How economists use sports to study market efficiencies and test business theories Featured

8:00pm EDT June 30, 2012
How economists use sports to study market efficiencies and test business theories

What do golf tournament payouts and executive compensation have in common? More than you might think. For starters, both offer rewards based on relative — as opposed to absolute — performance, and research shows that the bigger the purse, the harder people play.

Moreover, a review of executive compensation reveals that the economic theory of tournaments may justify the blueprint and the level of executive pay, and this is just one of the ways that economists are using sports data to test business theories.

“We can learn a lot about human nature, motivation and beating the odds by studying copious data from the world of sports,” says Dr. Stephen Shmanske, professor emeritus of economics at California State University, East Bay.

Smart Business spoke with Shmanske about what business leaders can learn from economists who use sports data to test market efficiencies and business theories.

Why are economists studying sports?

An abundance of accessible, high-quality data has made it possible for economists to study the management, turnover, performance and compensation of professional athletes and correlate the results to a wide range of economic and business theories. For example, economists can review the results of golf or tennis tournaments to determine the optimal way to structure sales contests or other incentives.

An early study looked at the impact of pay discrimination, in which economists compared whether men and women perform differently based on prize structure. The researchers found no differences in performance when the participants were vying for the same purse.

What does an in-depth analysis of sports gambling reveal about market efficiencies?

Various analyses have revealed that stock and gambling markets are equally efficient because all relative information is captured and considered when the betting line or stock price is set. In other words, the company’s management team, competitive position and future earnings are considered when investors decide how much to pay for a share of its stock.

Likewise, odds makers consider each golfer’s strengths and weaknesses and the course layout when they set the tournament betting line. The odds and share price shift based on changes in demand or circumstances leading up to the event. Because both markets are efficient, you’ll need luck or inside information to consistently beat the odds.

What is the Tiger Woods effect, and what can economists learn from this phenomenon?

A study examined whether Tiger skewed the odds or the wagering volume when he played in a tournament, which is similar to a thin market versus thick market effect. Although more people bet on Tiger when he’s the favorite, and they bet on the field when he’s not, those scenarios were consistently factored into the odds. If greater amounts are wagered on a tournament, it might allow the casino to offer more favorable odds, much as transactions costs, measured by bid-ask spreads, are lowered in thick markets. The study concluded that gambling markets are efficient because odds makers consider Tiger’s participation.

What can we learn about profitability by studying golf wagering and bettor biases?

One of the themes in existing literature concerns whether there are identifiable biases in bettor behavior or in posted odds that can lead to positive profit strategies. Studies show that there’s no way to increase profitability by taking shortcuts, employing arbitrage betting techniques or contrarian betting algorithms because the markets are efficient. In fact, there’s no secret market intelligence or formula that increases profitably when taking risk, because the favorites generally return less on every dollar wagered but win more. You need luck to beat the house and anyone who says they have a surefire system is mistaken.

What can we learn about predicting winners and losers?

Certainly every fan has an opinion about who might win or lose a tournament but the odds makers have access to the same information. They factor in players’ injuries, outing tendencies and even the weather forecast when they set the line, and they’re right most of the time. It’s like trying to predict whether the price of a stock will rise or fall by monitoring the trading activities of insiders when the information is released to everyone after a transaction. It may be possible to consummate an advantageous stock purchase if you have exclusive information about a new contract or product release, but while you might make more money, you could wind up in jail.

How are economists using sports data to test other business theories?

The theory of tournaments is often applied to compensation since economists can see how various structures and payouts impact individual motivation and performance. For example, top golfers tend to focus and put forth their best effort because sinking a put or managing to birdie the next hole can earn them an additional $100,000. While lower performers may only earn $200 for shaving a shot or two off their score so they’re inspired to preserve and improve their technique, in hopes of earning a bigger payout next year. Similarly, vice presidents are inspired to go above and beyond because they want to ascend to the CEO’s chair. What we can conclude is that the size of the prize does not guarantee absolute performance in any one match, but it does raise the absolute standard over time.

Dr. Stephen Shmanske is professor emeritus of economics and director of the Smith Center for Private Enterprise Studies at California State University, East Bay and the author of Golfonomics. Reach him at stephen.shmanske@csueastbay.edu.

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