Last season after the World Series I wrote about the payroll and performance hypothesis in MLB and questioned how strong this relationship was during the 2011 MLB season. At that time I admitted that only looking at one season was not a long enough time period to make a definitive conclusion about payroll and performance. So I thought that I would revisit this over a longer time period in MLB.
So I am going to look at the entire time period that the USA Today has MLB team payroll data, which is from 1988 to 2011, and then using mlb.mlb.com for the team standings data, I am going to compare the impact that relative payroll has on team regular season performance.
Why do I use relative payroll? It is a statistical reason, but let me see if I can explain. Of the two variables, winning percent is stationary - in other words average winning percentage for each season is 0.500, but total payroll is non-stationary - in other words the average of total payroll is increasing. Running a regression using a non-stationary independent variable (total payroll) will result in a poorer performing result if the dependent variable (winning percentage) is stationary. Thus to get both variables stationary, I convert the non-stationary total payroll variable to a stationary variable (relative payroll). Relative payroll is calculated as team i's total payroll divided by season j's average payroll. For example, for the Philadelphia Phillies in 2011, I took Philadelphia's total payroll of $172,976,379 and divided by the average of total payroll for the 2011 MLB season, which is equal to $92,872,043 which gives me a relative payroll for Philadelphia equal to 1.8625.
So after running the numbers, I find that relative payroll in Major League Baseball "explains" in a statistical sense only 17.6% of team winning percentage from 1988 to 2011. Another way of looking at this is that relative payroll explain less than 80% of why MLB teams win at different rates. If I fail to take into account this non-stationary issue and just use total payroll instead of relative payroll, then the explanatory power drops to 6.8%.
Hence for this reason, I seriously doubt that payroll is a good indicator of regular season team performance in Major League Baseball.
Still not convinced? Fine - tomorrow I will post a step-by-step procedure as how I calculated this result.