Making money out of football

Byassumption teams spend what they get on the pursuit of sporting success, andcollective selling means more spending power for the small market teams and lessspending for the large marke

Making money out of football

Stefan Szymanski1

Stephen Hall

The Business School, Imperial College London

April 2003

Abstract: In the US most economists have argued that professional sports teams are

profit maximising businesses, but it is a widely held view in Europe that professionalfootball clubs are not run on a profit maximising basis This belief has importantimplications for the impact of policy measures such as income redistribution that arewidely advocated This paper looks at the performance of sixteen English footballclubs that acquired a stock exchange listing in the mid 1990s If the European story istrue, we should have observed a shift toward profit maximising behaviour at theseclubs This paper finds no evidence of any shift in this direction This result isconsistent with the view that football clubs in England have been much more orientedtoward profit objectives than is normally allowed

Keywords: economics of sport, objective functions

JEL classification number: L21, L83

We thank to Dirk Nitzsche for assistance with data collection We thank Peter Sloaneand seminar participants at the CARR Outreach workshop on business history forhelpful comments

1 Corresponding author: The Business School, Imperial College London, 53 Prince’s Gate, Exhibition Road, SW7 2PG, UK Tel : (44) 20 7594 9107, Fax: (44) 20 7823 7685, e-mail: szy@imperial.ac.uk

“Those clubs which have floated to become public companies – Manchester United, Newcastle United, Aston Villa, Chelsea, Tottenham- now have as their principal objective the making of money for their shareholders.”

-David Conn, The Football Business, p154.

1 Introduction

In North America it is commonplace, especially among economists, to think of theowners of professional sports teams as profit maximisers (see e.g Fort and Quirk(1995)) In Europe, however, this assumption has been treated somewhat sceptically

In an influential paper Sloane (1971) argued that a plausible characterisation of theowners of football clubs is as “utility maximisers” subject to a budget constraint,where utility is largely associated with success on the pitch Reasons for this viewinclude the perceived lack of profitability of football clubs and the opinions expressed

by club officials In some countries football clubs are organised as sportingassociations which have no shareholders, but in England all professional clubs arelimited companies, and most have been so for around 100 years

This study focuses on sixteen English football clubs came to be traded on the LondonStock Exchange in the mid 1990s For the most part this arose through share placingsand offers for sale of up to 100% of the share capital If the directors of these clubswere acting as utility maximisers prior to their flotation, then flotation should havebrought about a significant change in the objectives, assuming that investors inpublicly quoted corporations are interested primarily in financial returns At the time

of flotation many fans expressed concerns similar to those implicit in the quote above.This paper examines the performance of these sixteen clubs before and after theirflotation The changes in measured performance of these clubs do not seem to beconsistent with a shift toward more profit oriented objectives

2 The Impact of Flotation

(a) The significance of objectives for league policy

It has long been recognised that the identification of the firm’s objective function iscentral to understanding its behaviour, and this is more than usually crucial when itcomes to understanding sports leagues Members of sports leagues typically enterinto a wide range restrictive agreements such as revenue sharing, limitations onplayers spending (salary caps and roster limits) and restrictions on player mobility.These restraints, the team owners claim, are necessary to preserve a competitivebalance without which the league’s product will become unattractive Antitrustauthorities have in general been persuaded by this line of argument However, criticssuch as Fort and Quirk (1995) and Vrooman (2000) have argued that these restraintswill be tend to raise profits, that this is the true motive for their adoption by owners,and that the impact on competitive balance will be negligible or non-existent Theassumption of profit maximisation is critical to the validity of these claims, as hasbeen shown in work of Kesenne (1996, 2000)

Consider for example, the case of collectively sold broadcast rights In the NorthAmerican major leagues the income derived from collective sale is typically dividedequally among the teams What effect would this have on behaviour compared to thealternative where teams negotiate their own broadcast rights individually and retainthe income for themselves? Let us suppose that if rights are sold individually thenthere are some large market teams that will generate a lot more income than smallmarket teams If owners are profit maximisers there is reason to doubt whethercollective selling will improve the competitive balance of the league, since owners areunder no obligation to spend what they receive Thus a small market team mayreceive more income under collective selling, but will not choose to spend more oncreating a successful team Under the profit maximisation hypothesis owners shouldspend up to the point where the marginal revenue of a win equals the marginal cost,and a fixed share of broadcast income will affect neither marginal revenue nor

2 Indeed, collective selling will impair competitive balance if it leads to a disproportionate fall in the marginal revenue from winning for the small market team, see Szymanski and Kesenne (2003) for an example of this possibility.

is success on the pitch then collective selling will improve competitive balance Byassumption teams spend what they get on the pursuit of sporting success, andcollective selling means more spending power for the small market teams and lessspending for the large markets teams.

(b) ownership and motives in English soccer

In this paper we are interested in the possible change in behaviour associated withstock market flotation The ownership structure of football clubs in the UK issignificantly different from the model adopted in other countries In most of Europe,football clubs have typically been organised as not-for-profit sporting associations.Even very large clubs, such as Barcelona and Bayern Munich, have been run as clubs

in a legal sense, i.e controlled by members who pay an annual subscription andmanaged (in a commercial sense) by a club committee One of the most practicalconsequences of this arrangement has been that football clubs have not been able totake advantage of limited liability and therefore their ability to borrow has been

as early as the nineteenth century No fewer than 68 of the 92 teams in the fourEnglish professional divisions (Premier League and Football League) adopted limited

The conventional view is that the ownership of a limited company resides with theshareholders and that the shareholders are motivated by profit However, there areplausible reasons to doubt this in the case of English football clubs Firstly, analysis ofshareholder lists (see references cited in footnote 4) suggest that the originalsubscribers were largely drawn form a club’s locality and were frequently supporters

of the club and hence the profit motive may have been tempered by an interest insporting success Even shareholders with purely commercial interests (such as localbrewers) may have been more interested in the success of the club from the

3 The finances of football clubs can be hard to understand In many cases wealthy patrons stand ready

to guarantee debts, or local government is involved, directly or indirectly in financial support of the teams

4 All of the teams in the Premier League in the current season (2002/03) were limited companies by

1920 For more details on the early history of English football clubs see Mason (1980), Vamplew (1988) and Tischler (1981) and Inglis (1988).

perspective of generating income for their core business interests rather than for anydirect financial return (Morrow (1999) provides a detailed analysis of the motivation

of directors with dominant shareholdings) Secondly over time most of these clubscame to be concentrated in the hands of a small number of wealthy individuals-usually because the limited company had fallen into financial difficulties Often theseindividuals were supporters themselves, and therefore unlikely to view their

This does not exclude the possibility that some owners of football clubs at some timeswere motivated by profit But arguably what distinguishes a private limited companyfrom a public limited company (floated on the stock exchange) is that in the latter casethe profit motive is likely to be even stronger It is not that the listing requirements ofthe stock exchange oblige companies to maximise profits, but rather that a stockexchange listing typically introduces a class of investors with little or no interest inthe business other than the returns that it can generate, either through the payment ofdividends or the appreciation of the share price Insurance companies and pensionfunds own the largest share of stock in most listed companies

The listing requirements of the stock exchange are intended to provide such investorswith all the information they require to make an informed decision about investmentprospects The directors of the company are thus obliged to achieve this return fortheir stock holders or see the company shares decline and risk a hostile takeover thatmay lose them their job The view that stock market flotation will introducecommercial objectives has been advanced in the North American context Most of theMajor leagues in fact ban stock market flotation on the grounds that this will lead to

directors of any single company will be more profit oriented following a stock market flotation, we can reasonably argue that on average directors of companies with a

listing will be more profit oriented than directors of companies that do not have alisting

5 A third reason is that the FA disapproved of the profit motive in football and took action to try and limit commercialism by means such as imposing a limit on the maximum dividend payable by football clubs But by the 1980s restraints such as these had lost their significance (there are other ways for clubs to reward shareholders) and the will of the FA to restrain commercialism had largely evaporated.

6 Although this is perhaps odd given the prevailing view that team owners in North America are in-the-wool profit maximisers See Cheffins (1998) for a critical discussion of this issue.

dyed-(c) the predicted impact of a change of objectives

If companies that float stock on the market adopt more profit oriented policies, whatdoes this mean in terms of the measurable performance of the company? Firstconsider the impact of success on the profitability of a given club Success, we mightreasonably suppose, is achieved by investing in the team This may mean investing intraining facilities or a good manager, but more often than not it means hiring the bestplayers, and the best players command the highest salaries The better the quality ofthe players on the pitch the more likely is success Szymanski and Kuypers (1999)explored at great length the data that demonstrates the extent of these relationships

If a club spends little or nothing on its players, success will be limited, but profits willalso be small, since few people are interested in paying to watch an unsuccessfulfootball team If player spending increases, however, fans will be attracted and profitswill typically rise This will continue up to some level of success, at which point moreplayer spending will increase success but profits will fall This is illustrated in figure

The directors of a football club are able, up to a point, able to select a financial policyfor the club based on the relationship between success and profits Figure 2 illustrates

7 Another reason why profits may decline as success increases is that fans may become disinterested in the competition because it is too predictable- this is the uncertainty of outcome hypothesis (see

Szymanski (2003)) for a review of evidence on this hypothesis

two different approaches The horizontal lines represents managerial indifferencecurves for a profit maximising owner These are horizontal because the profitmaximiser cares only about profit and so aims to reach the highest horizontal curvepossible- yielding the highest profit whatever the level of sporting success Theconcave indifference curves represent the preferences of utility maximising directors.For such managers increasing profits is seen as desirable, but not if the cost in termsreduced success is too great The shape of the indifference curves imply that amanager will demand ever increasing levels of profit (resp success) to compensate for

a constantly decreasing level of success (resp.profit)

Figure 2 here

Given the relationship between profit and success we can contrast the optimal choices

of profit and utility maximising managers in figure 3 (this treatment is based on

combination tangent to the highest feasible horizontal indifference curve, shown asπ(PM)* and S(PM)* in figure 3 A utility maximising facing the same success/profitpossibilities and choosing the same combination of profit and success would find

implies that a combination of lower profits and greater success would enable to themanager to reach a higher indifference curve Ultimately a tangency such as (π(U)*,S(U)*) could be reached yielding the maximum payoff for the manager

8 Szymanski and Smith (1997) derive a similar relationship.

dividend payments, which are sometimes considered an important indicator ofcompany performance by market investors Thirdly, it may be that companyefficiency is improved, so that resources are more productive and opportunities areexploited more fully (something here which may be associated with a higher degree ofcommercialism- e.g raising ticket prices if it is profitable to do so)

Our strategy is to search for any changes in the performance of these recently floatedcompanies relative to their peers in the professional leagues using the Fame database

of UK company accounting information which provides online records for theprevious ten years Thus in most cases we are able to track performance for about five

profits, league ranking, wage expenditure relative to the average for teams in thatseason and revenues relative to the average for that season The first two variablesshed light directly on any possible change in objectives associated with flotation Thelast two relate to variables that might be related causally with changes in thesevariables; for instance, increased wage expenditure is likely to lead to better leagueperformance Wage spending and revenues are expressed in terms of orthogonaldeviations serves for two purposes Firstly, given the rapid escalation of ticket prices,broadcast rights values and player salaries a relative measure provides a consistentbasis for comparison across years Secondly, in the context of a sports league anabsolute indicator of financial performance such as profits is likely to depend on theuse of inputs measured in relative terms rather than absolute terms (the absolute

9 Since Tottenham, Millwall and Manchester United were listed during this entire period their

performance has not been considered.

quality of a team will not determine its success on the pitch, rather its quality relative

to its competitors) The financial data was downloaded from the FAME database ofpublic and private UK companies, which in most cases provides a full ten year recordfor each company

Table 1: Flotation particulars

a Chelsea FC is owned by Chelsea Village PLC in which the directors and three other interests jointly held 83.5% of the equity at the company’s introduction

b Swansea City FC was purchased by Silver Shield PLC, a car windscreen replacement company Although located in Wales, Swansea plays in English Football League and hence is treated as an “English” club.

c Leicester City FC was acquired by Soccer Investments PLC

(a) Pre-tax profits and dividends

There are significant problems associated with the use of accounting profits tomeasure the financial performance of sports businesses, as is well documented in theAmerican literature on the subject (see e.g Scully (1989) and Quirk and Fort

have a significant incentive to understate profits Particular government policies, forexample in relation to depreciation, may create tax loopholes which enable firms to

10 Both of these drew heavily on the work of Roger Noll from Stanford University who dissected the profits statements of Major League Baseball teams on behalf of the players’ union in the 1980s and found that reported accounting profits significantly understated economic profits.

reduce profits and so legally limit their tax liability Owners may charge expenses tothe company which bear little relation to any economic services rendered, and sotransfer taxable income away from the company (e.g because personal incomes aremore favourably treated) – this is legal tax avoidance (for example, it would not beillegal to pay a director £1m for 10 minutes work), or may be able to illegally evadetax by exaggerating expenses.

Table 2 reports the pre-tax profits for fifteen of the sixteen clubs in Table 1 Summingprofits over the entire period only five of the clubs reported a net profit Newcastlereported a cumulative loss of £47m over this period while Nottingham Forest reported

a cumulative loss of £40m In general a business that runs perpetually at an economicloss will be closed by its owners if they are profit maximisers Several of the clubs did

in fact have to undergo a significant restructuring The shares of Nottingham Forest,Queens Park Rangers (Loftus Road PLC) and Leicester City have all been suspendedfrom the market while the latter two clubs have entered administration (in 2001 and

2002 respectively) Loftus Road is no longer a listed company, while the shares ofLeicester City remain suspended at the date of writing Nottingham Forest had theirshares delisted in 2002 following their failure to publish their accounts and inanticipation of a restructuring involving a cash injection of £5m from a wealthysupporter Swansea City, which was taken over by a listed company in 1997 was sold

to it Managing Director for £1 during the 2000/01 season) Thus it may be that thelosses indicated reflect a genuine failure to produce an economic return On the otherhand, Bolton has reported a pre-tax loss in each of the last nine seasons without filingfor bankruptcy while Newcastle has paid out dividends in each of the past fiveseasons (totalling £14m) despite the size of its reported losses

The ability to pay dividends is generally viewed as an indicator of financial health,although there may be many good reasons for not paying dividends It makes littlesense for a company with profitable investment opportunities to return internallygenerated funds to shareholders Of the quoted football clubs only six have paiddividends: Aston Villa, Bolton, Newcastle, Southampton, Sunderland and WestBromwich Albion The total payout across those years were available was in theregion of £0.9m per club per season

Table 2 illustrate that in general pre-tax profitability has deteriorated significantlysince flotation In the five or so years prior to flotation the clubs in total reportedlosses of £40m in aggregate, an average of £0.6m per club In the five or so yearssince flotation aggregate losses have been £103m, An average of £1.7m per club- i.e.around three times larger than before flotation Only Aston Villa, Chelsea Village,Sunderland and West Bromwich Albion have reported positive profits on average, and

argued that profitability should be compared against industry levels There areroughly sixty clubs which did not change status during the sample for whom we haveaccounting data In the five years from 1992 to 1996 these clubs reported an aggregateloss of £16m, an average loss of about £0.05m per season per club In the period 1997

per season per club Thus it appears that clubs that floated had much larger losses bothbefore and after listing, and in relative terms their losses declined after they werelisted It could even be argued that this indicates a shift toward profit maximisingobjectives However, if profit maximising concerns had weighed significantly moreheavily after flotation, it seems hard to believe that the directors of the listed clubscould not have done a lot more to bring their profitability into line with average of

The decline in profitability also seems to be reflected in the changing marketvaluations of the clubs The market valuations of eleven of the clubs, on a monthlybasis, are shown in the charts at the end of the paper What is clear is that marketvalues of clubs analysed here declined steadily and significantly after flotation except

in the cases of Charlton and Chelsea Furthermore, this performance contrastedsharply with that of Manchester United and the market in general until the stockmarket started to decline in 2000 This is consistent with a rational valuation offootball club shares based on expected profitability

11 I.e all other clubs experienced greater losses than before flotation Chelsea Village also appears to have had higher profits before flotation, but the series is too short to make a reasonable comparison.

12 The sample is not balanced, and there are about 6% more observations in the second half of the panel.

13 There is quite a lot of variability in financial performance Manchester United, the largest and most profitable club by far is often cited as an outlier, but omitting them from the set of clubs whose status did not change does not alter the profile of profitability that much Without Manchester United the 92-

96 average is a loss of £0.2m compared to a loss of £0.7m in the 97-01 period.

(b) League performance

Team performance could be measured in several ways Clubs compete in a number ofsporting competitions- the domestic league, the FA Cup, The League Cup, and at thehighest level the UEFA Cup and Champions’ League Domestic league performance

is the indicator used here, firstly because it is the competition within which teams playmost of their matches, and secondly because club performance over time iscomparable on this basis

The most striking feature of the data in Table 3 is that in twelve out of the sixteencases average league performance was better in the five years following stock marketflotation than in the five years before Moreover, in three of these four cases the clubsinvolved fell into severe financial difficulties and have lost their listing (NottinghamForest, Queen’s Park Rangers and Swansea City) Thus all but one of the clubs thathave retained their stock market listing since the mid 90s have improved their leagueperformance It seems quite likely that it is the financial crisis at these clubs, ratherthan the stock market listing, that led to the deterioration in performance

While this suggests a quite powerful tendency towards improved performance, somecaution should be exercised given the small number of observations involved In mostcases it could not be said that the change in performance was statistically significant

In some cases (e.g Aston Villa, Chelsea, Leeds, Preston North End, Southampton and

improvement in performance was apparent before flotation (e.g Bolton, Newcastle)

so that only in a few cases does there appear to be a significant improvement thatcoincides with flotation (Birmingham City, Charlton, Leicester City and Sunderland)

(c) Wage spending

Clubs improve their league performance by hiring or otherwise acquiring betterplayers Since there is a well functioning market for player talent any improvement in

14 Preston’s performance improved by an average of ten places, which would be a significant

accomplishment in the Premier League but is less impressive on the borders of the First and Second Divisions West Bromwich’s improvement is largely associated with the last two seasons (and their subsequent promotion to the Premier League).

player quality can only be achieved through higher wage spending15 Wage spending

is here defined relative to the average wage spending of all teams in the league since itnot absolute spending that produces success, but outspending your rivals Table 4shows that in 50% of cases wage spending relative to the average increased postflotation As with performance, relative spending fell at those quoted clubs that fellinto financial difficulties (Nottingham Forest, Queens Park Rangers and Swansea, butnot Leicester City) Relative spending also fell at Birmingham City, Preston NorthEnd, Sheffield United, Southampton and West Bromwich Albion However, in thesecase the relative decline was quite small Some clubs saw very large relative increases

in spending- notably Bolton, Charlton, Chelsea, Leeds, Leicester, Newcastle andSunderland In the cases of Bolton, Charlton, Leicester, Newcastle and Sunderland,these were also clubs that witnessed a significant improvement in performance

(d) Revenues

One expectation that one might hold about clubs that floated on the market is that theywould exploit their commercial opportunities more effectively, e.g throughmerchandising and sponsorship This would manifest itself in the ability the extracthigher revenues from a given level of performance Since on average relativeperformance improved post flotation, one might reasonably expect that revenuesrelative to the average would improve at most if not all clubs In fact, revenuesrelative to the average improved at only six clubs out of the sixteen

(e) Regression analysis

The analysis thus far has been discussed in terms of simple averages These shed light

on the proposition that flotation shifted football club owners away from utilitymaximisation toward profit maximisation given that such a change in objectives is

15 Unless the club possesses some distinctive capability that enables them to extract a better level of performance from a given player than any other club See Szymanski and Kupyers (1999), chapter 6 for

a discussion of this possibility.

likely to lead to an increase in profits and a relative decline in performance on thefield However, another approach is to look at the underlying causal relationships and

to see whether flotation led to any change in those causal links

The data available here is a panel, which is characterised by a relatively small timedimension (T) but a large number of clubs (N) The question we are interested in isessentially a dynamic one of the adjustment, which takes place in a club over time toflotation We therefore have a very well known problem in panel data estimation,which was first outlined by Nickell (1981) that under these circumstances OLSdynamic panel data estimation is subject to considerable bias We therefore employthe GMM estimation technique proposed by Arellano and Bond (1991) and Arellanoand Bover (1995) to estimate dynamic panel data models Essentially these techniquesbuild up a recursive varying set of instruments which provide good small sampleperformance even in the face of relatively short time periods (T), a good survey ofthese techniques may be found in Baltagi (1995)

The first causal mechanism that underlies the analysis in this paper is that leagueperformance is determined by the quality of players hired in a competitive market sothat in general higher player expenditure leads to better league performance Thesecond link is that better performance will generate increased revenue as teams attractfans, sponsorship and other income as a result of increased success This is essentiallythe model proposed and estimated in Szymanski and Smith (1997) Each teamchooses a level of investment in playing talent to meet its target level of performanceand profit given their underlying objectives and capabilities We can write

(2) Ωit = λπit + (1-λ) Pit

so that if, for example, λ = 1, the club cares only about profit Here we ask whetherflotation might change the underlying causal relationship as well as the weighting onprofit In effect we test to see whether a and c are affected by flotation This might bebecause a stock market listing is a more effective discipline on company managersand hence they become more productive, either in their ability to generate playingperformance from a given investment (a) or to generate income from success (c) Notethat flotation, since it raises income from the flotation proceeds, should at leastincrease c in the short run

Given that actual outcomes in football will often deviate substantially from plannedresults, the most natural approach to estimating these relationships is using an errorcorrection model Our two estimating equations are:

t it it

it it

it it

it it

it it

it it

i

it

l l

D D

Q Q

P P

R R

R

εβ

ββ

ββ

β

ββ

ββ

ββ

γ

+

∆++

∆++

∆+

+

∆++

∆++

∆++

1 11

1 10

1 9 1 8 1 7

1 6 1 5 1 4 1 3 1 2 1 1

ReRe

PrPr

(3)

t it it

it it

it it

it it

it it

it it

i

it

l l

D D

Q Q

w w

P P

P

ηδ

δδ

δδ

δ

δδ

δδ

δδ

α

+

∆++

∆++

∆+

+

∆++

∆++

∆++

1 11

1 10

1 9 1 8 1 7

1 6 1 5 1 4 1 3 1 2 1 1

ReRe

PrPr

where revenues, wage expenditure (both in orthogonal deviations) and leagueperformance are expressed in logs, Q refers to periods where listed on the stockmarket, D indicates the league division in which the team plays, Pr indicates winningpromotion in the current season and Rel indicates being relegated in the currentseason Parameter estimates are reported in Table 6 The first three columns reportestimates for the revenue equation, the last three columns reports estimates for theperformance equation

We are interested primarily in the sign and significance of the quoted variables In anerror correction model the terms specified in differences specify the way in which agiven variable influences the adjustment toward equilibrium and the levels termsdefine the underlying equilibrium relationship The most important result therefore is

that the variable defining stock market flotation is insignificantly different from zero

in each of the regressions reported- suggesting that stock market flotation has no longterm impact on the performance of the club In other words, quoted teams are notexpected to generate more revenue in the long term from a given league position or togenerate a better league position from a given wage expenditure relative to theaverage The first of these is perhaps most surprising, since many would haveexpected quoted clubs to exploit commercial opportunities of success moreefficiently One interpretation of this result is that all teams exploit commercialopportunities fully, regardless of ownership

The estimates of the dynamic terms tell a slightly differently story In the performance equation the dynamic terms are insignificant, suggesting that there wasnot even a short term adjustment brought about by flotation On the other hand thedynamic terms are significant in the revenue equation (expect in the specification withclub specific dummies included) The implication of this is that quotation broughtabout a one-off boost to income, but that this benefit had no long term effect Oneinterpretation of this finding is that flotation proceeds provided a temporary boost toincome As income was higher, this may have provided more funds for improved

wage-performance reported in Table 3 (this is not the effect of flotation per se, but the effect

of increased income associated with flotation), but this effect lasts only for a fewyears and eventually the team returns to the same revenue-performance/performance-wage equilibrium

4 Discussion and Conclusions

Interpreting the findings of this paper requires some caution On the face of it thereappears to have been a decline in profitability accompanied by increase in relativespending a league performance among clubs that floated some share on the market inthe mid 1990s One might question whether these results, given the size of the sample,are statistically significant, but the main fact is that the expectation, based oneconomic theory, that profits should increase and league performance declinefollowing flotation, does not seem to be supported by the data But there is more than