Summary: This paper analyzes the financial and sporting impact of the UEFA Financial Fair Play (FFP) regulations in four major European football leagues. The authors claim that the effect of the break-even constraint embedded in FFP is to strengthen the position of the traditional top teams. Since the benefits of the break-even rule to consumers remain unclear, the authors argue that these rent-shifting regulations might fall foul of European competition law.
I’ve been slow in restarting the Paper Discussions series this year due to travel and other commitments within and without Soccermetrics, but I had been searching for an appropriate first paper to review. I had downloaded an earlier working paper last year that looked interesting but didn’t get around to reading it. In light of the fourth full season of UEFA’s Financial Fair Play (FFP), and the departure of one of its architects (Padraig Smith) for Major League Soccer, it’s time to revisit that paper.
Thomas Peeters is a professor of Applied Economics at Erasmus School of Economics (from which graduated Erik van den Berg) and he received his PhD in Economics from the University of Antwerp. Stefan Szymanski is a professor of Sport Management at the University of Michigan and better known as the co-author of Soccernomics. Peeters was a visiting researcher at Michigan, so it’s very likely that he conducted this research with Szymanski while he was there.
The research presented in the paper is on Financial Fair Play and its implications for European football competition. FFP is a response by UEFA (or more specifically, its President Michel Platini) to the perception that finances in European soccer are severely broken. Club revenues and payrolls have risen substantially in the post-Cold War era, but the debt level of many clubs has risen even faster. According to the paper, which quotes a 2012 UEFA study, 63% of top-flight clubs in Europe reported an operating loss, 55% a net loss, and 38% negative net equity. The nature of club ownership has been perceived to have changed with the arrival of high-profile individual or corporate benefactors to either inject multi-millions (or -billions) of euros into a club or leverage the club’s assets to finance spending. Such practices are not new to European football (e.g. Jean-Michel Aulas at Olympique Lyon, Bernard Tapie at Olympique Marseille, Jack Walker at Blackburn Rovers, Dietmar Hopp at Hoffenheim, Parmalat at Parma), but it was the recent takeovers by foreign benefactors that appeared to motivate Platini’s desire to implement FFP.
FFP governs the provisioning of licenses to clubs that are eligible to participate in the UEFA club competitions (Champions League or Europa League). In order to receive a license, clubs must satisfy the following requirements:
- Payables: No outstanding payments due to creditors.
- Break-even: Football income balances football expenditure over a three-year period and within an accepted deviation (€5 million as of 2013, but will widen between now and 2018).
(Football income is defined as income from tickets, concessions, merchandising, broadcast rights, sponsorship, player transfer sales, and prize money. Football expenditure is defined as wages and transfer payments.)
In order to properly understand FFP and its implications, it is important to know what is not covered. For one, direct subsidies from owners are excluded from football income, and sponsorship contracts are monitored for deviations from fair-market value (Etihad Airways’ sponsorship of Manchester City is given as one such example). Second, expenditures on infrastructure, training facilities, and youth development are not counted as football expenditures. Third, clubs with revenues or expenses below €5 million are exempt from FFP, which means that 53% of the top-flight clubs in Europe and 41% of the clubs in European competition do not fall under the new rule.
The result is that while the break-even rule of the FFP can be seen as a soft salary cap, it is in effect a vertical constraint that has been imposed by the governing authorities. The kind of salary cap seen in North American and Australian sport competitions is agreed upon by the owners of the teams in the competition and the union representing the players and is seen as a horizontal constraint. Peeters and Szymanski discuss the differences between the two models and frame the upcoming analysis in terms of two issues: regulation of player payrolls, and regulation of competitive balance.
The remainder of the research paper centers on the mathematical model that Peeters and Szymanski built to examine the effect of FFP on the club payroll and revenue. There are multiple parts to this model:
- A simulation of a double round-robin league competition in which the win/loss/draw probabilities are a function of the relative difference in team payrolls, relative difference in team quality, and other uncertainties.
- A logistic regression model of club revenue, with relative league position, stadium value, team- and country-specific factors that control for local market size and the domestic league market size as inputs.
- A utility function that an owner will seek to maximize, whether that means finishing higher in the table or maximizing profit, by choosing a budget constraint.
- The manager will always seek to maximize sporting performance by selecting a payroll level that satisfies the budget constraint.
- A floor on the budget constraint that limits the amount of cash injections that an owner can make, which ultimately impacts payroll levels. This is the FFP effect.
The model is quite complicated and solutions involve estimating parameters of the model and using game theory to solve for optimal payroll levels. But the finances of sports teams are complicated and involve some sophisticated bookkeeping (no surprise there).
The model is trained with financial data from four of the Big Five European leagues: England, France, Spain, and Italy. Data from the German Bundesliga turned out to be infeasible to obtain at club level, but it was expected by the authors that the effect of break-even would be more limited in the Bundesliga than other leagues (German clubs already have financial criteria that they must meet).
Here are the major results of the paper:
- The effect of break-even rule is a drop in payrolls and wage-to-turnover ratios. In the simulations, the percentage drop in payrolls is significant, but most pronounced in England and Italy. As the restrictions tighten, more teams in the top flight until at least 50% of the clubs are impacted by FFP in the most restricted regime (no deviation between revenue and expense).
- A drop in competitive balance as FFP becomes more strict. Here the authors use the league simulation to study the point distribution in the league competitions and use the standard deviation of points to measure competitive balance. Again, competitive balance improves for the less restrictive FFP scheme — i.e., the bigger sides are more restricted — and the effect is greatest in England and Italy. As FFP becomes stricter, more teams, some of which are not large, fall under FFP and the competitive balance is reduced.
- FFP raises the barrier to elite status. This result is a corollary of the previous point, and it’s an effect of the model’s inclusion of local market size and the club’s scouting and training infrastructure. The paper argues that traditional clubs tend to be in major market series and have decades of facilities and experience in talent identification and development. It would be difficult for small clubs to build that infrastructure to challenge the larger sides — perhaps a 10-20 year project is necessary, but difficult to implement in an industry notorious for short-term demands.
- Nash equilibrium of payrolls appears to exist. This is more of a result of interest to the academic community, especially those who do research in game theory. What it meant in terms of the model was in all of the leagues considered, an optimum payroll was found over all of the teams in the competition given the best-response budget constraints of the owners. It’s just a simulation result and a more formal analysis of the existence and uniqueness of the solution is required.
The authors finish the paper with two claims: first, FFP represents a transfer of rents from players to owners with little to no benefit to consumers (i.e. fans). Therefore, in their opinion, a legal challenge to the rule under European anti-trust law could be successful. Second, a salary cap that more resembles that of North American professional leagues would satisfy the goals of wage spending control and competitive balance without raising barriers to success of the smaller clubs. It’s a nice goal to have, but I have no confidence that such a cap could be implemented in an European football industry as currently constructed.
Nevertheless, I think this is a good paper and I learned much about FFP, its implications, and its challenges.