Islj 2009 3-4 - TMC Asser Instituut

In this research, the focus will be on the three-way relation between
the club, agents and the players.
The government is also included as the legislator, who implements
different regulations on the three actors.
2.3. Principal-agent problem
In agency theory, the agent acts on behalf of the principal. The problem
in that case, is the existence of asymmetric information. This
could create a moral hazard problem, since the principal cannot perfectly
observe the effort of the agent, and the agent behaves not fully
in the interest of the principal (Holmstrom, 1979). The heart of
agency theory is the conflict of interests, when individuals with different
objectives cooperate with each other (Eisenhardt, 1989).
So, there are two important features of the theory, first there must
be information asymmetry and second a conflict of interest. The
sports agent has more knowledge about the bargaining process than
the athlete, because the experience of other negotiations. The sports
agents have more knowledge about the salaries of other athletes. The
sports agent, as well as the athlete, wants to maximize their own
objective function. In this research, the focus will be on the profit
maximizing actors, for convenience. There are other factors, which
can influence the objective function of an athlete or the sports agent,
but they are not included. The profit maximizing actors are resulting
in the conflict of interest between a sports agent and an athlete. For
example, a sports agent can make a quick deal with a club, which is
more beneficial for him than for the player. To overcome the agency
problems, arising from the relationship between a sports agent and an
athlete, the athlete has to give the right incentives to the sports agent.
As we sketched it above, it seems like a two-way relationship, but in
reality there is a three-way relationship. The third party is the club. 14
The traditional principal-agent problem is between the sports
agent and the player, because the sports agent is acting on the behalf
of the athlete. It is important to keep the role of the clubs in mind,
because they need sports agents as well. The clubs need the sports
agents, not only to contract a particular player, but also to attract
other players in the future. The other way around, the sports agents
need a club in the future, in order to obtain a contract for another
player. When an athlete has a sports agent, then it is important to
keep in mind that the sports agent (agent) has to do what the athlete
(principal) wants. An agent has to carry out the business affairs of his
principal not of himself. 15
The three parties in the bargaining process have different interests,
but by using the right incentives the conflict of interest between the
sports agent and the athlete can be mitigated. The clubs can also try
to reduce the alignment of interest between the sports agents and the
athlete, in order to get a lower salary in the contract (in the interests
of the clubs). The clubs could reward sports agents, when they act in
their interest and not in the interest of their principal. The three-way
relationship between the clubs, sports agents and the athletes is very
complex and it cannot be said who has a more powerful position in
the relationship.
An interesting example of the relation between sports agents and
players, derived from the brokers, is that the interest of the sports
agent is never fully the same as from the athlete. When the sports
agent gets paid by a commission of the salary, the commission is 10
percent for example. When the player receives an offer of 2 million
euro a year, the sports agent will receive 200.000 euro. With some
effort by the sports agent the player could also receive 2,2 million. The
14 Nowadays, the clubs also need the sports
agents by the increasing amount of regulations,
which results in more rules by
making up a contract. It could even
occur that the clubs assign a sports agent
and the player does that as well, but they
assign different sports agents. It will
result in negotiations with four parties:
two sports agents, the club and the player.
In order to keep it simple I will stick
to the three-way relation in this research.
15 Only if the principal wants something to
be done, which is illegal, than the agent
have no duty to obey the principal
(Shropshire & Davis, 2008, pp. 18-21).
16 A no-claim is a regulation implying that
a person gets an amount of money back,
when there was no claim on the insurance
for a whole year.
17 When a consumer needs his insurance,
there is a part of the costs which have to
be paid by the consumer himself.
reward for the sports agent is 20.000 euro’s, but the effort he has to
do could cost more than the 20.000 euro he receives. When this is the
case, he would accept the offer at 2 million euro a year. The player
misses out some extra benefit, but he did not know that. It is a good
example of how the interest of sports agents and players will conflict
even after the commission fee. It is hard to fully align the interest of
the sports agent and the player.
There are two related concepts, which can be introduced in the
principal-agent relationship. The moral hazard and adverse selection
will be discussed now. Moral hazard could occur, because sports
agents are acting on behalf of the athletes. It means that they could
benefit for it, but the sports agents are not bearing the full risks.
When reputation is introduced, then the sports agents are bearing
risks. It depends on the discount rate of future deals and how much
it affects future deals. Adverse selection could occur in the relationship
athlete-sports agent or club-sports agent. There is information
asymmetry in these relationships, this leads to the possibility of
adverse selection.
2.3.1. Moral hazard
Moral hazard is a market failure, which often occurs in the insurance
market. It occurs, when individuals change risk behavior, because of
insurance. It could lead to a different behavior of the individual. The
individual could act more risky than he would do when he was fully
exposed to the risk. It could be the result of a principal-agent relationship,
where the agent also not bears the full risk of his actions. The
agent cannot completely monitor the agent (Arrow, 1970, pp. 220-
222). When there is a conflict of interest, the agent will have an incentive
to act inappropriate. So, it is important, as has been said before
that the interests of the agent and the principal are aligned.
An example of the insurance market will explain it better. When a
consumer takes insurance from a firm, a part of his risk went to the
firm. He does not have to pay all the costs for damage done by his
actions. This has obviously an effect on the incentives of the consumer.
The consumer will be more careless than he would be when he
was fully exposed to the risk. So, more risks are taken by the consumer
with the insurance. This behavior is called moral hazard, and it leads
to more costs for the firms. When the moral hazard is happening very
often, the market for insurance companies will fail.
The difficulty is the information asymmetry between the insurance
company and the consumer. The insurance company cannot monitor
the consumers in the degree of risk taking (Arrow, 1963). A possible
solution for the market failure in the insurance market is, for example,
the introduction of the compulsory no-claim 16 regulation or compulsory
deductibles. 17 The risks for the consumer would increase by
such regulation, because with any damage they have to pay a part
themselves or they will lose their no-claim. The increase in risks for
the consumer will lead to a change in the incentives of risk taking by
the consumer. The insurance companies have to deal with moral hazard
through these regulations.
The moral hazard problem is also present in the market of sports
agents. As explained at the principalagent problem, the sports agents
are acting on the behalf of the athletes. The sports agent can earn
money by making a good deal, but cannot lose any money (no risk
involved). The risk of the failure of a contract is born by the athlete
(principal). It could lead to more risk taking by the sports agent. For
sports agents, there is some risk involved, because he is investing time
and money into the contracts between player and clubs. The sports
agent has some costs at the beginning, but still the risks are very low.
As can be seen in Figure 2, in the beginning the sports agents are
investing a little money and time.
The payoff is going down until the point where a contract is reached
(point A). When there is a contract between the athlete and the club,
the sports agent gets his commission fee and the payoff increases. When
the player is renegotiating the contract with the club, the sports agent
will receive a commission, which is at point B. Before the renegotiating,
the sports agent has to invest some time and money to make the deal,
this leads to the decrease in profits before point B. The figure is simplified,
but it gives a good illustration the low risk of the sports agent.
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