European football; financial crisis; regulation; competition

Transcription

1 Lago / et al. / FINANCIAL CRISIS JOURNAL IN EUROPEAN OF SPORTS FOOTBALL ECONOMICS / February 2006 The Financial Crisis in European Football An Introduction UMBERTO LAGO University of Bologna ROB SIMMONS Lancaster University STEFAN SZYMANSKI Imperial College London Is there currently a crisis in European professional football? Surely there exists a common set of problems afflicting clubs, with negative financial implications for all. Moreover, a crisis in one large club or group of clubs threatens to damage the financial stability of other clubs. This introduction reviews the financial crises in football in several European countries, searches for common explanations of these crises, and proposes a few solutions, ranging from tighter financial regulation to the restructuring of competition, with the aim of easing the financial burden for smaller clubs in particular. Keywords: European football; financial crisis; regulation; competition On March 12, 2004, a group of economists representing 11 of the national associations of the Union of European Football Associations (UEFA) met under the auspices of the University of Bologna at Rimini, Italy, to discuss the present financial state of football clubs in Europe. This introduction summarizes the conclusions of the group and sets the scene for the articles on specific European football leagues that follow. Our conclusions can be grouped under three distinct headings: (a) Is there currently a crisis? (b) What are the causes of the current financial problems of football clubs? and (c) What are the solutions? JOURNAL OF SPORTS ECONOMICS, Vol. 7 No. 1, February DOI: / Sage Publications 3

2 4 JOURNAL OF SPORTS ECONOMICS / February 2006 IS THERE CURRENTLY A CRISIS? There is currently much talk about a crisis in European football, but there is a need for caution before the word crisis is used. Individual football clubs across Europe have experienced financial crises on many occasions in the past. Such cases, however, cannot be considered examples of a general crisis in football. A general crisis implies that some deep-seated problems have produced a state of affairs in which a fundamental restructuring of the game itself is the only long-term solution. When individual clubs have fallen into difficulty in the past, such problems may have arisen as a result of particular local conditions, particular forms of conduct, and simply bad luck. In some cases, a football club may have been restructured, whereas in others, it may have disappeared altogether, but in either case, the crises have been narrowly located, and their implications for the competitive structure of football as a whole have been limited. Today, there is talk of a systemic crisis. The notion of a systemic crisis has two features: 1. There exists a common set of problems afflicting all clubs, with negative financial implications for all; and 2. the crisis in one club or group of clubs threatens to damage the financial stability of other clubs (this idea of contagion is similar to the notion of a banking crisis). The possibility of contagion is a special problem for a system of sporting competition not shared by many other types of commercial activity. In most industries, the financial failure of one company is likely to benefit its rivals, because the disappearance of one competitor will increase the demand for the products of the others and will tend to increase their profitability and hence their financial stability. Banking is an exception to this rule, because banks tend to be depend indirectly on one another through the credit system: The liabilities of one bank are often the assets of another, and hence the failure of a bank because of an inability to meet its liabilities also implies a reduction in the assets of other banks. In sports, the interdependence arises through the process of sporting competition: One team cannot play without the cooperation of another. If clubs fail, they may be unable to complete their fixture lists, undermining the value of the competition as a whole. If clubs with limited followings fail and are replaced by clubs with stronger followings, it can still be the case that the remaining clubs gain, but if popular clubs fail, the quality of the competition and the finances of all clubs may deteriorate. Talk of a financial crisis is set against a period in which the income of football as a whole has risen dramatically. Figure 1 shows how income has risen dramatically in the top divisions in large European leagues. Although growth has not always been as spectacular, smaller leagues have also enjoyed rapid income growth. Thus, if there is a crisis, it is not a crisis of income. Even if we allow that there has been a downturn in income in the past 2 or 3 years, income still remains significantly higher than it was a decade ago. Moreover, there is no reason to believe that income will ever fall back to earlier levels. In general, economists think of football

3 Lago et al. / FINANCIAL CRISIS IN EUROPEAN FOOTBALL 5 Figure 1: The Growth of Income in European Football SOURCE: Annual Review of Football Finance as a normal good, meaning the kind of product for which demand increases as income rises. It is not usual to think of a period of rising income coinciding with financial crisis, although in the next section, we discuss how this could happen. Two kinds of evidence can be presented to demonstrate the possibility of crisis. First, there is the imbalance between income and expenditures, and second, there is evidence of rising debt. The reliability of operating losses as an indicator of the financial health of sporting businesses has long been challenged in the United States. Many studies have shown that club owners frequently disguise the profitability of their franchises to manage their tax liabilities and to put pressure on municipal authorities to subsidize new facilities such as stadiums (see, e.g., Fort, 2006; Noll & Zimbalist, 1997; Quirk & Fort, 1992; Siegfried & Zimbalist, 2000). American commentators, however, also broadly agree that the owners of sporting franchises are driven primarily by commercial objectives (e.g., Zimbalist, 2003). In Europe, by contrast, there is a broad consensus that profit motives have been more restrained, although cases vary according to country. Thus, in France, Spain, and Germany, for example, the ability of clubs to operate as profit-maximizing businesses has been limited either by regulation or voluntarily, whereas in Italy and England, the scope for adopting commercial objectives has been greater. Yet even when profits may have been pursued by owners, the opportunities to disguise profits or to exploit accounting loopholes have been more limited in Europe than in the United States. This reflects in part the fact that in Europe, sporting clubs have generally not fallen under the control of

4 6 JOURNAL OF SPORTS ECONOMICS / February 2006 TABLE 1: Football Clubs Financial Crises in European Countries Country Large Clubs in Crisis? Small Clubs in Crisis? Italy Yes Yes England No Yes Scotland No Yes Belgium No Yes Portugal No Yes France No No Germany No No Spain No No The Netherlands No No Greece No No Switzerland No No larger business empires (although Italy is a significant exception) and in part a different culture and tradition. Operating losses in themselves do not imply a crisis, as long as they can be funded. There is a great deal of evidence from the past that football was able to sustain such losses over a long period of time without financial failure, except in one or two exceptional cases. Funding historically might originate from a number of different sources: wealthy patrons, banks, municipal authorities, and tax and social security systems. The fact that many clubs have found it increasingly difficult to meet funding gaps reflects the increasing difficulty clubs have faced in locating these traditional sources of finance. By and large, however, our discussions illustrated that the crisis in most of Europe, where it exists at all, is primarily to be found among the small clubs. Table 1 illustrates the situation in each country. Only in Italy was it clear that both large and small clubs are facing a financial crisis. The extent of this crisis is revealed by Baroncelli and Lago in their article in this issue. Total operating losses in Serie A increased from 144 million in ( 8 million per club) to 982 million in ( 54 million per club). The current losses appear unsustainable when set against the total revenues of only billion (excluding extraordinary items such as player trading). As a result, total indebtedness in Serie A increased to billion in Although AC Milan and Juventus can be reasonably confident that these losses will be absorbed by the conglomerate enterprises that support them (the Silvio Berlusconi empire and Fiat, respectively), few other clubs have reason to be optimistic that their debts can serviced in the longer term. Moreover, there must be a genuine risk that more than one Serie A club will fail at the same time, and hence a general financial crisis seems quite likely. In England, Scotland, Belgium, and Portugal, there is evidence of a financial crisis among the smaller clubs but not among the larger clubs. That is to say, even

5 Lago et al. / FINANCIAL CRISIS IN EUROPEAN FOOTBALL 7 if some larger clubs have run into financial difficulties (e.g., Leeds United in England) or have registered large losses in recent years (e.g., Benfica and FC Porto in Portugal), these losses are either exceptional (Leeds United) or likely to be financed (by public subsidies in the Portuguese cases). Buraimo, Simmons, and Szymanski s article shows how the financial crisis is apparent among the smaller English clubs. Twenty-two of the 72 professional clubs in the Football League (i.e., outside the Football Association Premier League) have entered administration in the past 6 years, a process that requires complete financial restructuring to avoid bankruptcy. Morrow s article on Scotland reveals that the two major clubs, Celtic and particularly Rangers, are facing difficult financial circumstances. However, to an extent, their financial positions are eased by very large and loyal supporter bases that provide substantial recurring income and, in the case of Rangers, through the financial support provided by its majority shareholder. Elsewhere in the Scottish Premier League, the situation is much worse: Three of the 12 Scottish Premier League clubs are currently in administration, another has only narrowly avoided this fate thanks to cuts in player wages, and the directors of a further club are attempting to sell the club s stadium to meet its debts. For Belgium, Dejohnge and Vanderweghe report in their article that 5 professional clubs have disappeared from the top division in the past 5 years because of financial difficulties. Some play at lower levels, one has merged, and the others have disappeared altogether. In Portugal, Barros found that smaller teams, such as Santa Clara and Setubal, have incurred significant losses, without much evidence that they have the means to cover them. In a majority of countries represented in our analysis, there is no evidence of a generalized crisis at the level of either small or large clubs. In some countries, there may be some clubs that have fallen into financial difficulties, but as explained above, this has been part of the pattern of football since its earliest days. But there is little evidence of any general crisis, for small or large clubs, either in the larger footballing nations (Germany, France, and Spain) or in the smaller nations (The Netherlands, 1 Greece, and Switzerland). WHAT ARE THE CAUSES OF THE CURRENT FINANCIAL PROBLEMS OF FOOTBALL CLUBS? Paradoxically, the root cause of the financial crises in some European countries has been the increasing amount of income entering the game, from TV and other sources. This massive increase triggered an even greater increase in spending on players. Thus, whereas clubs entered the 1990s more or less in financial balance, by the new millennium, clubs in countries experiencing crises had seen spending outstrip income and hence significant accumulations in debt, which in many cases can no longer be financed. Why should increasing incomes cause such overspending? One reason is simply speculative: If incomes are expected to rise on average, then average expenditures

6 8 JOURNAL OF SPORTS ECONOMICS / February 2006 will tend to rise in line. But if the increases on average incorporate a good deal of variation, teams that underachieve may face significant financial deficits. A related reason may be the expectation of growing inequality. If the income of every club increases in percentage terms by the same amount, the gap in absolute terms between the biggest and the smallest grows (e.g., suppose that one team has an income of 1 million and another an income of 2 million and that each enjoys an increase of 100% in its income, in which case the gap between the big club and the small club has also grown from 1 million to 2 million). If small clubs have ambitions to rival the large clubs, they will also anticipate that the absolute cost of bridging that gap will grow over time and may rationally calculate that now is the last opportunity to attempt to bridge that gap. But in doing so, they may also place themselves under increased financial risk. But if increasing income alone can cause a financial crisis, why has it affected some countries but not others? To answer this question, it is easiest to consider why there is apparently no general crisis in the six countries discussed at the end of the previous section. There are three broad reasons. First, in countries such as France, there is relatively tight regulation of football clubs by the national authorities. This regulation is analyzed in the article by Goughet and Primault. They show that French clubs finances can be closely monitored by the national association. As a result, it is relatively difficult for clubs to spend beyond their present means without facing external sanctions. It is notable that France experienced a financial crisis in football at the beginning of the 1990s and as a result imposed draconian rules to regulate club finances. For example, if a player purchase is deemed to be beyond the financial capacity of a club, the league can legally invalidate that transfer. Such regulation seems to have been highly effective in ensuring that clubs have not fallen into financial crisis. Second, the ownership structure may have helped avoid crisis. For example, in Germany, as shown in the article by Frick and Prinz, most clubs have a limited capacity to borrow money, and in general, loans must be personally guaranteed by the club officials. An ownership structure of this kind provides a significant disincentive to engage in financial speculation, and therefore, there has been limited opportunity for the clubs to jeopardize their futures. Third, in some countries, local government stands ready to bail out failing clubs. The contribution by Ascari and Gagnepain in this issue makes clear that there is no chance that Real Madrid or Barcelona would ever be allowed to go bankrupt, whatever the financial problems of these big-spending clubs. Thus, although there may exist a crisis for lenders, the clubs themselves are immune to all threat. Such cases are common in Spain but also in other countries, such as Greece. These explanations can help us understand why crises have occurred in other countries. The third explanation can also account for the problems in Belgium and Portugal, where traditionally, local governments have been willing to support failing football clubs but much more reluctant to do so in recent years. Other sources of finance, such as wealthy local businessmen, may also have been in relatively short

7 Lago et al. / FINANCIAL CRISIS IN EUROPEAN FOOTBALL 9 supply (the absolute cost of bailing out a typical club has increased dramatically, and therefore, there is now a smaller pool of people with enough wealth to perform this task, making it more likely that no one will be found in the end). The second explanation may also help explain some of the problems. In Italy, England, and Scotland, the directors of small clubs have been willing to gamble everything on success by borrowing large sums from banks while facing only limited personal risk. If shareholders exercised proper restraint on the activities of directors, there would be some disincentive to engage in such behavior, but, in common with many other businesses in the Anglo-Saxon culture, shareholder influence has been relatively limited. In most industries, shareholders leave directors to make choices, comfortable that a broad spread of investments will produce winners as well as losers. In football, however, the threat of systemic risk raises the question as to whether this investment strategy will be effective in the long term. The first explanation also plays a significant role. Regulation has been much lighter Italy, England, and Scotland than it has been in France, and as a result, clubs have had more opportunities to make mistakes (but equally to have successes). This is perhaps the ultimate paradox relating to the regulation and management of sports leagues. By and large, those leagues with lighter regulations have sustained higher levels of spending on players and hence have enjoyed higher levels of success in competition. Examples include English, Italian, and Spanish clubs in the Champions League. On the other hand, leagues with heavier regulation (e.g., in France) have, by and large, spent less on players and have as a result had less success (e.g., in the Champions League). WHAT ARE THE SOLUTIONS? We have suggested that the greatest problems lie with the financial situations of small clubs in a subset of European countries. These problems have been triggered by the substantial growth of football clubs incomes during the 1990s, primarily from TV rights. Competition for the greatest share of this expanding income has driven owners and managers of clubs, where they are able to do so, to in effect gamble the assets of the businesses on future success. Although this has led to spectacular collapses, such behavior is not necessarily irrational, any more than any other kind of gambling is irrational. However, it is often the case that actions that seem privately rational are collectively disastrous. 2 To the extent that selfish actions bring on one s own ruin, it can be argued that such disciplines are necessary in a responsible society. Football clubs are not run by children, and if we treat them as children, absolving them of responsibility for their decisions, the risk must be that they will become even more irresponsible. However, irresponsibility has consequences for other clubs in a league, and hence there is a case for implementing measures that ensure that club directors cannot take actions that destabilize the league as a whole (or the European system as a whole).

8 10 JOURNAL OF SPORTS ECONOMICS / February 2006 UEFA has already taken steps in this direction through the introduction of the club-licensing plan. UEFA has stipulated that all clubs expecting to participate in their competitions (Champions League, UEFA Cup) must meet the specified criteria. Beginning in , these are annual audited financial statements, proof that a club has no overdue payments for transfer activities, and proof that a club has no payments owed to employees (including taxes and national insurance contributions). Additional criteria to be imposed beginning in are a liquidity plan demonstrating a club s ability to met liquidity needs for the license period; a declaration of liquidity shortfalls as they appear and regular monitoring by UEFA, together with action plans; and notification of negative deviations from the preannounced budgeted profit-and-loss account. Eventually, at a date to be decided, UEFA will move to a general requirement of proof of positive equity. These steps are a move in the direction of tighter regulation of the kind already imposed in France. The sanction of exclusion from the Champions League and UEFA Cup will clearly impose significant discipline on many of the larger clubs, but as we have already seen, it is not in general the larger clubs that are in crisis. Moreover, even for the larger clubs, these rules will require strict enforcement, and in many cases, they may not be credible. What would happen, for example, if Real Madrid or Manchester United were in breach of the rules: Would UEFA be willing to exclude either team from the competition, given the value of broadcasting rights generated by these clubs? Given the current difficulties of so many of the large Italian clubs, UEFA s resolve may be fully tested in the coming seasons. UEFA s plan is unlikely to have much impact on the behavior of smaller clubs that are unlikely to qualify for UEFA competitions. Although national associations may seek to introduce licensing systems that harmonize with UEFA s system, once again, the issue of credibility arises. Because credibility is such a problem, it is worth pausing to ask how it can be achieved. In France, this was achieved in the early 1990s by the establishment of an independent commission to monitor the finances of football clubs and with powers, supported by law, to enforce their rulings. Moreover, the commissioners themselves held appointments of sufficiently long duration that the fear of dismissal was not likely to play a role in their decision making. The legal power of the commission was established though a number of test cases.

9 Lago et al. / FINANCIAL CRISIS IN EUROPEAN FOOTBALL 11 Could the French scheme be easily translated into a European context? This seems quite unlikely. It is very unlikely that national or European legislation would ever confer the necessary powers to the federations so that they would be able to establish these kinds of commissions. Any voluntary scheme is likely to face severe political pressures. Thus, despite the apparent success of the French plan in establishing financial stability, it is unlikely to be adopted more widely. As suggested above, French fans have paid a significant price (not for their own system but for the excesses of the systems in other countries), because despite producing an exceptional generation of footballing talent and success at the national level, success at the club level in Europe has been limited. It is tempting to speculate that only if French teams started to achieve success at the European level would other associations see the benefits of adopting, to the extent that it is legally possible, a similar style of regulation. There is an alternative to tighter regulation: the adoption of American practices. Even though this is anathema to many in Europe, it must be observed that the American major leagues (baseball, American football, and basketball) are much more financially stable than European football. The major leagues have in place a number of mechanisms that have the effect of maintaining both competitive balance and financial stability. These include salary caps, draft rules, roster limits, revenue sharing, and other redistributive measures, many of which have been advocated in Europe. One of the key reasons that clubs in the United States agree to these measures whereas European football clubs seem unwilling to do so is precisely the openness of competition in the European context, exemplified by the system of promotion and relegation. In the United States, clubs that are successful today are willing to share with the less successful because they know that in the future, the positions are likely to be reversed, and they will one day benefit from the system. In Europe, however, large clubs fear the idea of sharing with weaker clubs in case the latter do become strong and cause the relegation of the former at some later date. There can be little doubt that many of the larger clubs have been looking at a European superleague that would be either closed or have restricted access not only to develop more attractive competition (to TV at least) but also to bring about a basis for a more secure financial system. In other words, we conclude that there are two broad approaches to dealing with financial instability in European football. The first is to impose tighter financial regulation from above, as exemplified by UEFA s club-licensing plan. Within the current system, we doubt whether such mechanisms can be credible without strong legal backing such as is provided in the French system, as outlined by Gouget and Primault. The alternative to tighter regulation is a restructuring of football competition in Europe to create a more sustainable basis for smaller clubs in particular. This would involve adopting greater restrictions on the mobility of the clubs up and down the leagues.

10 12 JOURNAL OF SPORTS ECONOMICS / February 2006 NOTES 1. In The Netherlands, a new team (AGOVV in Apeldoorn) was given a license for professional football in 2003, expanding the number of professional football teams to 37. A number of smaller teams have had financial problems recently, but they have all been bailed out by local government or local businesses. 2. Other examples include the overfishing of the oceans or the emission of greenhouse gases, which lead to global warming. REFERENCES Annual review of football finance (2004). Manchester, UK: Deloitte and Touche. Fort, R. (2006). The value of Major League Baseball ownership. International Journal of Sport Finance, 1, Noll, R., & Zimbalist, A. (1997). Sports, jobs and taxes. Washington, DC: Brookings Institution. Quirk, J., & Fort, R. (1992). Pay dirt. Princeton, NJ: Princeton University Press. Siegfried, J., & Zimbalist, A. (2000). The economics of sports facilities and their communities. Journal of Economic Perspectives, 14, Zimbalist, A. (2003). Sport as business. Oxford Review of Economic Policy, 19, Umberto Lago is an associate professor of management at the University of Bologna. He has recently published a book (with A. Baroncelli and S. Szymanski) on the Italian business of football. He teaches marketing and the marketing of sports at both the graduate and undergraduate levels. Rob Simmons is a senior lecturer in economics at Lancaster University Management School. His research interests include sports economics, labor economics, and the economics of gambling. Stefan Szymanski is a professor of economics and director of the full-time M.B.A. program at Tanaka Business School, Imperial College London. His main research interest is in contests.