This morning news leaked that LeBron James, the most famous active basketball player in the world and arguably the best, is going to opt out from the final year of his contract with the Miami Heat and become a free agent. Interestingly, however, this doesn't mean that LeBron is going to leave the Heat. And it doesn't even mean that LeBron is going to try to get the Heat to pay him more money. Instead, opting out is a negotiating tactic that's primarily aimed at getting his teammates — specifically Chris Bosh and Dwyane Wade — to accept pay cuts in order to make it more likely that the Heat will win a championship in the future.
1) LeBron James and all other NBA stars are underpaid
The key fact about LeBron James and every other truly first-rate player in the National Basketball Association (guys like Kevin Durant, Chris Paul, etc.) is that he is underpaid. It may sound odd to describe a person getting paid a $19 million salary as "underpaid" but it's true.
The basic reason for this is that the collective bargaining agreement between the league's owners and the players' union is unfavorable to the top talent in the league. It imposes a maximum amount of money that any given player can be paid in any given year. The max varies according to years of service in the league and other factors, but for a top player in his prime like LeBron it is generally considerably less than he could earn on the open market. Indeed, underpaying the top players is the whole point of the rule.
One somewhat unanticipated consequence of imposing this rule is that since star players are underpaid wherever they end up, stars are increasingly considering non-monetary issues when deciding where to play. Due to the individual maximum salary rule, we can be sure that LeBron isn't opting out primarily in an effort to get a raise for himself — his salary is limited not by market conditions but by the collective bargaining agreement.
2) Teams can only spend so much on salary
The other big structural factor that's relevant is that NBA teams are subject to what's called a salary cap, a series of rules whereby NBA team owners collude to reduce the amount of money they spend on player compensation. The details of the salary cap are extremely complicated, but broadly speaking the point of the cap is that you can't simply go out and hire all the best players.
This means that when teams are hiring players, it is crucial to consider not just the quality of the player but the value proposition the player provides. Teams are working with a somewhat fixed pool of financial resources, so the opportunity cost of hiring very expensive players is large.
That means it's extremely valuable to hire players who are underpaid. Not just in the general sense that all business owners everywhere like underpaid workers, but in the specific sense that hiring an underpaid worker helps you fit more fairly paid players onto your roster.
3) Stars and rookies are the best resources
Put facts number one and two together and you can begin to see why LeBron's decision-making is so critically important. To win in the NBA, it is crucial to assemble some underpaid talent. One way to assemble underpaid talent is for your organization to become consistently good at identifying underrated players. But this is difficult. What's much easier is to simply take advantage of the rules.
Players who are new to the league are forced to play for rookie scale contracts that limit their salary regardless of skill. And players who are extremely talented have their earnings potential limited by the maximum salary rule. That means that the two greatest sources of value in the NBA are superstars like James and highly skilled rookies. Any team that manages to hire LeBron James secures the services of not just one of the best players in the league, but a player who generates wins far out of proportion to his salary.
4) James took a pay cut to play in Miami
LeBron James has been at the center of free agent drama before. He was drafted by the Cleveland Cavaliers in 2003 and played with them through the 2009-2010 season. At the end of the season, he departed in free agency to join Dwyane Wade on the Miami Heat. Wade and James were also joined by Chris Bosh, formerly of the Toronto Raptors. All three players were drafted in 2003 and had been perennial All-Stars for years. They were also close friends.
Given the salary cap rules, it was not possible for the Heat to pay all three players the individual maximum salary. But they all decided that they wanted to play together and maximize their odds at winning championships, so they all agreed to accept small discounts to play in Miami. The sting of reduced salary was salved by Miami's high quality of life and the fact that Florida has no state income tax.
The terms of the arrangement were that Wade, James, and Bosh would all accept essentially the same salary (James and Bosh are paid the exact same amount, Wade is paid very slightly less) even though everyone agreed that James was the superior player.
5) LeBron is amazing, but the Heat need more talent
When James signed with the Heat, he was unquestionably the best player in the NBA. And he led Miami to a loss in the NBA Finals followed by two straight victories, and then this spring another NBA Finals appearance. (The Heat lost to the San Antonio Spurs, four games to one.)
And while James is still amazing (he was probably the second-best player in the NBA last year after Oklahoma City's Kevin Durant), Bosh and especially Wade have become less effective due to age and injury. Meanwhile, the quality of the "supporting cast" of players behind the big three has deteriorated substantially. Udonis Haslem, Ray Allen, and Shane Battier have all seen their effectiveness deteriorate with age; Mike Miller left the team; and Chris "Birdman" Andersen can only play limited minutes.
Indeed, the fact that the Heat made it to the Finals this year probably overstates their quality. For a variety of reasons, the Eastern Conference in which the Heat play has become much weaker than the Western Conference. Miami was probably the fourth-best team in the NBA last year, and their age problems are only getting worse.
6) To improve, the Heat need Wade and Bosh to take pay cuts
Because of the salary cap, the Heat can't easily improve by simply going out and hiring more good players. They are currently scheduled to pay a combined $61 million to their big three next year, which leaves little room for free agent signing. A solid rookie or two could make a huge difference, but the Heat have not had much success with this in recent years (in part because the draft process deliberately penalizes good teams) and it would be unwise to count on this working.
Meanwhile, Bosh and Wade, who were clearly underpaid at an earlier point in their careers, are now arguably overpaid. Because maximum salary levels increase continuously with age but player effectiveness does not, there is a tendency for young underpaid stars to become old overpaid ex-stars very rapidly.
Wade and Bosh, like James, have a one-year player option remaining on their contract. They each are entitled, in other words, to be paid $20 million by the Heat next year. The best scenario for the Heat, however, would be for both of them to opt-out and then sign new contracts that last several years and pay a lower annual rate. That would allow Miami to resign LeBron to a new maximum salary deal and go out and hire another free agent or two. The message LeBron is sending by opting out is that if Wade, Bosh, and the Heat don't work something like this out, he'll leave town.
7) LeBron's non-Miami options are not that great
LeBron is so good that any team would gladly hire him, and a number of teams have the ability to pay him a maximum salary. But to the extent that LeBron wants to earn a maximum salary and contend for a championship, his non-Miami options are not actually all that appealing.
The disparity between the Western and Eastern Conferences is very relevant here. Most of the teams where LeBron could go and join other quality players — places like Houston and Dallas — are in the Western Conference where most of the good players are. But in the West, LeBron would need to battle the existing powers — the San Antonio Spurs, the Oklahoma City Thunder, and the LA Clippers — to even make it to the Finals. In the East, by contrast, the bar to play in the championship series is much lower. In the East the only other team with an established track record of quality is the Indiana Pacers who can't afford to pay him very much.
LeBron could choose to join an Eastern Conference team with some promising young talent — Philadelphia or Charlotte or Cleveland — but that would be a big risk.
8) The last time LeBron was a free agent, it was a PR disaster
LeBron's previous spell as a free agent back in 2010 was highly anticipated. So highly anticipated that he turned it into a 75-minute special on ESPN called "The Decision."
On its face, leveraging public interest in the story into a fundraiser for charity was a nice idea that should have increased the public's esteem in LeBron. But the execution was somewhat tasteless, and helped feed a public backlash against LeBron and the Heat. Since that time, he has largely repaired the damage done to his reputation. But any time a player leaves his longtime team there's a tendency to generate ill will, and James is doubtless eager to avoid a new backlash.
Here's where this move gets a bit dicey. Having scorned the Cleveland fan base for a chance at winning rings with his friends in Miami, James is now threatening to abandon them unless they agree to settle for less money. That's not exactly endearing behavior. Rationally, it is difficult to fault LeBron for either move. He did not choose to play in Cleveland in the first place, nor is he the architect of the league rules that create the salary jam in Miami. Every working American should be entitled to use the bargaining power he has to get the best possible deal. But unless the situation is resolved swiftly and amicably, the power move seems likely to land LeBron back on the celebrity villain list.
9) LeBron makes a ton of money outside of basketball
In theory, LeBron could agree to play for the league minimum salary and still have an extraordinarily high income. Kurt Badenhausen at Forbes estimates his annual earnings from endorsements at $42 million a year.
On the one hand, this means that James is clearly able to make financial sacrifices in order to pursue other goals (championships, glory) if he so desires. It also means that the exact extent of the financial tradeoffs isn't entirely clear. LeBron's ability to continue earning huge endorsement deals depends in part on his ability to continue playing deep into the playoffs, which hinges in part on the quality of his teammates.