Show Me the Money: Examining the Validity of the Contract Year Phenomenon in the NBA

Abstract

The media narrative of the ‘contract year effect’ is espoused across all major professional American sports leagues, particularly the MLB and NBA. In line with basic incentive theory, this hypothesis has been shown to be true in baseball, but the analysis in basketball to this point has been flawed. In estimating the contract year effect in the NBA, this paper is the first to define rigorously the various states of contract incentives, the ignorance of which has been a source of bias in the literature thus far. It further expands on previous analyses by measuring individual performance more broadly across a range of advanced metrics. Lastly, it attempts to account for the intrinsic endogeneity of playing in a contract year, as better players get longer contracts and are thus less likely to be in a contract year, by using exogenous variations in the NBA’s contract structure to form an instrument, and by comparing performance to a priori expectations. In this manner, this paper produces the first rigorous finding of a positive contract year phenomenon. The estimated effect is about half that found in baseball, equivalent to a 3-5 percentile boost in performance for the median player in the NBA.