The economic environment and contracts
Key topic
This is a comprehensive guide on issues that directly and indirectly affect earnings, hence should be weighed in for any financial decision. We will go over the details pertaining to contracts and we will try to explain them as simply as possible. We will also discuss certain macroeconomic concepts and how they affect our financial lives. Macroeconomic concepts are broad economic indicators used by economists and analysts, such as unemployment levels, balance of trade, GDP and so on. The aim is to enable you to use information that you hear from news outlets and elsewhere regarding the economy and understand on a basic level at least, how it affects you.
Learning objectives
- Understand the different types of economic circumstances that affect your decisions
- Learn how the economy in general has an effect on your income and finances
- Understand how the labor market works
- Develop a good understanding on how sport contracts work
Macroeconomic factors that affect financial planning
Generally, financial planning must take into account wider conditions in the national and global economy and the forces that make up and influence the markets. These markets inhabit a dynamic economic ecosystem; the realities of this ecosystem should be part of sound financial planning.
History has proven that in the long-run an economy grows, the value of a currency remains relatively stable and investments offer lucrative returns. In the short-run, however, that is not necessarily the case. Periods of economic contraction can upset financial plans, particularly if they last for prolonged periods or occur at a vulnerable time in your life. Being able to identify macroeconomic patterns and understand the factors that indicate the health of an economy, can help you make informed financial decisions. These systemic factors include, the gross domestic product (GDP), employment rates, inflation levels, interest rates and currency values.
Business cycles essentially describe the stages of the economy and there are four of them: expansion, peak, contraction and depression. Each stage of the business cycle has its own effect on people’s financial plans. A booming (expanding) economy inspires optimism for the future and businesses develop an anything-is-possible attitude. Business decisions are made with an optimistic and positive outlook. A contracting economy, on the other hand, gives rise to feelings of pessimism, even of despair at certain points. Hence, financial decisions are made with the negative attitude.
An economy’s performance or output is measured by its gross domestic product or GDP, which represents the value of what is produced in a country. GDP measures the value of all goods and services produced in an economy over a specific timeframe. The GPD is also related to the business cycle we described above. When the GDP is rising that is when an economy is expanding, whereas when the GDP is falling, an economy is said to be contracting. An economy remains in a state of contraction for two quarters (or half a year) is said to be in recession.
Over time, both periods of contraction and expansion are normal. You cannot have one without the other. The economy is said to be cyclical, hence the term business cycle. Cycles occur because of changing realities around the world that distort the economic equilibrium. In essence, that means that events upset the balance between supply and demand in the economy overall. There are many reasons that this could happen ranging from war to the overthrow of a government on the other side of the planet, but whatever the reasons, buyers and sellers react either positively or negatively to these developments. Business cycles can affect any industry, including the sports industry which is considered a luxury good and not a necessity.
Even though it is difficult to imagine the sports industry suffering the same way that conventional industries do, the last economic downturn, a bit more than decade ago, had its toll on the sports industry as well.
For decades, the sports industry had been largely impervious to economic cycles. No matter what the state of the economy, sports leagues were expanding, sports stadiums were built and sports sponsorships were soaring high. During the last recession, which swept the United States first and then the remaining continents, things changed; sponsorships funds, match day attendance, and match day spending declined. Sports teams and leagues have become increasingly reliant on revenue from corporate sponsorships, advertising, luxury boxes and suites, and as a result they have suffered a considerable decline in their revenues during the last economic downturn and the recent pandemic.
Let’s watch a short video on what caused the great recession of 2008
Now we will look into how the economy affects income, employment, currency values and inflation within the sports industry and in relation to athletes.
Sports Salaries
The lower revenues of sports franchises and clubs have a direct, negative effect on player salaries. In the United States leagues salary caps are set up as percentages of prior league revenues, so the overall player compensation is affected perhaps not in the short term but definitely in the long term. Usually in times of a recession or a financial downturn, sports franchises try to realign things in their favor and secure a profitable future. Sports contract duration is usually shortened and the values of such contracts are cautiously lowered!
Endorsement Revenue
Professional athletes may feel the pains of a recession in their endorsement deals as well. Corporate sponsorships of sports professionals and endorsement revenue take a hard hit during a recession because corporate budgets and especially marketing budgets are squeezed. Athletes should be prepared for such a predicament and they should perhaps have their endorsement contracts insured so as to secure this source of income in the event their corporate sponsors terminate their endorsement contracts prematurely.
Investment Portfolios
A recession will most probably have a negative effect on your investment portfolio, at least in the short term. Downward stock and real estate market corrections usually come with a recession. At times like this you should remember that building wealth over time is all about taking the long view and not getting bogged down by short term losses. Instead of focusing on the ups and downs of each individual investment, you should step back and look at the big picture. With the help of a financial advisor, you could evaluate your portfolio and implement appropriate strategies which will lead to an eventually balanced and profitable investment portfolio. Economic storms are part of life and we all go through them, more than once.
Employment Rate
The Employment rate is a very important economic indicator since it tracks the number of people who are willing and able to find a job. People participate in the labor market by trading their labor (time, skills, knowledge etc) in exchange for monetary compensation. Most people rely on wages and salaries as their main source of income.
The employment rate, shows the ability of an economy to create and sustain opportunities for people to sell labor and its efficiency in utilizing its human capital. A healthy economy provides plenty of employment opportunities and uses its labor productively and efficiently.
The unemployment rate depicts the proportion of people who are actively looking for a job but are not able to find one. This is usually expressed as a percentage. There is always some unemployment which is called natural, because of unemployment that does not depend upon the market. For example, when someone moves between industries or countries or wants to take some time off to be with family. When the only unemployment in an economy is natural unemployment, then the economy is said to be at full employment, since zero unemployment does not exist. The idea behind natural unemployment is that it is temporary. Natural unemployment is consistently low and does not affect the productivity of the country’s economy.
The employment market for elite sports professionals has traditionally been rather inelastic. Inelastic means not very responsive to changes in income, prices etc. When something is elastic, it means the exact opposite. However, the employment market for lower-tier- income sports professionals is negatively affected by high unemployment. High unemployment is usually the result of a recession and when faced with financial difficulty, sports teams tend to lower player salaries and make reductions in their playing rosters.
Athletes should strive to negotiate longer term contracts which include hefty penalty clauses for premature termination so as to ‘bulletproof’ themselves as much as possible during periods of high unemployment.
Action steps – Exercise 1 (10 minutes)
The economy currently has an unemployment rate of 10% which is rising and at the same time the country’s GDP is falling. Sam has a playing contract for US$ 1 million per year which ends in three months and he is currently renegotiating it with his club. The club is happy to renew the contract for another three years at US$ 1 million per year. Sam is rather disappointed as he was expecting more so he is thinking of not renewing the contract, even though he knows that a number of his colleagues are in a situation similar to his. He currently has no other offers but he believes that he deserves much more in terms of compensation. What would you advise Sam to do and why?
Currency Value and Inflation
A stable currency is another important indicator of a healthy economy and very important for financial planning purposes. Like all other things, the value of a currency depends upon its usefulness as expressed in the demand for it. We use currency, among other things, as a medium of exchange, so the value of a currency depends on how and to what extent it can be used in trade, and it depends on what the economy is producing. If an economy-country does not produce much that consumers want, then the country’s currency has little value relative to other currencies, because the demand for it will be low.
When the value of the currency falls, then an economy will experience inflation. Since the currency is less useful and has lower value, prices rise and less can be bought with it as a result. It takes more units of currency (money) to buy the same amount of goods. For example, let’s assume that $1 can buy you a chocolate bar made in the UK. If the value of the dollar falls then that same chocolate bar may cost $1.50. The chocolate bar hasn’t changed in terms of quality or quantity but is now more expensive. When the value of a currency rises, an economy may experience deflation; prices falling; the value of the currency increasing and thus more can be bought with it. That chocolate bar may cost $0.50. The price fell once again without changes in quality or quantity.
Inflation and currency value may affect athletes in different ways. Currency exchange rates largely affect the real value of the playing contracts of international players. A number of sports professionals who play abroad, sign contracts in currencies other than that of their home country. As a result, their contracts are sensitive to currency exchange fluctuations, especially because they may be sending money back home to their families or for investment purposes. Therefore, international athletes need to be aware of the currency trends of the country they currently reside vis-à-vis the currency trends of their home country and they should try to use currency fluctuations to their benefit rather than to their detriment.
Action steps – Exercise 2 (5 minutes)
Sam’s current contract in the U.S. is worth $1 million per year and it is ending in 3 months. He has been approached by several European Clubs to play in Europe. One club in Italy offered him a contract of €1 million. The current rate is €1=$1,1 but the Euro is on the decline due to economic instability in Europe. What do you think Sam should do and why?
Other Indicators of Economic Health
There are other indicators that give us clues as to how our economy is currently doing and if we should expect growth in the future. These indicators include such things as, consumer spending, construction spending, number of houses constructed, number of home sales, industrial production, and so on. However, GDP and unemployment are the two most important and therefore most closely watched indicators, because they are at the core of an economy’s objectives; to provide opportunities for people to take part in the economy, to create jobs and to satisfy consumer demand.
Contracts
For athletes starting professional careers, dealing with contracts can be intimidating. While athletes can technically choose to negotiate contracts on their own, nearly all athletes form relationships with sports agents who negotiate on the athlete’s behalf. We have already discussed agents and attorneys, but now we will zoom in on their roles when it comes to contracts. Agents are usually attorneys who are experienced with the details of sports contracts and are able to find and negotiate the most lucrative deals for the individuals who seek their services.
Occupation “Athlete”
There is no doubt that being a professional athlete is one of the most financially rewarding jobs out there. In addition to the sports employment contracts of athletes, sports sponsors often pay hundreds of thousands of dollars to them to promote their products. Contracts for the employment of athletes are always in writing and have clauses that oblige the athlete to refrain from certain activities and behavior, such as going out before a game competition past midnight, or engaging in violent activities and they generally set the framework for professional behavior.
Sports Agents and Contracts
Sports agents occupy an important place in sport. They are mainly responsible for securing and negotiating contracts on behalf of pro-athletes. Sport lawyers who represent athletes tend to be trained and experienced in the fundamentals of contracts and are familiar with the market for sports, especially when it comes to the market value of athletes.
Nonetheless, it should be noted that having a lawyer or an agent on the payroll is not a requirement. Some athletes prefer not to hire an agent for several reasons, including the various fees and commissions associated this service.
Since the occupation “athlete” is a unique one in terms of skills, abilities and talent, their contracts are categorized as personal services contracts.
Sports Contracts Categories
There are three general types of contracts for athletes: Professional services contracts, endorsement contracts and appearance contracts.
- Professional Services Contracts are the standard contracts that athletes sign when they agree to compete for a team. For some organizations and leagues, standard player contracts establish the basic salary for all players, though in others, each salary is addressed individually in addition to the contract. These general, multipurpose contracts are delivered to all athletes without negotiated salaries or bonuses. The wording of these contracts is very similar for all with the exception of financial incentives. Athletes usually negotiate gross amounts (before the deduction of taxes and contributions). Taxes and contributions withheld include federal income tax, state income tax and social security contributions.
- Endorsement Contracts govern relationships between athletes and sponsors who work with the athlete instead of the athlete’s club. The purpose of these contracts is to allow sponsors to use an athlete’s name, image and/ or likeness in advertising, in exchange for monetary compensation. While there are some limitations – legal and ethical – on the endorsement of certain products, such as medical supplements, tobacco and alcohol, athletes are generally free to sign contracts with a wide range of organizations regardless of their professional contract.
- Appearance Contracts refer to contracts that athletes sign to make public appearances for additional monetary compensation. They allow for additional compensation for athletes who choose to appear at public functions. For instance, an athlete may be invited to speak at a graduation ceremony or to be interviewed by someone. These contracts establish compensation, parameters and requirements for both parties.
What is included in a Sports-Contract
Sports contracts, particularly professional services contracts, tend to be formulaic and include standard elements. As a legal contract, a sports contract is highly detailed, and is designed to provide maximum clarity and specify exactly what an athlete can and cannot do while employed by a sports franchise.
Contracts generally begin with common clauses that title the negotiation at hand and describe the parties involved. These clauses are the foundation for ensuing details. Once set, sports contracts must clearly define the contract length of service to the organization as well as whether renewal options exist at the end of the period.
Next, contracts must describe the precise duties and obligations that a player will be expected to perform while employed by their franchise. This can include game time, practices and public team appearances. It is also important to indicate whether an athlete is required to hold limited employment with a particular organization, and whether options for additional incentives, compensation, and employment exist.
With these major sections addressed, the remainder of the contract tends to focus on individual salary details, options for bonuses and the steps to be taken in the event of early contract termination. Sometimes, athletes choose to break a contract before their term has finished. It is very important for agents to be clear on contract specifications to determine whether their client is permitted to leave, and what kinds of penalties the athlete may be required to pay should they choose to breach the terms of the contract.
Comparing Contracts
While they may seem complex, sports contracts are largely similar to business contracts. Given the role of many athletes as highly visible figures, the key differences are in the specific compensation requirements, possibilities for sponsorship from external companies and potential for public appearances at a variety of functions.
With an experienced agent, familiar with these types of specifics, athletes can rest assured that the complexities of sports contracts will become clear in time, ultimately allowing them to play the sport they love and be well-compensated for their efforts.
Lesson wrap-up
Today’s lesson was divided in two parts. First, we discussed macroeconomic concepts, how they affect the economy and by extensions how they affect you when they change; either for the better or for worse. Such knowledge is very important and a cornerstone of financial literacy since you not only need to understand money management and financial planning, but also appreciate the broader climate that undoubtedly affects your finances. Moreover, we explored sports contracts; the different types of contracts that exist for athletes, some of the information that you might expect in them and how your advisers factor in.
At this point we will wrap up today’s lesson. First, we will go over the learning objectives of this lesson and we want your feedback as to whether they have been achieved and then we will address any questions you may have. Please feel free to ask anything you’d like in relation to today’s lesson and we would love to hear how the concepts we discussed today relate to you and your life!