, there is a distinction between the contest organizer, who fulfills functions such as designing the prize (which gives the contestants incentives to compete) and setting the rules, and the competitors who aim to win the prize. Given the distinction between organizing a competition and participating in a competition, Szymanski (2003) argues that the peculiar structure of professional team sports--whereby clubs have agreed to integrate the function of championship organization under their joint control--represents only one, possibly inefficient, means to run a competition. (4)

Ross and Szymanski (2006) argue that a vertical separation, such as is found in individualistic sports such as tennis and golf or in motor sport championships such as National Association for Stock Car Automobile Racing (NASCAR) and Formula One, may be a more efficient organizational form. They identify three principal benefits:

* The ability to draw up rules and regulations that meet the best interests of the league as a whole (consumers, owners, and players) rather than the interests of any particular group or faction.

* The ability to market products of the league that are truly joint, such as national broadcast rights, in such a way as to maximize the return to the league as a whole.

* The ability to facilitate Pareto-improving entry into the league through the adoption of systems such as promotion and relegation.

The NASCAR example illustrates the point. Here, a variety of auto racing competitions are organized by a closely held corporation, which enters into agreements with racetrack operators and racing teams to host and participate in contests. NASCAR's history demonstrates founder William France's vision that the sport "would require a central racing organization whose authority outranked all drivers, car owners, and track owners" (Hagstrom, 1998). NASCAR has demonstrated a remarkable ability to respond to dynamic changes in technology and consumer demand to enhance the sport's popularity, including successful strategies to maintain manufacturer subsidies for racing, to restrain those achieving innovative advantages from so dominating the competition as to lessen fan appeal, minimize excessive costs to maintain a large number of competitors, and increase speeds and excitement while maintaining the image of "stock'' racing. These policies would have been significantly hindered if stakeholders with a temporary advantage had a veto over changes, as is the case in traditional leagues.

These ideas are not entirely new of course, in the sense that we can find other examples of leagues that have achieved efficiency gains through some form of vertical separation. In Europe, the role of national federations as governing bodies of sport is often held up as a good example of vertical separation, where the clubs compete and the governing body sets the rules and runs the competition in the best interests of all. In the United States, the creation of the role of commissioner, with a responsibility for the "best interests" of the league, has similarly created a kind of vertical separation, and it is possible to cite examples of efficient decision making through the agency of the commissioner.(5) However, thus far economists and legal theorists have said relatively little about the vertical aspect of sporting organizations. The aim of this paper is to set out a framework for this kind of analysis and to suggest some of the more important theoretical issues which arise from it.

Vertical relationships arise not merely in context of the internal organization of leagues. In all sports, there exist hierarchies of leagues, recognized tacitly or explicitly, that affect the economic possibilities of both players and clubs. For example, when we talk of "organized baseball," we are really referring to a set of contractual agreements established between baseball clubs operating at different levels (e.g., AAA, AA, A). These contracts establish a set of vertical relationships not so much from the point of view of the consumer (from the consumer's perspective, AAA baseball and AA supply-independent products and teams at each level do not contribute to the final product of teams at any other level) but from the point of view of the player, whose career consists in a set of moves between hierarchical levels in the sport. So, for example, baseball's famous Reserve Clause, which restricts the right of a player to move to rival teams and is thus normally characterized as a horizontal restraint, also possesses the character of a vertical restraint in the sense that it restricts the movement of players between hierarchical levels of the sport. Thus, we may perhaps speak of vertical restraints affecting "intraleague" and "inter league" competition, just as the analysis of vertical restraints is typically interpreted interms of their effect upon intrabrand and interbrand competition.

The principal debate in economic analysis of vertical restraints has been between the Chicago school, which is associated with the view that vertical restraints are created to enhance efficiency, for example, in pricing (avoiding double marginalization) or investment (avoiding free rider and holdup problems), and its critics, who identify vertical restraints that can undermine market efficiency by deterring entry (e.g., by contractual restrictions) or retarding interbrand competition (e.g., by exclusive dealing, tying, or bundling).(6) In the world of professional sports leagues, the analogous debate has focused on whether arrangements such as territorial exclusivity and limitations on player mobility have been mechanisms to enhance efficiency or to extractrents from consumers and players.

The rest of the paper is structured as follows. In the next section, the development of modern sporting organizations is discussed and the difference between United States and European systems is examined. Section III considers intraleague restraints and Section IV interleague restraints. Section V concludes.

II. THE ORGANIZATION OF CLUBS

The fundamental political and economic unit of modern team sports is the club. The first sports clubs were formed in England and Scotland in the 18th century. These early clubs were responsible for formulating laws of the game--for example, the London club laid down the first laws of cricket in 1744; the Jockey Club (established around 1750) came to rule over the organization of horseracing; also in 1744, the Gentlemen Golfers of Edin-burgh set down the first rules of golf.(7) Similarly, Alexander Cartwright took it upon himself to lay down the rules of baseball for the first baseball club, the Knickerbocker Club of New York, around 1845. As others imitated the lead taken by these organizations, they entered voluntarily into interclub competitions voluntarily into interclub competitions according to the rules laid down by them. Other clubs accepted the authority of these founder clubs or their successors, such as the Marylebone Cricket Club founded around 1787, which governed cricket until the early 1990s, or the Royal and Ancient Golf Club, which to the present day lays down the laws of golf. When it became clear that the Knickerbocker Club was unwilling to take on the mantle of leadership in baseball, the leading clubs agreed to the creation of the National Association of Base Ball Players in 1857 to legislate over the rules and conduct of the game.

We tend nowadays to take for granted the idea that a group of individuals might get together and organize in accordance with a set of rules chosen and agreed among themselves without any interference from the state. However, such ideas were revolutionary in the 18th century, not much accepted outside of Great Britain and the United States in the 19th century, and only became a fundamental characteristic of the liberal democracies in the 20th century. Under communist and fascist regimes, military juntas, and personal dictatorships, sporting organizations, along with most other forms of associative activity, have been controlled by the state. In many cases, even in the liberal democracies, the state has taken and continues to take a role in nominating members of bodies set up to dictate the rules and organization of sport, including nominations for international organizations such as the International Olympic Committee (IOC). For example, in France, all sporting organizations are licensed by the state and granted monopoly powers in controlling their sport. Thus, in some cases, the organizational structures are created by the state with its own objectives in mind. However, the principal team sports (soccer, cricket, baseball, basketball, rugby, and American football) developed in the Anglo-Saxon world, and their organizational structures evolved entirely out of voluntary agreements between clubs.

In each case, these sports developed first as games played by amateurs and only later evolved into professional sports.(8) For the purpose of playing amateur sport, little more was needed than agreement over the rules. The concept of the championship race and the structure of competition was generally quite fluid, since in the end, there was little at stake. Moreover, the ethic of gentlemanliness and fair play which the participants in these early contests espoused mitigated against excessive emphasis on the competition. In most cases, amateur clubs were, as many remain today, organizations founded upon the idea of sociability rather than competition. The interest of spectators, the commercial opportunity that this presents, and the incentive to hire professionals to attract more spectators generated a new set of challenges for established amateur team sports.

Szymanski and Zimbalist (2005) contrast the way in which this challenge was dealt with in the United States and in Britain. The problem first arose in baseball, when the Cincinnati Red Stockings became professionals in 1869. The amateur clubs soon decided that they were unwilling to play alongside professionals, and in 1871, the amateur and professional game split. Following the collapse of the cha-otic National Association of Professional Base Ball Players, the National League (founded in 1876) quickly established the pattern of organized baseball: a closed major league controlled by owners of participating clubs, with formal and informal agreements with other player development leagues. This pattern has been largely followed by the other North American sports. In England, amateur soccer clubs agreed to set up the Football Association (FA) in 1863 and faced the same dilemma, the introduction of professionals into the sport by teams seeking a commercial advantage, in 1885. However, instead of splitting, the FA remained as governor of both the amateur and the professional game. Unified governance allowed professionals to continue to compete in popular open knockout tournaments and shielded them from the risk of easy entry by rival leagues.

The decision of the amateurs and professionals to remain together under a unified governance structure had momentous implications since it became the model of sporting organization in almost every country outside North America. The reasons for this decision are complex (see, e.g., the discussion in chapter 2 of Szymanski and Zimbalist, 2005). As with baseball, it was the amateurs who controlled the governing body at the time, but unlike their baseball counterparts, they decided that they would be willing to play alongside professionals. One reason may have been that the amateurs were largely concentrated in London and the professionals in Lancashire (about 200 miles away), and therefore, they did not think that they would meet that often.(9) Less than 10 yr later, the amateurs and professionals playing rugby football (itself a variant of football that separated from Association Football in 1871 and was in many ways the model for the American version of football) split in two, the professionals forming Rugby League and the amateurs playing Rugby Union. In this case, a significant fraction of the amateurs played very close to the professionals and felt that this proximity threatened the integrity of their game. For their part, professional soccer players, unlike the professional baseball players, had much to lose from leaving the established association since it would have excluded them from participating in the Football Association Cup, an extremely popular competition that had been established in 1870. The professional clubs no doubt calculated that they would be better off remaining within the fold rather than moving outside it. Whatever the true reasons, this scheme now prevails in almost all sports in Europe and the rest of the world outside of North America.

The decision on whether to split the amateur and professional games had momentous implications. The professional sports which separated themselves from the amateurs were able to design their own commercial organizations and devise rules that suited the business interests of the team owners. In sports where amateurs and professionals remained united within a single hierarchy, business interests have been subordinated to the interests of those who control the game. In the 20th century, these sports became organized in a hierarchical system that the European Commission calls the "European model of sport." In this model, there exists a hierarchy of governance from local to national to international level. At the apex of the pyramid stands the global governing body (e.g., Federation Internationale de Football Association [FIFA] in soccer or the IOC for the Olympics). Affiliated national federations select representatives onto the global body and administer the sport played nationally, both at the club level and at the national representative level. The national associations sanction the organization of domestic leagues and competitions and require that clubs release their employees to play for the national team.(10).

This form of integration has two commercial implications. First, the governing body may tax clubs or leagues in order to divert resources to areas which they consider in long-term interests of the game (e.g., subsidies to the grass roots). When resources are diverted in this way, the expenditures may or may not have a commercial return. For example, Union of European Football Associations (UEFA), the governing body of European soccer, uses some of the funds generated by the highly lucrative UEFA Champions League competition (involving the large commercial soccer clubs) to subsidize the national associations of smaller nations whose teams are unlikely ever to appear in the competition. To the extent that these funds may help develop interest in the game and the training of young players, it is possible that the clubs participating in the Champions League would choose to invest their profits in this way if they controlled the distribution. However, in part these funds are probably devoted to activities that have little long-term commercial benefit (even if they are not used corruptly, as has been frequently alleged).(11)

Second, this form of integration may lead to choices that would not be made if leagues operated on purely commercial lines. For example, in 2001, a number of leading clubs from smaller soccer nations, including Celtic and Rangers from Scotland, Ajax and PSV Eindhoven from The Netherlands, Anderlecht from Belgium, and Benfica from Portugal, explored the idea of creating an "Atlantic League," which would have been capable of generating larger broadcasting revenues for these teams than competing in their domestic competitions.(12) UEFA, reflecting the interests of several of its national association members, threatened sanctions against any teams that might join this new league. Similarly, it has long been argued that a European Super-league that enabled the top teams to meet each other regularly in competition would be revenue enhancing, but the national associations, individually and collectively through UEFA, have consistently opposed the idea (see, e.g., Hoehn and Szymanski, 1999). In economic terms, money is being left on the table in order to pursue what the governing bodies argue is the wider good of the sport and others believe is the narrow self-interest of association bureaucrats and the less successful clubs that dominate national associations. These issues are clearly related to the question of inter-league restraints. Before turning to these in more detail, we consider the nature of intra-league restraints.

III. INTRALEAGUE RESTRAINTS

In American professional sports, the major leagues are controlled by their member clubs who determine the rules, the rewards, and the general running of the league competition. Under the European model, many of the rules are dictated by the governing bodies. For example, in the case of soccer, the rules of the game are determined by a committee of the global governing body, FIFA, and the schedule of games played must be consistent across all competitions. Leagues are not free to admit clubs from outside the national association (e.g., a French club could not play in the English leagues), and it is unlikely that any league would be permitted to abolish the promotion and relegation system which requires it to admit teams from lower ranked leagues to replace poor performing teams.

Despite these important differences, the most striking intraleague restraint is the reserve system, which was invented by baseball's National League in 1879, adopted by the English Football League in 1890, and thereafter became part of the international soccer system. The reserve rule is essentially a horizontal restraint, an agreement between teams not to compete for each other's players, thereby creating monopsony power in the hiring of talent, reducing costs, increasing profits, and potentially affecting the optimal allocation of player talent. However, the leagues soon found that the reserve rule was of limited value if it related only to clubs within the league. The extension of the reserve rule to the minor leagues was the cornerstone of organized baseball, and this is discussed in the next section.

Other horizontal restraints include agreements such as the draft system and salary caps. However, such restraints are only feasible because of the existence of a vertical restraint in the American system, namely the control of league rules and regulations by the clubs that compete in the league. Essentially, a sporting contest consists of two main activities: the playing of games by the contestants and the management of the contest by some organization. In many sports, the organizers decide to create a competition and then invite competitors (consider, e.g., a tennis championship or a marathon race). One might therefore ask the question, why would a group of tennis players or marathon runners decide to organize their own competition?

Following the Chicago School, one should first look for an efficiency-enhancing rationale to explain this vertical integration. The most plausible explanation would relate to the threat of holdup, either on the part of the contest organizer or on the part of the participants. Preparation for a marathon, for example, takes several months and demands considerable commitment from the athlete. At the last moment, the organizer has an incentive to renege on commitments since the runner is still likely to be willing to participate. Even if commitments are contractual, there are likely to be elements of the contract that are nonverifiable and therefore may be subject to holdup. Such a problem did in fact arise in 2006 FIFA World Cup in relation to the participation of the Togo team. The Togo FA had agreed to pay bonuses to the players contingent on their performance, to be paid out of Togo's share of the income generated from the tournament. However, during the competition, the players became fearful that the Togo FA would renege on this promise, and the players threatened to strike. The situation was only resolved when FIFA agreed to pay the players directly rather than through the agency of the Togo FA. (13)

By the same token, a contest organizer might fear holdup on the part of the participants. In this case, there are clearly non-contractible elements in any agreement to participate in a race or competition, most notably in relation to fitness. Athletes can easily declare themselves unfit without fear of sanction, and therefore, organizers are at risk that this kind of threat will be used at the last moment to extract higher payments.

Despite the logic of vertical integration, we in fact see relatively few examples in the world of individual sports. However, in many sports, we have seen associations of players becoming more involved in the management of their sport as they seek to take a greater share of the rents. Perhaps the best example is the Association of Professional Tennis Players (ATP), which was created in 1972 to bargain over payments for participation in major tournaments such as Wimbledon, and has since 1990 organized the ATP Tour for professional players.

The logic of vertical integration to avoid the threat of holdup is even greater in the professional team sports since the commitments on the side of the participating clubs are likely to be much larger. Thus, investing in assets such as stadiums and committing to paying the pay-roll of players make a team owner vulnerable to the possibility that the competition organizer reneges on commitments. From the point of view of the league organizers, the threat from the clubs is that they will refuse to play games which are not economically profitable because they fail to internalize the cost to the league as a whole of failing to complete the fixture list. These problems were specifically recognized by William Hulbert and the other founder members of the National League, who established the system of territorial exclusivity and the commitment to play all games agreed in the schedule, following the chaos that surrounded the operation of the National Association between 1871 and 1876.

These might seem to provide a plausible economic basis for vertical integration. However, one might also ask why such benefits cannot be achieved by arm's-length contracting. Such an alternative remains necessary, even in vertically integrated leagues, to solve holdup problems when clubs behave opportunistically vis-a-vis the league and with regard to players and separate television rights purchasers. While holdup is a recognized issue in the wider economy, it has not led to the universal adoption of vertical integration as a solution even if vertical integration is wide-spread and often motivated by concerns for the holdup problem. Moreover, one can identify a number of problems that emerge when the participating clubs jointly own the league itself. Most significantly, clubs that control a league have an incentive to minimize effective competition so as to raise joint profits, and the existence of significant transaction costs can result in a failure to reach agreement on Pareto-improving reforms.

Teams sell competition, and the quality of competition depends in part on the effort contributed by the participants. For this reason, contest organizers typically offer large prizes to give incentives to participants to win. In professional team sports, however, we typically see club-run leagues arguing that it is necessary to minimize such incentives. Almost since the foundation of the National League, clubs have argued that it is necessary to impose restraints on competition to ensure that the outcome of competition is sufficiently balanced (see, e.g., Eckard, 2001). The competitive balance debate has dominated the economics of sports leagues. While there is much disagreement about the value of competitive balance in a league (compare, e.g., Berri, Schmidt, and Brook, 2006, and Sandy, Sloane, and Rosentraub, 2004), economists are unanimous in agreeing that the restraints justified on the grounds of competitive balance raise profits at the expense of players and possibly consumers.

In a world of zero transactions costs, there is no efficiency-enhancing arrangement that might be designed by a contest organizer that would fail to be adopted by a club-run league. In reality, however, club-run leagues might fail to adopt a number of efficiency-enhancing arrangements. Even the clubs themselves have recognized the need to create an authority to control certain decisions. The most notable example is the Office of Commissioner for Baseball, created after 1919 Black Sox scandal, with a remit to look after "the best interests of baseball." The other major league sports have also created commissioners. The precise extent of the commissioner's powers has varied both within and between sports. It seems clear that baseball clubs did not intend the commissioner to have powers that went much beyond the control of gambling and corruption (see, e.g., Zimbalist, 2006). But in some sports, the role of the commissioner has been expanded significantly, most notably in the case of the National Football League, where the role played by Commissioners Rozelle and Tagliabue are often given a large share of the credit for that league's meteoric rise. In part, these visionary executives receive credit principally for their ability to overcome transactions costs and to persuade self-interested owners to approve league-enhancing innovations, skills that are only necessary because of the integrated structure of North American sports leagues. Full vertical separation would go further still and give the league organizer the power to control the entire structure of competition in the league independent of the clubs.

This situation may be said to be approximated by the system of national federations which govern sport in the European model. One of the principal advantages of the European league system that has been noted else-where is the possibility that existing member teams that are not performing well can be replaced by teams from lower leagues that are performing well (e.g., Noll, 2002; Ross and Szymanski, 2002; Zimbalist, 2003). Benefits of the promotion and relegation system include:

* Exciting competition until the end of the season as clubs compete both for championship honors and to avoid relegation.

* The possibility that all cities can have one, if not several, major league teams at some time or another.

* Greater ties between teams and locations (relocation is not a credible threat since every city can have its major league team by buying good players and winning promotion; they do not need to buy someone else's team).

Critics may point to possible weaknesses of the system as well: for example, underinvestment in facilities because tenure in the major league is so uncertain, financial instability caused by overinvestment in playing staff, and the adoption of excessively risky strategies. However, the main reason that the major leagues would be unlikely to introduce the system voluntarily is, more than anything else, the fear that they will lose the relocation threat by means of which clubs have been able to extract substantial subsidies from local taxpayers. The restraint that the incumbent clubs control the organization of the league means that they can prevent entry by new teams that would diminish the economic rents that can be extracted.(14)

This argument is reminiscent of contracts for exclusive dealing between an upstream and a downstream firm. The Chicago School argument is that such contracts could only be efficient since the monopoly rent that would accrue to the downstream supplier would never be as great as the total surplus that could be gained by the upstream firm through down-stream competition. Applied to the context of a league, the league organizer should be unwilling to agree to an exclusive contract with existing clubs since there is potential to realize a greater surplus through downstream competition. (15) Vertical integration may therefore be seen as a way for clubs to foreclose competition from potential rivals.

Antitrust lawyers have long been uncomfortable with this argument since it seems to imply that league organizations are a kind of "essential facility" to which courts must mandate access. This seems to many observers excessively interventionist; moreover, viewed from the perspective of the American system, there is a limit to the number of franchises that can participate in a league (see, e.g., Weiler, 2000, chapter 19). However, the alternative route to dealing with the competitive harm that appears to be caused by foreclosure, namely the creation of a rival league, seems even less likely to be feasible.

There have been a small number of cases where new leagues have tried to challenge the market power of incumbent leagues, but for the most part, these attempts have been labeled failures (see, e.g., Quirk and Fort, 1992). The obvious reason for this is that entering on the scale of an entire league involves huge capital investments when the incumbents have mostly sunk their costs. In addition, many new leagues have faced predatory conduct by incumbent leagues, who were determined to bid salaries up to nonre-munerative levels that could only be economically justified by the prospect of exclusion or merger with the entrant (see, e.g., Ross, 1989). Incumbents have placed particular emphasis on challenging competitor leagues in the large markets where they experienced head-to-head competition, in the knowledge that failure in the major markets would cause the entrant league to fold. They have also proved adept at following a divide-and-rule strategy, offering entry to a small number of critical franchises and thereby destroying the unity of their rival.

IV. INTERLEAGUE RESTRAINTS

The Reserve Clause is commonly understood as a horizontal restraint among the member clubs of a league. However, this restraint on its own would do little to discourage the emergence of rival leagues or limit the pay of players. We have already observed that the National League created the Reserve Clause in 1879. But even before this, the National League had created the League Alliance in 1877, which involved an agreement that clubs should respect each others' player contracts and territorial rights.(16) In effect,, this agreement also established the relationship between "major" and "minor" leagues. The beginning of "organized baseball" is usually considered to be the Tripartite Agreement of 1883 between the National League, the American Association, and the Northwestern League. This agreement specified that owners in each league would recognize contracts signed in their rivals' league,(17) a contract described as the "Magna Charta of professional baseball" by the historians of the minor leagues.(18) While a precise definition of minor league status is hard to find, it clearly refers to a league where the playing talent is on average inferior to that of the major leagues, and this inferiority was confirmed in the Tripartite Agreement by the lower compensation required to reserve a player's services in the minor league. Interestingly, a similar process underlay the development of the Football League in England. This was the first professional soccer league in England, but within months of its creation, rival leagues were set up. By 1891, Football League clubs were agreeing with these leagues not to poach each other's players, and gradually, the League's equivalent of the reserve rule (called the retain and transfer system) had been extended across all professional soccer.

Although the American system created by organized baseball and the European system that followed the evolution of English soccer ended up with quite different organizational structures, they often dealt with quite similar problems in similar ways. Thus, the National League at first extended its network of contracts to cover all the minor leagues and developed the classification system (AA, A, etc.), mainly as a means to fix prices for players traded between clubs. The system established a hierarchy of leagues, such as exists within the European league system. However, the American system ultimately led to a high level of vertical integration as clubs recognized the benefits of direct control for managing the rotation of players.(19) In England, the Football League set out to expand its control by admitting more and more teams, so that by the early 1920s, it contained 88 professional clubs (for a population of around 40 million at the time). The promotion and relegation system emerged as a way to hold together a league of this size (although undoubtedly it was not the only way it could have been done). Moreover, national federations banned the ownership of one club by another.

In both cases, the reserve systems meant that clubs were able to trade players and that players could move up and down the hierarchy of leagues, while at the same time holding down player wages. In the United States, it was the militancy of the player unions that finally broke down the reserve system and the artificial limitation on salaries; in Europe, it was the intervention of European Court of Justice in 1995 to rule such restraints on the free movement of labor contrary to European law.(20)

In the American system, these interleague restraints significantly restricted opportunities for rival leagues to enter. In the European system, these restraints have done much to restrict the development of existing leagues. The most important current example is the restriction on teams entering national leagues other than their own. To take a simple example, Celtic and Rangers, two Glasgow-based large market teams that dominate the Scottish Premier League, would like to enter and would be welcomed by most teams in the English Premier League. However, because England and Scotland are, for the purposes of playing soccer, separate nations with separate national federations, soccer's international governing body will not permit this move. In recent years, a number of proposals for teams in different European nations to form cross-border leagues have been considered, but so far all these have likewise been blocked by the governing bodies (see, e.g., Kesenne, 2005). Although the merits of specific proposals are beyond the scope of this paper, the integrated structure of the governing bodies--who comprise representatives of each national federation--makes it likely that Pareto-enhancing reforms will not be approved because of the harm to existing federations and the inability to negotiate appropriate compensation.

Interleague restraints imposed by the governing bodies of sports can be viewed as a means to pursue objectives considered to be in the wider interests of the sport. Governing bodies tend to see themselves as possessing a broad remit (see, e.g., the principles of Governance in Sport, prepared on behalf of the European Olympic Committee and the Federation Internationale d'Automobile, downloadable at http://www.governance-in-sport. com/). These may include the creation of new international competitions, cross-subsidies form rich leagues to poorer leagues, as well as social/charitable goals often associated with sporting activity. However, they may also limit the ability of leagues to adopt innovative ideas and develop new markets. The rivalry that has emerged between UEFA (the governing body of European soccer) and G14, a lobby group representing the interests of the biggest clubs, is a good example of the conflicts of interest that can emerge. UEFA serves as a competition regulator (at the top of the "pyramid" that characterizes the European model of sport), but it is scarcely a disinterested party or even a residual claimant to revenues or profits from all of European football. Rather, UEFA directly receives huge revenues from its operation of the Champions League and the UEFA Cup, two international competitions involving the best clubs of different countries, and all UEFA members profit significantly from the efforts of their national team. Thus, controversies continue when UEFA seeks to achieve a balance between the interests of national team competitions, European club competitions, and domestic competitions, all of which fall within its jurisdiction.

V. CONCLUSIONS

This paper has focused on the analysis of sports leagues in the context of vertical relations. The paper suggests two types of vertical relations that are important. The first are intraleague restraints, by which member clubs in a league integrate the activities of competing in a sport with the activity of organizing a sporting competition. This is essentially the system of governance which emerged in the U.S. major leagues at the end of the 19th century. The second are interleague restraints, which often attract less attention but are perhaps more important. The network of contracts between leagues that created the system known as organized baseball enabled the clubs for many years to hold down player salaries while maintaining some player mobility between teams. In the European context, interleague restraints are administered by governing bodies, which nowadays are generally formed as national federations affiliated to international organizations that claim jurisdiction over an entire sport. The restraints imposed by these governing bodies often enable the creation of different kinds of competition and can help promote the broader development of the sport. However, restraints imposed by both governing bodies and vertical interleague contracts can be used as impediments to entry and competition. These trade-offs are clearly important and worthy of further investigation.

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ABBREVIATIONS

ATP: Association of Professional Tennis Players

FA: Football Association

FIFA: Federation Internationale de Football Association

IOC: International Olympic Committee

NASCAR: National Association for Stock Car Automobile Racing

UEFA: Union of European Football Associations

Szymanski: Professor of Economics, Tanaka Business School. Imperial College London, SW7 2AZ. UK.

Phone (44) 20 7594 9107, Fax (44) 20 7823 7685. E-mail szy@imperial. ac.uk

Ross: Professor of Law, Dickinson School of Law, Penn State University; and Director. Penn State Institute for Sports Law,Policy and Research, University Park, PA 16801. Phone 814-865-8995, E-mail sfr 10@psu.edu

(1.) Federal Club v. National League, 259 U.S. 200 (1922).

(2.) Zimbalist (2003, p. 17).

(3.) Fort and Quirk (1995, p. 1265).

(4.) The distinction between the two market functions fulfilled by participants in a league championship organizing services and championship participation services has already been recognized by the Australian courts. See Ross and Szymanski (2006). footnote ll.

(5.) Although European national federations and American league commissioners serve important roles and their utility illustrates the benefits of vertical separation. our analysis below suggests that their current powers are at best partial solutions to some of the structural problems in organizing sporting competitions. This paper identifies a variety of conflicting interests that arise when participants collectively organize a competition using horizontal restraints. In Europe, national federations regulate the sport and also manage, and profit from, the success of the national team. Many international rules appear to be more in the nature of horizontal restraints among other-wise competing national federations rather than vertical restraints imposed by a separate upstream firm in the best interests of the global sport. In the United States, commissioners have traditionally had very limited roles in dealing with the business operations of sports leagues.

(6.) This is a very large literature but a good starting point for a discussion of recent debates on the issue in Rey and Tirole (2005).

(7.) See Szymanski (2006) for a more detailed analysis of the early evolution of clubs and rules in modern sports.

(8.) Cricket is slightly different in that paid professionals played alongside amateurs even at the time the first known rules were written. However, the amateurs clearly controlled the organization of the game from its early days up until recent times.

(9.) It is important to note that the psychology of amateur sport in the Victorian era revolved to a considerable extent around concepts of "gentlemanliness" and that as long as social conventions were observed, the prevailing atmosphere was liberal.

(10.) Typically without compensation for the club, an arrangement which some of the larger European soccer clubs are currently challenging in the European Court of Justice. http:/www.euractiv.com/en/sports/ecj-rule-second-landmark-case-football/article-155382

(11.) For information on the distribution of UEFA Champions League monies to national associations, see, for example, http://www.uefa.com/uefa/keytopics/kind=16384/newsid=405660.html. Many books have been written about corruption in national and international associations; one example from the soccer world is Sugden and Tomlinson (2003).

(12.) See, for example, http://www.sportbusiness.com/news/136725/uefa-warn-clubs-over-atlantic-league

(13.) http://news.bbc.co.uk/sport I/hi/football/world_cup_2006/teams/togo/5098446.stm

(14.) One referee asked why the professional clubs ever agreed to such a system given the disadvantages. Since the system was first adopted in England and then copied by other soccer playing nations, the answer may have something to do with the incentives facing the Football League during its early years. We argued above that the league chose to stay within the governance structure of the FA partly because it wished to benefit from participating in the cup competition sanctioned by the FA. Likewise, the league may have wanted to placate strong teams that were not original league members, fearing that otherwise they would lobby for their expulsion from the FA and hence removal from the competition. Since these other teams also had the option to form their own rival leagues, the Football League members may have calculated that their best chance of survival lay with the creation of an inclusive rather than an exclusive system. Clearly, however, there are costs associated with this choice.

(15.) Indeed, this was clearly the case in the evolution of rugby league in Australia. A semi-independent competition organizer, the Australian Rugby League, refused to grant clubs a permanent license to participate in the sport, and only granted 5-yr licenses when a rival league began operations and sought the wholesale defection of entire clubs to the new competition.

(16.) For example. Sevmour (1960, pp. 98-103).

(17.) Rader (1995. pp. 128-30).

(18.) Finch, Addington, and Morgan (1953. p. 16).

(19.) For a recently published study of vertical integration in baseball, see Winfree, McCluskey, and Fort (2007). The authors consider possible causes of the different choices of full integration land affiliation (where a major league team enters an exclusive relationship with a minor league team). They find that none of the conventional motives for vertical integration can explain the variation of relationships although they do find that owners with media interests, that form part of larger (vertically integrated) businesses, are more likely to opt for ownership.

(20.) Court of Justice of the European Communities, Case C-415/93. This is known as the Bosman case, after the player whose contract was under investigation.
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