What is the Salary Cap
7 minute read · Issue Number 109 · February 25th, 2022
Friends,
After writing last week’s post about underdogs in sports, I reflected on the diverse strategies leagues can undertake to have a more balanced competition (i.e., close the gap between the underdogs and the favorites).
One of those strategies is the salary cap.
Grab a cup of coffee while I explain to you about it.
The Salary Cap
Imagine you suddenly become the owner of your favorite team in sports. Life’s great – you take your friends and family to VIP seats at every game, you get unlimited nachos, meet all your favorite players, and you couldn’t ask for any better entertainment.
After a few seasons, you decide it’s time to win some championships to bring joy and happiness to the city and fans of the club.
You come up with this brilliant idea – you’ll raise millions of dollars from wealthy investors overseas and offer massive contracts to the best players in the world to win championships for your team.
Easy money, right?
Well, it turns out the moment you try to do this, you receive a letter from the league’s commissioner stating you’re violating the league’s salary cap restriction.
“What the hell?!” – you think – “this is my team, my business, and I decide what to do with it!”
Well – yes and no. Being part of a league means you must adhere your desires to what’s generally allowed.
The salary cap is a rule that a league sets that aims to limit the amount of money teams can pay to their players in the form of salaries in a year.
The main goals of the salary cap are to promote fair play and prevent ‘rich teams’ from developing an unfair competitive advantage from roster spending and control costs—more on this in a second.
Each year’s salary cap is different, and it is calculated and announced before the beginning of each season.
History
The NBA implemented the first salary cap in 1984, which disrupted a clause in the rulebook that required players to stay with the team that drafted them for the entirety of their career.
The NFL introduced its first salary cap for the 1994 season and the NHL in 2005.
The MLB works a bit differently – teams have a “luxury tax” they must pay if their payroll surpasses a specific level.
Many leagues from diverse sports worldwide have a salary cap rule or variations of the rule, but plenty still don’t (cough, cough, Ligue 1).
Types
There are three types of salary caps; hard, soft, and floor.
Hard cap is when a league sets a maximum amount that teams may not exceed for any reason.
Soft cap means there are specific circumstances where teams can exceed the amount stated.
Floor is the minimum amount each team must spend each season.
Usually, leagues will impose strong economic sanctions on those who overspend or underspend. Other penalties include stripping championships or suspending teams from specific competitions.
Benefits
Erase money from the equation of the winner – whoever wins won’t be judged for their spending
Parity is good entertainment – you’d get bored if the same team won every year
Players are incentivized to switch – just like in a job market; there could be benefits from changing jobs, great players could find opportunities in smaller teams as well
Cost control & budgeting – prevents teams from overspending and suffering long-term instability
The Bottom Line
The salary cap rule creates something I call “The underdog parity paradox” – oddly enough, we love watching underdogs win, but rules like the salary cap aim to get rid of underdogs overall.
As with everything – there are advantages and disadvantages to salary caps. Understanding what they are and how they work provides us a more clear picture of the diverse efforts leagues do to be more entertaining.
🔗 Links
What happened to Barcelona and Real Madrid? A fascinating read on how they lost Messi and Ronaldo – and slipped from the world’s summit.
Are Salary Caps for Professional Athletes Fair? More on the history, pros, cons, and arguments around salary caps.
How Salary Caps Changed Sports? This quick read from Investopedia provides more context on some issues around Salary Caps.
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