The Financial Crisis in European Football: An Explanation of the High Survival Rate of European Football Clubs using the Soft Budget Constraint
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1 Bachelor Thesis Lisanne Bos The Financial Crisis in European Football: An Explanation of the High Survival Rate of European Football Clubs using the Soft Budget Constraint ABSTRACT: This thesis applies the concept of the soft budget constraint, created by Kornai (1979, 1986, 2003), to the financial crisis in European football. Currently there is a financial crisis in European football, though there are three reasons why not every football league in Europe is dealing with those financial troubles. First of all, in some leagues there exist a strict supervision of national authorities. Secondly, various leagues have a strict structure of ownership, and as last in several leagues football clubs will be bailed out by external institutions. If a firm faces the soft budget constraint it will expect to be supported financially by other organisations when they are in financial trouble. As the financial survival of European football clubs is an unique phenomenon, this thesis will focus on the following research question in order to shed some light on this phenomenon: How can the soft budget constraint explain the high survival rate of European football clubs? The soft budget constraint is a good concept to clarify the high survival rate of European football clubs, but the softness of the budget constraint depends on the league structuring. Supervisor: drs. Boris van Leeuwen Date: Number of words:
2 Table of Contents 1. Introduction 3 2. Do football clubs have financial problems? Is there a current crisis in European football? What are the causes of the crisis in European football? Summary 9 3. The soft budget constraint A conceptual clarification of the soft budget constraint Softening of the budget constraint The hard budget constraint The incentives of the borrowers and lenders Means of softening the budget constraint Summary Application of the soft budget constraint in European club football Soft budget constraint in European football leagues Institutional mechanism of the football market Social attachments to football clubs Application of the soft budget constraint in three different regulated football leagues Soft budget constraint in tight regulated football clubs Soft budget constraint in a strict structure of ownership Soft budget constraint in bailed out financial troubled football clubs Summary Conclusion References 25 2
3 1. Introduction This year s Champions League winner is Chelsea, an English football club. Though five out of eight football clubs who were fighting in the quarterfinals for the biggest European football trophies were Spanish clubs. It seems like a major sportive achievement, but it is also an achievement which is build on huge debts and opaque financial structures (Bosca, Liern, Martines & Sala, 2008). Football is the number one sport around the world (Morrow, 2008). According to van Tuijl & van Ours (2009) a big budget has become an important condition for international success. You will need a big budget to get sportive success in the international top, this is visible in the financial problems some clubs encounter. Especially the clubs in a high level league deal with financial problems, clubs in Italy, Spain and England have major deficits in their budget (A.T. Kearny, 2010). But also clubs in the Netherlands deal with financial problems. For example AZ which lost his main sponsor in the end of 2009, or HFC Haarlem which is bankrupt since the beginning of 2010 after an existence of 130 years (Scheepmaker, M.P.C., 2010). In France, for example, its noteworthy that they have experienced a financial crisis in football at the beginnings of the 1990s (Lago, Simmons & Szymanski, 2006). Since that crisis the finances of French football clubs are closely monitored by national authorities. The German football league is structurally more profitable than all other European leagues thanks to a more stable financial setting and larger crowds (A.T. Kearny, 2010). Although many football clubs have enormous financial deficits, most of them don not collapse. Football clubs have a really high survival rate. This means that many of football clubs survive their structural deficits (Storm& Nielsen, 2012). Because of the increase in income, due to an increase in media revenues and other income, expenditure increases as well, which creates a gap between small clubs and big clubs (Lago et al., 2006; Koning, 2010). In this paper the theory of the soft budget constraint will be used as a framework in order to explain the high survival rate of European football clubs. The soft budget constraint is a economic concept originally formulated by Kornai (1986). It shows the economic behaviour in socialist economies marked by shortage (Kornai, Maskin & Roland 2003). In short, when a firm has a soft budget constraint, it receives financial support from external institutions when they exceed the normal budget line. Because these firms receive financial 3
4 support from other institutions they might change their behaviour as they expect to receive this financial support (Kornai, 1986). As the financial survival of European football clubs is an unique phenomenon, this thesis will focus on the following research question in order to shed some light on this phenomenon: How can the soft budget constraint explain the high survival rate of European football clubs? Storm & Nielsen (2012) apply the soft budget constraint concept to the general context of European football, but in this paper different league structures will be determined and the softness of the budget constraint will be discussed. The paper is build up as follows: first, there will be considered on whether there exists a financial crisis in European football and what are the causes of this crisis. In the third section of this paper, there will be a conceptual clarification of the Soft budget constraint, as well as an examination on what the incentives of the borrowers and the lenders are, and the means of softening the budget constraint. In the fourth section of this paper, the soft budget constraint will be applied to the financial crisis in European football clubs, ended with the conclusion in section five. 2. Do Football Clubs in Europe have financial problems? Club football has changed over the last decade, as is reflected in the following issues. To begin with, players now earn more in a day than some supporters earn in a year (Morrow, 2003). Besides, many clubs consist of players who originally are not born in the country in which their club is based, this is due to the Bosman-arrest which will be explained in the following paragraph. Finally, many clubs are structured as businesses who are dealing with finance and economics (Koning, 2010). However, the continued social attachment and community significance of football make these companies different from other companies according to Morrow (2003). The A.T. Kearney EU Football Sustainability Study (2010) for instance, claims that three out of five top European football competitions would collapse within the next two years if they do not receive extensive subsidies. In this section, there will first be a check on whether there is currently a crisis in European football. Secondly, the question is asked what the causes of this potential crisis are. 4
5 2.1 Is there currently a crisis in European football? First, the word crisis should be explained. According to Lago et al. (2006, p. 4) a general crisis implies that there are some significant problems which have produced an environment in which essential restructuring of the game itself is the only long-term solution. There are two important features for a crisis: There exists a common set of problems afflicting all clubs; and the crisis in one club threatens to damage the financial stability of other clubs (Lago et al., 2006) Just as in banking, football clubs depend on each other. The interdependence exists through the process of the competition: A team cannot play without the cooperation of another team (Lago et al., 2006; A.T. Kearney, 2010). Especially when popular clubs collapse, the quality of the competition and the finances of all other clubs may be depreciated (A.T. Kearney, 2010). The financial crisis in European football has nothing to do with a decrease in income, it is even completely reverse: the top 20 football clubs received combined revenues of over 4,4 billion in 2010/2011, which is an increase of 3% on the previous year (Deloitte, 2012). In the Netherlands the cash flows generated into professional football in the season of 2003/2004 is estimated at slightly more that 600 million, which is an increase of 66% compared to 1998 (Koning, 2010). Still, people suggest that there is a crisis in European football. According to Lago et al. (2006) there are two kinds of evidence that there is a possibility of a crisis. First, there is a instability between income and expenditures. Second, there is a rising debt (Lago et al., 2006). The largest costs of a football club are players salaries. In England, for example, those costs are approximately 60% of total revenues, and there are also clubs known for spending more than 100% of their revenues on players salaries (Koning, 2010). Another reason for the instability between income and expenditures is the negative import balance for players (A.T. Kearney, 2010). The net transfer balance equals income from selling players minus expenditure on buying players (A.T. Kearney, 2010).There is a strong correlation between transfer balance and sport successes. As seen in Figure 1, England has the lowest net transfer balance of the five major football countries (Italy, Spain, 5
6 Source: A.T. Kearny (2010, p. 5) England, France and Germany), but they achieved the best sport performance. The Spanish football clubs are doing really well in international competitions, but they are also the most aggressive buyers of star players in Europe (A.T. Kearney, 2010). In the case of the French League they have build a business model based on football academy and players transfers to other leagues, so they achieve a positive net transfer balance. According to A.T. Kearney (2010) it is not rewarding in a sportive point of view to be financially healthy for a football club. In short, one could state that there indeed is a crisis in European football. The causes of the crisis in European football will be discussed in the next section. 2.2 What are the causes of the crisis in European football? According to Lago et al. (2006), the principles of the crisis in European football lie in the increase of income, due to higher media revenues and other sources. This increase in income has led to an even bigger increase in expenditure (Lago et al., 2006; Koning, 2010). If income is expected to rise, than average expenditure will tend to rise in line (Lago et al., 2006). Since the existence of cable television and commercial broadcasters the possibilities of watching the game online or on television have been extended (Koning, 2010). Another 6
7 reason of the increased income is that there have been some institutional changes in the last decade (Koning, 2010). For example, the Dutch national team still have some chance that they will achieve important success. However for Dutch club football in European competition there is a very small chance to achieve important prices. Why is that? At first because there has been a change in the European competition (Koning, 2010; Dietl, Franck & Lang, 2008). The Champions League is the successor of the Europe Cup I. In the first round, the Champions League is played in groups, because of this it became a more predictable source of revenue (Koning, 2010). To participate in the Champions League or not has a big influence on the club s finance. Of all the revenues UEFA (the governing body for football in Europe) collects, it uses 25% to finance projects and internal organisation, the other 75% will flow to the participating clubs (Garcia, 2007; Koning, 2010). It depends on the sportive performance and on the market pool how much each club receives. The market pool is divided over the participating countries in the first round depending on the proportion of the television market value in that country (Koning, 2010). This marketpool is, according to Koning (2010), destabilizing in two ways. First it limits smaller clubs to compete with the bigger clubs, because a part of the revenues of the Champions League is marked for the bigger teams. Secondly, on national level this marketpool is also destabilizing. The Dutch television network NOS spends a lot of money for the rights to broadcast the Champions League, which will be divided over the Dutch participants at the end of the league. This is a really high budget compared to budgets of other clubs who aren t participating in the Champions League (Koning, 2010). Because of this, the gap between bigger and smaller clubs widens. Also on national level there has been made some institutional changes, according to Dietl et al. (2008) this has to do with four conditions: first, the system of relegation and promotion, secondly they unequal distribution of the league s revenue, thirdly they increasing inequality between the first and the second division in the domestic leagues, and fourth the additional reward awarded to the winner of the national championship. Another important change is the Bosman-arrest from According to this arrest players from Europe are free to leave their club when their contract is finished (Koning, 2010; Garcia, 2007; Fort, 2000). The previous football club can not ask for a compensation when the player wants to play for another club. Another important impact of the Bosmanarrest was that European competitions weren t allowed to limit their players from Europe- 7
8 countries (Koning, 2010; Garcia, 2007; Fort, 2000). This created a new international labour market for football players with increasing transfers and increasingly high transfer fees (Slot, 2010). Because of these changes, it became more difficult for small football clubs to contract talented players and to collect transfer fees during transfers of players. These institutional developments led to a bigger separation between strong countries and weak countries (Koning, 2010). If the revenues of every football club increases by the same amount in percentages, the gap in absolute terms between the small and the big clubs grows (Lago et al., 2006). If small clubs want to aim for the same goals as the strong clubs they first need to close the gap between them. The expectation that the absolute cost of closing the gap will grow over time gives the small club the incentive to close the gap now before the absolute cost will increase. In doing so, they also increase their financial risk (Lago et al., 2006). Source: A.T. Kearney (2010, p. 6) But why does this financial crisis in football not occur in all countries? According to Lago et al. (2006) there are three reasons for this. First of all, in some countries there exists a 8
9 relatively tight regulation of football clubs by the national authorities. For example French clubs, finances are closely monitored by the national authorities. As seen in Figure 2, they have a positive return on assets (RoA) and they have good economic performance (A.T. Kearney, 2010). However, because of the strict regulations French teams were not able to buy talented players and as a result they enjoyed less success, as seen in Figure 2. On the other hand, leagues with lighter regulation were able to spend more on buying talented players so they have enjoyed a higher level of success in competitions (Lago et al., 2006). For example English, Italian and Spanish clubs, who are not tightly regulated, gain higher sportive success. However, according to Deloitte (2010), the English football authorities will strengthen their supervision to reduce the risk of clubs getting in to financial trouble. The second reason is the existence of different ownership structures (Lago et al., 2006). As seen in Figure 2, Germany has great economic performance and the highest return on asset (2,1%), which has to do with their ownership structure. German clubs have limited capacity to borrow money and the loans have to be personally guaranteed by club officials (Lago et al., 2006). This is a structure which discourages taking financial risks. In England and Italy, there does not exist such a structure, so the directors are willing to risk everything on sportive success by borrowing from banks while they are facing only limited personal risk (Lago et al, 2006). The difference between the German Bundesliga and the French Ligue 1 is that the German league is not closely monitored by national authorities. The French league is closely monitored by national authorities and will be punished when they exceed their budget, German football clubs will not be punished when they exceed their budget, the chance that they will exceed their budget is already small because the directors are personally responsible for the financial health of their football club. The third and last reason is that in some countries, local government or wealthy businessmen will bail out financial troubled clubs (Lago et al, 2006). This is common in Spain, for example Real Madrid and FC Barcelona will never go bankrupt because they will always be bailed out by local governments. In such an environment it is expected that big ambitions will be expressed even though they are not realistic (Koning, 2010). 2.3 Summary In the last decade, there have been many changes in club football. This has lead to a different structure of football clubs, since they became more like a business. The clubs are 9
10 not just dealing with sportive pressure but also with financial and economic pressure. The revenues of football keep increasing, which has also led to an increase in expenditure. There are three different reasons why not all countries deal with financially troubled football clubs. First, in some countries there exists a tight regulation on the finances of football clubs by their national authorities. Second, differences exist in ownership structure. The last reason is that in some countries the local government or wealthy businessmen will always bail out financial troubled clubs. 3. The soft budget constraint The soft budget constraint is an economic concept originally formulated by Kornai (1979, 1980, 1986). The soft budget constraint shows the economic behaviour in socialist economies marked by shortage (Kornai et al., 2003). Although the soft budget constraint is particularly persistent in socialist economies, it can also appear in other economic environments (Kornai et al., 2003). The expression soft budget constraint is borrowed from the terminology of micro-economics. Although the usage here is figurative, the phenomenon it describes is real and specific (Kornai et al., 2003). First there will be a conceptual clarification of the soft budget constraint, subsequently the incentives of borrowers and lenders will be explained, and at last the means of softening the budget constraint will be explained. 3.1 Conceptual clarification of the soft budget constraint and the hard budget constraint In micro-economics the budget constraint is known as a concept for households. A household has a budget which it can spend on goods. The assumption is that the decisionmaker (the household) has a budget constraint equivalent to the assumption that Say s Law prevails (Kornai, 1986). Say s law states that a firm will only start a project if it gravely believes that the received revenues from the sale of output, generated by the new project, will cover the expenditures needed to complete the project (Kornai, 1986). The budget constraint refers to the behaviour of the decision-maker: he uses his 10
11 budget, which he receives from selling his output, to cover his expenses (Kornai, 1986). Furthermore, the budget constraint is a constraint based on ex ante variables and on demand, this means that the constraint is based on his future financial situation when the expenditure will occur (Kornai, 1986) Softening of the budget constraint By softening of the budget constraint Kornai (1986) means the occurring phenomena when the strict relationship between expenditure and earnings depreciate. This happens when the excess spending will be paid by some other institution. Another condition of the softening of the budget constraint is that the decision-maker expects financial aid from an external institution with high probability which has a major impact on his behaviour (Kornai, 1986). Kornai observed the soft budget constraint for the first time in the Hungarian economy of the 1970s (Kornai et al., 2003). Enterprises had high survival possibilities because they could always count on bail outs, which left its mark on their behaviour (Kornai et al., 2003). An explanation of the soft budget constraint through an illustration (see Figure 3). In a standard situation, there is a choice between two commodities: A and B. The figure shows the commodity space for these two commodities and the original budget line. The original budget line shows the upper limit on the sustainability of the financial deficit (Kornai et al., 2003). In the first period (P1) there is an overrun on cost, the actual spending in period one (P1) excesses the original budget line. The Source: Kornai (1989, p. 5) decision-maker expects this overrun on 11
12 cost to be paid by an external institution. If this happens in period one, the decision-maker may change his behaviour. So, in the next period the decision-maker takes the financial support he received in the previous period into his decision. So, also in the second period (P2) the decision-maker will excess his budget line and again this excess will be covered by an external institution. The decision-maker changes his behaviour, he expects the financial aid if he excesses his original budget line. So, also in the following period (P3) the decisionmaker expect financial aid, so he will excess his budget line and again he will be supported financially. This will lead to the softening of the budget constraint. The higher the subjective probability that excess expenditure will be covered by external institutions, the softer the budget constraint (Kornai, 1986, p. 5). The soft budget constraint phenomena occurs when one or more external institutions are willing to cover all or parts of the deficits, also the rescues are not completely unexpected, nor are they necessarily limited to once-off interventions (Kornai et al., 2003). When the budget constraint is soft a firm which makes losses will not change his way of performance or procedures, but it will look for external financial support to cover his deficits. The lender is acting like an insurance company covering the losses of the firm with financial problems (Kornai, 1986). This may lead to a Moral Hazard problem: a change in behaviour because of an insurance against an adverse outcome (Rosen& Gayer, 2010). Kornai (1986) states that firms which cannot pay their bills and receive support from external institutes, do not have a compulsory limit on demand for inputs or investments. The firm can start a project even if they expect that the initial costs will be higher than the revenue, because they will get financial support from other institutes (Kornai, 1986). Which means that the soft budget constraint is no longer equivalent to the assumption that Say s Law prevails. In the next section the opposite of the soft budget constraint will be explained The hard budget constraint A firm faces a hard budget constraint as long as it does not receive any external financial support to cover their losses and is obliged to reduce or end its activity if the deficit persists (Kornai et al., 2003). When the loss-maker is spared by his environment the budget constraint becomes soft. Another important element of the hard budget constraint is the psychological effect: A firm with losses experiences fear because the losses might lead to extremely serious consequences (Kornai, 1986). According to Kornai (1986) the softness or 12
13 hardness of a budget constraint refers to the external tolerance of the environment. If a budget constraint is hard a firm which makes losses has no other goal than to cut his losses by cutting costs or introducing new procedures, it must behave in a entrepreneurial manner. In the next section an explanation of the incentives of borrowers and lenders will be given. 3.2 Incentives of Borrowers and Lenders Starting with the incentives of the so called borrowers. The motives of the borrowers asking for financial support is not hard to explain, many firms are profit-motivated organisations so the reasons are self-evident. But are football leagues profit-maximizing? According to Fort (2000), European football clubs are profit-maximzing because it is not rational for all football clubs to optimize the winning percentage. Fort (2000) states that clubs will find a place in the league hierarchy based on their finances and adopt a profit maximizing approach based on these grounds. Though, Storm & Nielsen (2012), state that overspending is caused by expectations of bailouts due to social attachment and emotions. These two factors form the football club as markers of identity, which is causing a willingness by supporters to provide the football club resources to survive financial deficits (Storm& Nielsen, 2012). The meaning of supporters is suggestive, several stakeholders play from time to time the role as supporters of their respective football clubs (Storm& Nielsen, 2012). However, Kornai (2003), states furthermore that even in the case in which the organisation is not profit-motivated the survival motive works just as effectively. Even though the motives of the borrowers are transparent, the motives of the lenders are often less transparent because there is no single motivation to lend to a firm in financial trouble. There are many possible motives for a supporting organisation to lend to a firm with financial trouble, the next section involves possible motives concerning football. A possible motivation for an organisation to support a troubled football club that it is in his own best business interest to extend financial support (Kornai, et al., 2003). Football is the number one sport around the world. An organisation which shows its commitment to this popular sport may increase its output. Investments in football shows goodwill and therefore it may boost a firm his reputation which can lead, indirectly, to better credit conditions, increased political influence, and increased profits of other investments (Storm& Nielsen, 2012). 13
14 Another reason is paternalistic behaviour motivating the supporting organisation to support a troubled football club (Kornai, et al., 2003). The current sponsors of a football club may feel protective and responsible for their football club (Kornai, et al., 2003). When the football club needs more liquidity to, for example to invest in a new player, the current sponsor is able to provide more financial aid. Also supporters of the football club can behave paternalistic. As in the case of the Dutch football club Feyenoord where the supporters collected money to save their club. Also political arguments to obtain subsidies for football clubs is a possible explanation for lenders to invest in financially troubled football clubs (Kornai, et al, 2003). Saving a financial troubled football club will increase the popularity of the lender, and improves the chance for re-election for the lender. For example in the Italian league, the Lazio case. In 2005 the managers of Società Sportiva Lazio (Lazio) agreed to pay their taxes to the Italian tax authorities over an extended period of 23 years to avoid an immediate collapse. The Italian Prime Minister Silvio Berlusconi explained that this was well undertaken because of the number of fans of the club. When Lazio collapsed there could have been public disorder. Also the mayor of Rome accepted this deal because he claimed that Lazio is a national heritage for the sport and on that account Lazio deserved to be bailed out. 3.3 Means of softening the budget constraint There are three different ways of means to soften the budget constraint of a firm (Kornai et al., 2003; Kornai, 1986). All three means of softening the budget constraint of the firm refer to a dynamic process: support fills up the gap between the expenditures and generated revenues (Kornai, 1986). The first consists is the financial means, which can be in the form of subsidies granted by national authorities or other financial institutions (Kornai et al., 2003; Kornai, 1986). A subsidy is soft if it is negotiable it is also adjusted to the past, present or future cost overruns (Kornai, 1986). Also softening of taxations is a form of fiscal means, the taxation is soft if the rules are negotiable, subject to bargaining and political pressure (Kornai, 1986). The softness of taxation does not depend on the rate of taxation, even with a high tax rate the taxation can be soft as long as the rules are negotiable. The second group of softening instruments involves some form of credit (Kornai et al., 2003; Kornai, 1986). Soft credit is used to support firms in continuing financial trouble 14
15 without real hope of repayment of the debt (Kornai, 1986). Again the credit system can be soft even with a high interest as long as the fulfilment of the credit contract is not enforced, unreliable debt service is tolerated and postponement and rescheduling are in order (Kornai, 1986; Kornai et al., 2003,). This second group of softening instruments has become the main means of softening the budget constraint (Kornai et al., 2003). The third group of softening instruments consists of various indirect methods of support (Kornai et al., 2003). 3.4 Summary In short, the soft budget constraint is an economic concept created by Kornai (1979, 1980, 1986). It describes the economic behaviour in a socialistic economy, though it can also appear in other economic environments. If a firm faces a soft budget constraint it receives financial support from other institutions when they exceed the normal budget line. Because these firms receive financial support from other institutions they will change their behaviour, they expect to receive this financial support. A firm faces a hard budget constraint as long as it does not receive any external financial support to cover their losses and is obliged to reduce or end its activity if the deficit persists (Kornai et al., 2003). The incentive of a borrower is very transparent, also for football clubs who are not profit-maximizing, the survival motive makes the reasons self-evident. For the borrowers on the other hand it is less transparent to borrow to a financial troubled firm. For lenders there exist several reasons to invest: the first reason could be that it is in the firm best interest to extend financial support. Another reason could be that the supporting firm is paternalistic, and the last reason could be the political arguments. Furthermore, there exist three different means to soften the budget constraint of a firm. First of all the financial means. Secondly, the use of soft credit and as last the various indirect methods of support. 15
16 4. Application of the soft budget constraint in European club football. As written in part two of this paper, there exists a financial crisis in club football. But not all clubs deal with the same problems. There are three different types of clubs. First, in some countries there exists a tight regulation on the finances of football clubs by their national authorities. Secondly, a different structure in ownership. And the last reason is that in some countries the local government or wealthy businessmen will always bail out financial troubled clubs (Lago et al., 2006). In this section of the paper the soft budget constraint concept of Kornai is applied to European club football. First, it will work as a general framework for European football. After this section, the soft budget constraint is applied to the three different types of football structuring. 4.1 Soft budget constraint in European football leagues In the original soft budget constraint concept, the organisations have an important social role in the society to serve or affect a large number of people (Kornai, 1986). This causes the effect that supporters consider the organisation, in this case the football club, to be too big to fall. Also stakeholders look at European football clubs as too big to fall and this reflects the behaviour of these stakeholder to similar expectations (Storm& Nielsen, 2012). These social attachments and emotions facilitate and sustain the soft budget constraint. The soft budget constraint also exists when football clubs buy, sell and rent facilities at subsidized prices (Storm& Nielsen, 2012). There are cases known that, for example, the local government buys facilities at a higher price than the market price, and rent it back at a lower fee than the market fee (Bosca et al, 2008; Storm & Nielsen, 2012; Lago et al., 2006). According to Storm & Nielsen (2012) the existence of the soft budget constraint in European football clubs is due to two main factors: First, the institutional mechanism of the football market and secondly the social attachments to the club. In the next two sections both factors will be explained. 16
17 4.1.1 Institutional mechanism of the football market According to Koning (2010) the institutional mechanism of the football leagues has changed over the last decade. European football clubs are facing financial problems due to the conditions of competition in the European league structure (Storm& Nielsen, 2012). According to Dietl et al. (2008) this has to do with four conditions: first, the system of relegation and promotion, secondly the unequal distribution of the league s revenue, thirdly the increasing inequality between the first and the second division in domestic leagues, and at last the additional reward awarded to the winner of the national championship. At first the system of relegation and promotion: to avoid relegation, clubs invest in talented players. Buying talented players will result into a reduced financial situation. Though, due to talented players, the chance to get a promotion will increase, and this will lead to an increase in revenues (Lago et al., 2006). The second reason according to Dietl et al. (2008) is the unequal distribution of the league s revenue: a part of the revenues is marked for the bigger teams (Koning, 2010). Thirdly the increasing gap between small clubs and big clubs has to do with the unequal distribution of revenues which leads to the incentive to gamble for success (Storm& Nielsen, 2012; Koning, 2010). At last the additional reward awarded to the winner of the national league: according to Koning (2010), the awards from the Champions league, for example, will lead to an ever increased gap between small clubs and big clubs. According to Storm & Nielsen (2012), these mechanisms are actually at work in European football leagues. Weaker performances are not met with descending adjustments in costs, as in the case of a hard budget constraint, it is the opposite: in order to be able to compete and raise sportive performances, football clubs buy talented players. There is a strong correlation between the net transfer balance and the sportive performances (A.T. Kearney, 2010). Storm & Nielsen (2012) however claim that this will result in a higher demand for football players, which leads to higher expenditures. So, these kind of mechanism creates strong incentives to overspend, which may contribute to the softening of the budget constraint (Storm& Nielsen, 2012). However, even if high spending may lead to high rewards this does not explain why football clubs overspend, if such behaviour would contribute to higher risk of failure this would no doubt limit the excesses (Storm& Nielsen, 2012). This does not happen due to 17
18 social attachments to football clubs which will be explained in the next section Social attachments to football clubs The excessive expenditure of the football clubs can be explained by the social attachments to football clubs. Football clubs can been seen as markers of identity in their regions; supporting a club is about a long-term commitment (Morrow, 2003). This commitment makes supporters willing to provide (financial) resources to let their football club survive the impacts of the competition. Also being part of European football may have positive consequences for a supporters reputation, therefore stakeholders are more willingly to risk their own money by supporting their football club (Storm& Nielsen, 2012). For example, when the Dutch football club Feyenoord dealt with financial troubles, Van den Herik, a lender of Feyenoord who became the treasurer of Feyenoord in 1991 and the chairman in 1992, invested his own money to save the club from destruction (van Tuijl & van Ours, 2009). Also in England, a Russian oil billionaire invested his own money in Chelsea (Storm& Nielsen, 2012). There are many more cases known like this. Because football clubs represent many of ethnic, geographical and cultural values, they ensure commitment from fans and local communities. This causes many (financial) support by governments and financial institutions (Koning, 2010; Bosca, 2008; Storm & Nielsen, 2012). If football clubs are in heavy financial problems, local governments or other supporters may be willing to provide (financial) solutions in order to prevent the football club to collapse, (Koning, 2010) what can be interpreted as a form of the soft budget constraint. In the next section the soft budget constraint will be used as a framework to explain the high survival rate of the three different regulated football leagues. 4.2 Application of the soft budget constraint in the three different regulated football leagues As found in part two of this paper there are three different ways of regulation in football leagues. Are the budget constraints in these three cases as soft? 18
19 4.2.1 Soft budget constraint in tight regulated football leagues In a tightly regulated football league, the finances can be monitored by national authorities (Lago et al., 2006). An example of tight regulated leagues is the French league and the Dutch league. Let s start with explaining the regulations of the French league. In the beginning of the 1990s French clubs experienced a financial crisis in football (Lago et al., 2006). Because of this crisis the regulations in French football has changed, now the French clubs are closely monitored by the national authorities what makes it difficult for the clubs to spent beyond their current budget without facing sanctions (Lago et al., 2006). If a transfer fee is beyond the clubs financial capacity, the league is legally allowed to invalidate the transfer (Lago et al., 2006). Also the Dutch league is tightly regulated by the KNVB (the Dutch football association). The KNVB has access to all financial data of all clubs in the Netherlands (Koning, 2010). Based on different ratios the KNVB can put clubs under strict supervision. When a Dutch club is facing financial trouble for too long the KNVB is allowed to give sanctions to these clubs (Koning, 2010). Sanctions can be fines, deduction in points, and the heaviest one is revocation of the professional football license (Koning, 2010). Can the soft budget constraint concept of Kornai be linked to these leagues? The definition of the soft budget constraint is that in this case, football clubs receive financial support when they are facing financial trouble, this leads to a change in behaviour of football clubs because they expect financial support from other institutions (Kornai, 1986). In this case the clubs get sanctions when they are not in a good financial environment. This is more like the definition of the hard budget constraint: A firm with losses experiences fear because the losses might lead to extremely serious consequences (Kornai, 1986). According to Kornai (1986, 2003) the softness or hardness of the budget constraint depends on the willingness of the environment to support a financial troubled club. So in the case of countries with tight regulations for the financial health of football clubs the budget constraint is rather hard than soft Soft budget constraint in a strict structure of ownership According to Lago et al. (2006), directors in a strict structure of ownership are personally responsible for the loans they arrange for the football club. This results in less risky 19
20 behaviour and a more healthy financial environment. Also, these kind of football clubs have a limited capacity of getting loans from banks (Lago et al., 2006). Though, according to Koning (2010), directors and trainers will be remembered by sportive achievements, not by their strict financial policy, which gives the director a higher incentive to take risky investments. Can the soft budget constraint concept of Kornai be linked to these leagues? The definition of the soft budget constraint is that in this case, football clubs receive financial support when they are facing financial trouble, this leads to a change in behaviour of football clubs because they expect financial support from other institutions (Kornai, 1986). Even though these leagues have a limited capacity of getting loans from banks, and the fact that directors are personally responsible for those loans, it is possible to apply the soft budget constraint to this kind of league structure. As described in part 3.3 of this paper there are several means of softening the budget constraint. Soft taxation is, for example, common in the context of professional football clubs (Storm& Nielsen, 2012). Many football clubs fail to pay taxes and many tax authorities have often little incentive to enforce payments thorough the legal system (Storm& Nielsen, 2012). Also soft credit is one of the means to soften the budget constraint. Soft credit is frequently used in football leagues, when football clubs fail to meet their credit obligations to banks, the credit contracts are often renegotiated which is a instrument to soften the budget constraint (Kornai et al., 2003; Kornai, 1986; Storm & Nielsen, 2012). So, even though directors are personally responsible for the loans they arrange for their club, which ensures less risky investments, it is possible to apply the soft budget constraint concept to these kind of ownership structure. Softer credits and taxes may contribute to the softening of the budget constraint. Though because of the fact that the director is personally responsible, it may fear consequences of its actions. This fits more in the definition of the hard budget constraint: A firm with losses experiences fear because the losses might lead to extremely serious consequences (Kornai, 1986). So in this case it is not completely clear whether the budget constraint is more soft or hard. It may depend on the riskiness of the director. 20
21 4.2.3 Soft budget constraint in bailed out financial troubled football clubs In some countries local governments and wealthy businessmen are willing to bail out clubs with financial troubles (Lago et al., 2006). According to Bosca et al. (2008), Spanish teams are good in attracting sufficient funds. They sell material assets, for example football stadiums, plots of land etc, in order to continue financing their deficits (Bosca et al., 2008). There is not a chance that Real Madrid or FC Barcelona will collapse, because they will always be saved by local authorities or wealthy businessmen. These clubs became immune to all financial threat (Lago et al., 2006). Can the soft budget constraint be connected to these clubs? According to the definition, the soft budget constraint, in this case, ensures football clubs to receive financial support when they are facing financial troubles, this leads to a change in behaviour of football clubs because they expect financial support from other institutions (Kornai, 1986). This is exactly the case in this situation. Football clubs like Real Madrid and FC Barcelona attract sufficient funds from local governments by selling material assets (Bosca et al., 2008). Kornai (2003), claims that the softness or hardness of the budget constraint depends on the willingness of the environment to support a financially troubled club. The environment of these kind of clubs seem to have high willingness to support financial troubled clubs, so in this case the soft budget constraint is a good concept to explain the high survival rate of these clubs. 4.3 Summary There are two main reasons which make it possible to use the soft budget constraint as a framework to explain the high survival rate in European football. First, the institutional mechanism of European football, and second the social attachment and emotions. There are three cases considered to be connected to the soft budget constraint concept of Kornai. The first case is the league with tightly regulated football clubs. Because these clubs are closely monitored by national authorities they can not excess their budget. They will get punished when they do excess their budget. According to the definitions of the soft budget constraint, it is considered that leagues with tight regulations, the budget constraint is rather hard than soft. Secondly, the case of a strict structure of ownership. Because directors are personally 21
22 responsible for the financial health of their football club, they will not take more financial risk than necessary. Though, due to soft credits, and soft taxation it is possible to apply the soft budget constraint to this kind of ownership structure. However, because of the fact that the director is personally responsible, it may fear consequences for its actions. Which is more like the definition of the hard budget constraint. So, in this case it is not completely clear whether the budget constraint is soft or hard. It may depend on the riskiness of the director. The last case, the bailed out financial troubled football clubs, seems to be well connected to the soft budget constraint. The football clubs get bailed out by local governments or wealthy businessmen. They have higher expenditure than their revenues, which may indicate that their behaviour is changed because of the financial support they receive. So, in this case the soft budget constraint is a good concept to explain the high survival rate of these clubs. 5. Conclusion Since the financial survival of European football clubs is a unique phenomenon, this thesis has focussed on the following research question in order to shed some light on this phenomenon: How can the soft budget constraint explain the High Survival Rate of European Football Clubs? First it has been considered whether there is financial crisis in European football clubs. According to the literature review in part two of this paper there can be concluded that there is a financial crisis in European football. This is due to many changes in club football over the last decade. Clubs gained more revenues and as a result their expenditure increased. There are three different reasons why not all leagues deal with financial troubled football clubs. First, in some leagues there exists a tight regulation on the finances of football clubs by their national authorities, for example in France or in the Netherlands. The second reason is the different structure in ownership. For example in Germany, the directors have limited capacity to borrow money and the loans have to be personally guaranteed by club officials, which reduces financial risk management. The last reason is that in some countries the local government or wealthy businessmen will bail out financially troubled clubs, for example in 22
23 Spain where Real Madrid and FC Barcelona will never go bankrupt because they will always be bailed out (Lago et al., 2006). In the third part of this paper the soft budget constraint concept was explained. The soft budget constraint is an economic concept created by Kornai (1979, 1980, 1986). It describes the economic behaviour in a socialist economy. A firm faces a hard budget constraint as long as it does not receive any external financial support to cover their losses and is obliged to reduce or end its activity if the deficit persists. When a firm faces a soft budget constraint it receives financial support from other institutions when they exceed the normal budget line. Because these firms expect to receive financial support from other institutions they might change their behaviour. The incentive of a borrower is very transparent, also for football clubs who are not profit-maximizing, the survival motive makes the reasons self-evident. For the borrowers on the other hand it is less transparent to borrow to a financial troubled firm. For lenders there exist several reasons to invest: the first reason could be that it is in the firm best interest to extend financial support. Another reason could be that the supporting firm is paternalistic, and the last reason could be the political arguments. Furthermore, there exist three different means to soften the budget constraint of a firm. First of all the financial means. Secondly, the use of soft credit and as last the various indirect methods of support. At last in the fourth part of this thesis, the soft budget constraint is used as a framework to explain the high survival rate in European Football clubs. There are two main reasons that makes it possible to apply the soft budget constraint concept in European football. First, the institutional mechanism of European football, and second the social attachment and emotions. There exists different ways of football league structures. The three different cases are applied to the soft budget constraint. First, the case with tight regulated football clubs. Because these clubs are closely monitored by national authorities they can t excess their budget. They will get punished when they do excess their budget. According to the definitions of the soft budget constraint, it is considered that in the case of leagues with tight regulations for the financial health of football clubs the budget constraint is rather hard than soft. 23
European football; financial crisis; regulation; competition
Lago 10.1177/1527002505282871 et al. / FINANCIAL CRISIS JOURNAL IN EUROPEAN OF SPORTS FOOTBALL ECONOMICS / February 2006 The Financial Crisis in European Football An Introduction UMBERTO LAGO University
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