In the 1970's, economists studying oil lease auctions coined the term "Winner's Curse." The idea behind the Winner's Curse is that in an auction, the "winner" of the auction -- the one who lands the desired item -- is the one that most overvalues the item. If multiple bidders bid on an item, assuming the true value of the item is roughly the average of these bids, and the winner of the auction is the highest bidder, the auction winner has overvalued the auctioned item. In recent decades, the Winner's Curse has been applied to many industries, including financial markets, real estate, and television broadcasting.
In the NBA, teams' bidding on free agents can give rise to the idea behind the Winner's Curse. During free agency, teams have relatively similar levels of information regarding a players' future production. While free agents often select cities based on non-monetary factors -- the chance to compete for a title, playing time, or a livelier city -- one can imagine a situation in which every team in the NBA has cap space and bids on a free agent solely driven by money, agreeing to join the team that will offer the most money.
While not a perfect corollary, the free agency bonanza in the summer of 2016, demonstrates the premise behind the Winner's Curse. The salary cap for 2016-17 jumped 34%, from $70.0 to $94.1 million. The result was that almost all teams were flush with cap space and unafraid to use this money given the potential for additional cap spikes in the near future. Numerous teams gave large contracts to mediocre players.
The Los Angeles Lakers lavished Luol Deng and Timofey Mozgov with four-year deals worth a combined $136 million, far in excess of reported offers from other teams. Similarly, the New York Knicks gave Joakim Noah a four-year deal worth $72 million and the Milwaukee Bucks signed Miles Plumlee to $52 million over four years. Both Noah and Plumlee were signed after seasons thoroughly undeserving of large long-term deals, neither played well in limited games last year, and neither player has played this season. In all of these deals, the signing team "won" the rights to the free-agent by offering the highest price. But, per the Winner's Curse, the signing team lost because they valued the players' future production more than any other team. Eighteen months after these signings, it is clear that the signing teams significantly overvalued these free agents' future production.
The Washington Wizards entered the 2016 offseason with aggression and money to spend. On July 1st, the first day of free agency, the Wizards resigned Bradley Beal to a five-year maximum contract worth $128 million. Even after signing Beal, the Wizards had $31 million in cap space with which to lure free agents. With holes in their frontcourt, the Wizards set their sights on Al Horford. While the Atlanta Hawks initially had the upper-hand in the bidding, given their ability to offer an additional year and more money, they quickly squandered this advantage by signing Dwight Howard. This meant that the remaining teams pursuing Horford, including the Houston Rockets, Boston Celtics, and Wizards were all similarly constrained in their bidding by the rules governing maximum contracts. Ultimately, Horford selected the Celtics, signing a four-year deal worth $113 million.
With Horford signed, the Wizards retained their $31 million in cap space and entered the bidding for other frontcourt free-agents. Within hours after Horford chose the Celtics, the Wizards signed Ian Mahinmi to a four-year contract worth $64 million. Prior to the Mahinmi signing, NBA.com's David Aldridge reported via Twitter that the San Antonio Spurs, Minnesota Timberwolves, Charlotte Hornets, Dallas Mavericks, and Portland Trail Blazers were all interested in Mahinmi. While the value of any offers made by these teams was not reported, it is likely that the Wizards' $64 million offer was the highest. With additional cap space and frontcourt concerns remaining, the Wizards also signed Jason Smith to a $16 million deal over three years and Andrew Nicholson to $26 million over four years. Again, contract terms offered by other teams (if any were made) went unreported, but it is likely that the Wizards were the highest bidders. In effect, the Wizards "won" the bid for the services of Mahinmi, Smith, and Nicholson, acquiring the free agents by offering more money than any other organization.
Photo taken by Keith Allison
Unfortunately for the Wizards, the premise behind the Winner's Curse applies to their signings of Mahinmi, Smith, and Nicholson. While the Wizards may have won the bid for their services, the Wizards lost as they overvalued their future production. All three players -- in particular Mahinmi and Nicholson -- have failed to live up to their contracts. Nicholson's production certainly did not merit $26 million; he was traded away after playing only 28 games in a Wizards' uniform. After a series of trades, Nicholson is now playing in China after the Blazers released him via the stretch provision and agreeing to pay him $2.5 million for the next seven years. Meanwhile, Mahinmi has failed to produce at a level that merits a $16 million a year contract. Injured for most of the 2016-17 season, Mahinmi played sparingly and ineffectively in only 36 games including the playoffs. This season, Mahinmi is healthy, but produces little, averaging only three points and four rebounds in twelve minutes of playing time. Compared to the Mahinmi and Nicholson deals, Smith's contract is relatively harmless. But, due to injuries and DNPs, Smith has played in fewer than half the Wizards' games this season and has made only one three-pointer despite reinventing himself as an outside threat.
The impact of these poor signings on the Wizards' current and future cap flexibility is significant. While the Blazers will pay Nicholson until 2024, the Wizards used a first-round pick to trade Nicholson to the Brooklyn Nets. The Nets selected Jarrett Allen with that draft pick, 22nd overall. Allen is a 19 year-old center, exactly the kind of athletic frontcourt presence the Wizards desperately need. In addition, by virtue of the rookie salary structure, Allen is an extremely cost-effective frontcourt option. The Nets have Allen's rights for three seasons after this season and owe Allen a total of only $10.1 million over that time. Meanwhile, the large contracts given to Mahinmi and Smith have hamstrung the Wizards' ability to sign other players. Due in part to their meager production, the Wizards' bench ranked second to last in the league in scoring last season.
The premise behind the Winner's Curse does not suggest that teams should decline to bid on free agents, rather it provides a blueprint to properly approach free agency. The key is to target players deserving of maximum contracts. Teams should target maximum contract players because the NBA's salary rules limit the amount that teams can spend (or overvalue) a player's production. In the case of Al Horford, numerous teams were willing to give Horford a maximum deal, and without the salary rules, teams almost certainly would have offered Horford a contract in excess of the $113 million deal he signed. The salary rules protect teams, restricting their ability to overvalue a player's production and allow teams to sign players for less than they would receive in a pure bidding situation.
During the summer of 2016, the Wizards took the right approach initially, but their backup plan proved disastrous. Giving Beal a maximum contract was the right thing to do; while $128 million is a lot of money, the maximum contract rules limited the size of his deal. Next, the Wizards' targeted Horford, again hoping to sign a maximum contract player, and again hoping to get an effective discount based on the league's salary rules. However, once Horford selected the Celtics, the Wizards panicked, severely overvaluing the production of Mahinmi, Nicholson, and Smith. Unfortunately, those mistakes will have long-term consequences that will impact the Wizards' organization for years, effectively cursing the Wizards for signing those players.