Abstract
In this paper we demonstrate how the Major League Baseball (MLB) free agent compensation system (FA-CS), intended to achieve parity across MLB teams, has the unintended and adverse consequence of increasing inequality. The FA-CS compensates teams that release a Type A Free Agent by giving them a compensation pick – the highest draft pick from the team that signs the free agent. The cost of each lost pick decreases as teams sign multiple Free Agents. This characteristic lowers the cost per Free Agents, when multiple Free Agents are signed. However, such benefits are solely accessible to teams that are relatively resource unconstrained, giving rise to an inequality-increasing positive feedback. To explore the importance of the FA-CS positive feedback, we develop a dynamic model of the flow of Type A Free Agents through their MLB career, including their maturation from draft picks, to minor league, to major league, to free agency, and finally to retirement. Additionally, we model teams’ free agent hiring process to understand free agent dispersion within the league. Isolating the FA-CS feedback from other scale effects and calibrating the model to MLB data we estimate the strength of this adverse inequality-increasing effect.