After Adam Silver brought the hammer down on Los Angeles Clippers’ owner (and notorious racist) Donald Sterling, the NBA and the country breathed a sigh of relief. When the Clippers’ answered with a win against the Warriors in Game 5 of the first round of the playoffs, it was in part to try and put this dark episode in the organization’s history behind it. Yet now, after the owner received his lifetime ban from the league, sportsfans and non-sportsfans alike are asking the question: will Donald Sterling sell the Clippers?
We can look to economics for the answer to the question (what issue can’t be informed by a little economics?)
Coase theorem says Donald Sterling will sell the Clippers, and soon…not even a local monopoly within the NBA.
— tylercowen (@tylercowen) April 29, 2014
Tyler Cowen suggests that the Coase Theorem can explain what the beleaguered Clippers owner will do with his team. First, a little background on the Coase Theorem. Conceptualized by economist Ronald Coase, the theorem states that, no matter resources are allocated initially, economic efficiency can be reached in a market even when externalities are present as long as property rights are clearly defined and transaction costs are sufficient low. According to Coase, economic actors will bargain to reach the most effective allocation of resources based on who is able to reap the most economic benefit from the good. For example, say a wind farm operating near homes causes noise pollution. Assuming negligible transaction costs and sufficient property rights, if the value of operating the turbines is greater than the noise costs imposed on the residents, then the turbine operator could pay the residents an amount between its benefit and the residents’ cost. This allocation will thus make both parties better off. To figure out if the theorem holds in the case of Sterling, we need to figure out if its conditions are met.
1. Is there an externality?
Does Donald Sterling’s ownership of the Clippers create externalities? In other words, does his ownership the team incur a cost or benefit on a party who did not choose to incur that cost or benefit? In this case, the NBA, as well as Clippers fans, are both outside parties who have to bear costs of Sterling’s poor ownership of the team. Any decreased advertising revenue to the NBA constitutes as a negative externality. Also, any emotional or otherwise negative costs bore by fans supporting a team with a racist as an owner would be a negative cost.
2. Are property rights clearly defined?
While you can argue if Sterling deserves to own the Clippers, no one can argue if Sterling owns the Clippers. The NBA also has a clear set of rules and property allocating outlining advertising revenue.
3. Are transaction costs sufficiently low?
@tylercowen I see transaction costs…
— Matt Yglesias (@mattyglesias) April 30, 2014
In this case, Ygalesias is right, there are are some significant transaction costs to Sterling selling the Clips. While the market for national sports franchises (even the worst ones) is hot right now, Sterling would have to pay some significant transaction costs when selling the team. After buying the team for just $12 million back in 1981, many now value the franchise at close to $1 billion. Like any other investment, if Sterling sells he’d have to pay the 33% capital gains tax in the change in value ($987.5 million x 33% = $329 million in taxes). Now, if Sterling dies and one of his family members inherits the team, they’ll only have to pay capital gains tax on the value that appreciates under their ownership reign. So, if the team only appreciates from $1 billion to $1.1 billion they’d only have to pay tax on $100 million ($33 billion). Besides being a litigious and ornery man, this difference in transaction costs is why Sterling is planning to sue the NBA if (but more like when) the owners try to force him to sell.
While countless billionaires and celebrities have already expressed interest in purchasing the team, the Coase Theorem tells us that Sterling will use any means necessary to hold on to the team until the transaction costs are significantly lower.
Comments or questions? Send them to me @jeremysjacob