October 8, 2014
The average professional athlete earns in a single season incomes well above the income an average family could earn a lifetime. For example, according to the latest statistics from the U.S. Census Bureau, in 2012 the median annual income of American households was US$51,371. This figure may seem paltry when compared to the annual earnings of athletes like Floyd Mayweather (US$105 million), Cristiano Ronaldo (US$80 million), LeBron James (US$72 million), Tiger Woods (US$61 million) and Roger Federer (US$56.2 million). Moreover, if we consider only the aggregate income of 100 families located at the lower bound of the top 5% richest households in the United States, these families would earned a total of US$21 million per year, well below than the US$2,750 million earned by the top 100 paid professional athletes.
Despite the astronomical figures of the income earned by professional athletes, it would be difficult for us to imagine that these people can have economic difficulties throughout their life (actually they have!). According to a report published in the popular magazine Sports Illustrated, most professional athletes declare bankruptcy during the first 5 years after retirement. Specifically, 78% of former athletes of the National Football Association (NFL) declared bankruptcy less than two years after their retirement date; while in the case of the National Basketball Association (NBA), 60% of former athletes declare bankruptcy within the first 5 years after retirement. For athletes of the Major League Baseball, the bankruptcy rate is lower than the rate observed in athletes from the NBA or NFL, but can be up to 4 times the bankruptcy rate of the average American household (see Torre, P. “How (and Why) Athletes Go Broke”, Sports Illustrated, March 23, 2009).
There are few studies that attempt to determine the factors that cause professional athletes declared bankruptcy shortly after retirement. Some reasons cited in the work of Torre (2009) include compulsive purchases of luxury goods, divorces and a low aversion to risky investments. Regarding the latter, the level of self-confidence that these individuals develop could play an important role explaining attitudes toward risk. For example, Ruby (2013) develops a model in which entrepreneurial activity is associated with adverse financial results. Using statistics of professional basketball players from the NBA, Ruby constructs measures of the player’s self-confidence levels and finds that the self-confidence level of athletes can significantly explain the probability of bankruptcy. That is: the more confident and sure of themselves are athletes, the greater the proportion of athletes engaging in risky financial activities and increasing their chance of declaring bankruptcy in the future.
From my point of view, another factor that could explain the frequency with which professional athletes declare bankruptcy is related to the Permanent Income and Consumption hypothesis developed by Milton Friedman, the 1976 Nobel Prize winner in Economics. According to this theory, individuals make their consumption decisions based on their permanent income, or income received throughout their life. In turn, they can also earn income temporarily and/or unexpectedly. Friedman argues that individuals sometimes are not able to distinguish between temporary or permanent income, leading to consumption decisions that are not optimal; for example, individuals might over-consume during certain time periods. Since the average duration of the careers of professional athletes is only 3.5 years in the NFL, 4.8 years in the NBA and 5.6 years in the MLB, it is possible that professional athletes are not distinguishing what could be a temporary income from a permanent one and overestimate the duration of their careers, leading them to adjust their spending in a non-optimal way and declare bankruptcy a few years after retirement when they are in the lower side of their income-generation curve. Obviously, it would be the subject of an empirical study to confirm this hypothesis.
Professional athletes earned during their career sums of money that many of us could not imagine ever achieve. However, the frequency with which these individuals are involved in such financial scandals and go bankrupt significantly exceeds the average household’s bankruptcy rate of any nation. Some famous cases of athletes involved in financial scandals or incurred in bankruptcy include Mike Tyson, Michael Vick and Allen Iverson, who accrued together the incredible sum of US$800 million during their careers. Lenny Dystra, three-time All-Star MLB player, is another interesting case because, after his retirement, the former center field of the New York Mets was known to be a financial “guru” until he declared bankruptcy in 2009 and, in late 2012, was convicted to 6 months in prison for fraud.
There are some ideas that might explain why athletes are involved in such situations. However, we need more research to reach more accurate conclusions. The truth is that the lack of money, as many people try to justify, is not the main cause that leads us to financial problems, but it is mostly the handling we give our personal finances.