Gaming the System: Loss Aversion and the Contract Year Effect in the NBA

The contract year effect, which involves professional athletes strategically adjusting their effort levels to perform more effectively during the final year of a guaranteed contract, has been well documented in professional sports. I examine two types of heterogeneity in the National Basketball Association, a player’s value on the court relative to their salary, and the presence of several contract options that can be included in an NBA contract. Loss aversion suggests that players who are being paid more than they are worth may use their current salaries as a reference point, and be motivated to improve their performance in order to avoid a “loss” of wealth. The presence of contract options impacts the return to effort that the players are facing in their contract season, and can eliminate the contract year effect. I use a linear regression with player, year and team fixed effects to evaluate the impact of a contract year on relevant performance metrics, and find compelling evidence for a general contract year effect. I also develop a general empirical model of the contract year effect given loss aversion, which is absent from previous literature. The results of this study support loss-aversion as a primary motivator of the contract year effect, as only players who are marginally overvalued show a significant contract year effect. The presence of a team option in a player’s contract entirely eliminates any contract year effects they may otherwise show