Don’t rush into a flawed contract

By — on / Business Negotiations, Daily

Adapted from “A Contingent Contract? Weigh the Costs and Benefits of Making a ‘Bet’,” by Guhan Subramanian (professor, Harvard Law School and Harvard Business School), first published in the Negotiation newsletter, August 2006.

Contracts in professional sports are often chock-full of contingencies -“bets” that parties place on their different expectations of future outcomes – and former National Football League running back Corey Dillon’s deal with the New England Patriots was no exception. In 2004, Dillon left a guaranteed $3.3 million salary from the Cincinnati Bengals to join the Patriots for a guarantee of just $1.75 million per year. But in addition to his base salary, Dillon received stepladder bonuses from the Patriots based on the number of yards that he “rushed” (ran with the ball) during the regular season: $100,000 for 700 yards, $150,000 more for 850 yards, another $375,000 for 1,000 yards, another $375,000 for 1,200 yards, and a final $375,000 for 1,600 yards.

At first glance, the deal was contingent contracting at its best. The Patriots paid Dillon only if he performed well, and Dillon had a strong incentive to do so. Dillon demonstrated confidence in his abilities by taking a big cut in his guaranteed income. A closer look reveals a potential moral-hazard problem – a distortion in behavior caused by the agreement – fueled by a kink in Dillon’s incentive function. The stepladder incentives were motivated by a desire to avoid NFL salary-cap limits, but they also created a potentially perverse incentive.

By the final game of the 2004–05 regular season, the Patriots had already secured a spot in the play-offs, and Dillon was 81 yards short of achieving the final $375,000 bonus in his contingent contract. Some sports commentators argued that the Patriots should have rested their star running back, who had been plagued by injuries. Instead, the Patriots left Dillon in for most of the game. He ran for 116 yards, securing the final piece of his bonus, and the Patriots beat the San Francisco 49ers in an insignificant game. Some in the press suggested that coach Bill Belichick left Dillon in to collect the last piece of his bonus. (Belichick didn’t personally pay Dillon’s salary and had a strong incentive to keep his player happy.)

“The whole week all the talk was about the incentives,” Dillon told The Boston Globe in a January 2005 article. “I didn’t want to focus on that. I didn’t care if I did get it, and I didn’t care if I didn’t get it.” That may be true. But the Patriots and Dillon did not benefit from suggestions in the press that the contract contingencies influenced Belichick’s decision making. What can less famous negotiators learn from this story? To avoid fueling moral-hazard problems, smooth out deal incentives in advance.

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