Are Pay Decisions Based on Pre-Contract Efficiency Necessarily Correct? Evidence From Players Contracts of National Basketball Association

Abstract

This article explores whether pay decisions based on pre-contract efficiency are necessarily correct. Overcoming methodology problems of previous studies, we use each player’s contract of National Basketball Association (NBA) as an observation. The empirical results show that managers indeed pay their employees according to an evaluation of their pre-contract efficiency. However, the pay decisions are not correct. Relative to the final year of the last contract, employees’ efficiency in the first year of the current contract decreases with increased salary. The reason is that managers put more weight on players’ efficiency in the final year of the last contract than on the average efficiency. Our findings deepen our understanding of the mechanism of compensation contract.