Yesterday, I looked at how competitive MLB was using the Noll-Scully measure of competitive balance and today I want to look at the relationship (and its magnitude) between regular season MLB team payroll and MLB regular season team performance. If you are interested in doing this type of analysis, here is a step-by-step guide to payroll and performance analysis.
After combining the data and performing the statistical analysis, one finds the following. First, for the 2016 MLB regular season, there is a positive and statistically significant (t-statistic is greater than two in absolute value) relationship between team payroll and team performance. In fact, the relationship is that an additional increase of ten million dollars in one teams payroll would move an average team (i.e. the Kansas City Royals) from a winning percentage of 0.500 to 0.509 and an additional increase in team payroll equal to the average team payroll ($126 million) would move the average performing team from 0.500 to 0.614, which is basically an increase in 18 wins over the regular season or almost $7 million for each additional win. While for the average team this moves them from not making the playoffs to being a World Series contender, for teams like the Minnesota Twins, this moves them from being the worst team in MLB with a winning percent of 0.364 to a winning percent of 0.478 and still out of playoff contention.
Second, the performance of the regression is better than in years past, with the amount that the variation in team payroll "explains" the variation in team performance being around 39%.