The Economics of College Athletics

As the O'Bannon v NCAA litigation progresses, ever so slowly, through our legal system, there is one defense that gets tossed around quite a bit--very few football or men's basketball programs actually make money.  The argument, ergo, is that schools would be unable to compensate these athletes their fair market value without jeopardizing the existence of their entire athletic departments.

Recently, the NCAA released their latest "Division I Intercollegiate Athletics Programs Report on Revenues & Expenses" which can be accessed here.  John Infante on the Bylaw Blog, an expert in NCAA issues, summarizes this report as follows:

• 23 athletic departments operated in the black last year, same as in 2011. By the NCAA's definition, this means the school's athletic department generated revenue exceeded expenses, and the athletic department needed no allocated revenue (i.e. subsidy) from the school to break even.
• While revenues are going up, expenses are rising faster. Expenses in FBS were 10.8% in the last year, while revenues increased only 4.6%.
• The median negative net generated revenue (generated revenue minus expenses) was a "loss" of over $12 million while the median positive net generated revenue was a "profit" of $8 million.

Not surprisingly, there is another opinion.  Expert witnesses for the plaintiffs in the O'Bannon case submitted a document that describes a far different economic reality within Division I athletics.  Dr. Daniel Rascher, a partner at OKSR, LLC, an leading economic consulting firm specializing in applying economic analysis to complex legal issues, submitted this document supporting the plaintiff's claim.  While you are welcome to download this entire submission, and if you do pay careful attention to pages 59 through 99, Rascher argues a few main points:

1. The NCAA's financials are intentionally inaccurate:
2. Athletics departments operate within non-profit universities, thus there is less of an incentive (and mechanism) to show a profit;
3. That "athletic deficits" reflect the accounting practices of universities or the flow of revenues back into expenses rather than the inability of revenues to meet costs.....Within athletic departments it can flow into salaries for athletic staff (coaches, athletic directors, support personnel) or into facilities;
4. And finally a market in which all but a dozen or two programs out of 340-plus are losing money does not experience the sort of entry we have seen in Division I sports since the Board of Regents case ended the NCAA's television cartel in 1984.

Bottom line is we all know the quote "Lies, damn lies, and statistics...."

------

While we are talking about the never ending legal case of O'Bannon v NCAA, documents were filed in court last week in anticipation of the June 20th class certification hearing.  For those of you captivated by the arguments, or writing semester ending analyses of this case, I wanted to provide two important documents for your review.

1. Here is the "Reply Brief of Antitrust Plaintiffs in Support of Motion for Class Certification."  This document supports the O'Bannon plaintiff's efforts for class certification.  You can download this document here.

2. Please find the "Rebuttal Report of Dr. Robert McCormick in Support of Antitrust Plaintiffs' Motion for Class Certification.  You can download this document here.

Legal Perspectives on Morals Clauses and Endorsement Agreements

Reprinted with permission from The Delaney Report

Endorsement Agreements and the “Morals Clause”

Most endorsement agreements in which a company pays an athlete (or celebrity) to promote its products or services contain a “morals clause.” A morals clause allows a company to terminate, or otherwise take some corrective action against, an endorser who is tarnishing the company’s reputation based on some “immoral” conduct. This type of protection seems reasonable considering what a company invests and its goals in entering into an endorsement agreement. It is not unusual for a company to pay an athlete millions of dollars to be the public face for the company’s products, and then spend millions more to build its advertising and marketing campaign around the athlete so that the athlete’s name and achievements become associated with the company’s products. When the endorser’s talents and achievements are overshadowed by scandal or criminal conduct, the company understandably wants to part ways.

The key terms in a morals clause are the behavior triggering the morals clause and the company’s options when the clause is triggered. Typically, the athlete seeks to have the morals clause narrowly drawn so that only certain actions trigger the clause, such as a conviction of a felony. A company paying for the endorsement prefers a broadly worded morals clause giving it the right to terminate or sanction the athlete for a variety of transgressions. For example, there are many kinds of behavior that fall short of a criminal conviction that could tarnish a company’s image, such as public fights, arrests for drunk driving, drug use, criminal accusations (even if the charges are later dropped), and domestic scandals. A company may also want to be able to take action if the endorser criticizes its product or management.

A morals clause will likely spell out what action the company can take if the endorser’s behavior triggers the morals clause. Depending on the bargaining power of the athlete, the morals clause may allow the company to terminate the agreement, levy fines, recoup payments, pull the athlete’s products from stores, such as happened with Michael Vick, or not use the athlete’s image or likeness in advertisements.

Morals Clauses in the News

In the last few years, there have been many examples of athletes whose endorsement deals were terminated due to criminal, offensive or unseemly conduct from, Kobe Bryant to Tiger Woods to most recently Lance Armstrong and Oscar Pistorius. Even before he admitted to doping to win his seven Tour de France titles, Armstrong lost endorsement deals with Nike, Trek and Oakley following the U.S. Anti­Doping Agency’s (USADA) decision to strip him of his titles. Although his confession does not constitute a conviction of a crime, it seems likely that there was some language in the morals clauses of his endorsement contracts that allowed these companies to terminate the agreements. Similarly with Pistorius, sponsors are distancing themselves from him or terminating their relationship with him because he has been charged with murder, even though he has not been convicted. 

Sometimes a morals clause is triggered by behavior that would be considered “disreputable.”  Pittsburgh Steelers running back Rashard Mendenhall entered into an agreement with Hanesbrands, Inc., in which he agreed to advertise and promote Champion brand products. The morals clause provided that “[i]f Mendenhall commits or is arrested for any crime or becomes involved in any situation or occurrence tending to bring Mendenhall into public disrepute, contempt, scandal, or ridicule, or tending to shock, insult or offend the majority of the consurning public or any protected class or gyoup,” then Hanesbrands will have the right to immediately terminate the agreement. Hanesbrands did in fact invoke the morals clause and terminated its agreement with Mendenhall immediately after the killing of Osama Bin Laden, he expressed unpopular opinions concerning Bin Laden, women and religion via his Twitter account. Mendenhall filed suit against Hanesbrands, claiming that the decision to terminate the endorsement agyeement was unreasonable, contrary to the course of dealing between the parties, and violated the covenant of good faith and fair dealing. The court hearing the case denied Hanesbrands’ motion to dismiss, suggesting that Hanesbrands’ decision to terminate the agreement might violate the covenant of good faith and fair dealing if it were arbitrary, irrational or unreasonable. Another contested issue was whether the public’s response to Mendenhall’s tweets rose to the level of “shocking, insulting or offending a majority of the consumer public or any protected class or group,” as required by the morals clause. The case was recently settled and the settlement terms have not been disclosed.

When To Invoke the Morals Clause

Even if a company can legally invoke the morals clause in an endorsement contract, it must still face the question whether doing so is a wise business decision. Is the conduct of the athlete of such a potentially damaging nature to the company that a continued relationship would be detrimental, and if so, what are the consequences to the company for terminating the agreement? In the case of an athlete endorsement agreement, for example, the company will typically consider several issues before terminating the agreement such as (1) the severity of the endorser’s transgression and the company’s audience, (2) the company’s investment in the ad campaign, including production costs for commercials, purchases of on­air, online and print media space, and event sponsorship fees, (3) whether other commercials or individuals are available to fill the void created by terminating the endorser, and (4) the likelihood of litigation brought by the athlete.

Certain behavior by an endorser may be so reprehensible that a company should not hesitate to invoke the morals clause, but other types of behavior may be less damaging to the company. And a company should consider the demographics of its audience: for example, a younger audience may be more forgiving towards certain behavior than an older audience. Michael Phelps’ involvement with marijuana did not result in the termination of his Subway endorsement deal but Michael Vick’s involvement with illegal dog fighting resulted in his loss of his Nike endorsement.

Conclusion

With prominent athletes and celebrities seemingly so often embroiled in scandals, companies that sponsor them need to carefully consider morals clauses in their endorsement agreements. By focusing on the language and remedies permitted in a morals clauses, companies will be able to better protect themselves when a scandal hits.