Skip to main content

West Ham, the Olympic Stadium, and the puzzle of sunk costs

Yesterday West Ham United Football Club were essentially given the London 2012 Olympic Stadium for the bargain price of £15 million. True, they will not own the stadium, and will have to pay rent. But, this does nothing to alter the basic fact that West Ham has been handed a bargain.
   And its a bargain deal that has annoyed many. The Stadium cost around £500 million to build and converting it into a football stadium is going to cost at least another £100 million. Most of this funding has come from the taxpayer. So, on face value it looks like the UK taxpayer is giving a football club a very big gift - a £600 million stadium for £15 million. To make sense of this we need to think about sunk costs and bargaining. 
    Let's look at sunk costs first. The stadium was built for the London Olympics, and not the benefit of West Ham. Spending £500 million on the stadium was, therefore, arguably money well spent by the British taxpayer. But times move on: the London Olympics has long finished, the stadium still exists, and the question that matters now is what to do with the stadium. The money spent building the stadium is a sunk cost, it's gone, and should not be a factor in current decisions. So, London Mayor Boris Johnson was right to be relatively upbeat about the deal. The taxpayer is going to get a revenue from the stadium that is much better than could have been hoped for without West Ham. 
    West Ham, though, are getting a fantastic deal. They are getting a fantastic, iconic stadium that they could not possibly have afforded themselves. And this will dramatically increase the value of West Ham. Indeed, we already have the example of Manchester City to illustrate how a 'stadium for free' can transform a club - they got the stadium built for the Commonwealth Games and have not looked back. The owners of West Ham have got a very good deal. The supporters will also soon get over the nostalgia for their current ground.
    The deal struck is thus one that benefits the taxpayer a little and benefits West Ham a lot. Why did we end up with such a one-sided deal? Bargaining theory can help explain. The first thing to keep in mind is that while the stadium cost £500 million it is not worth £500 million anymore. Its a liability for the tax payer and worth, say, £200 million for West Ham. So, the parties are bargaining over £200 million. Note that a second potential user of the stadium might have changed this equation but that did not materialize. The taxpayer is in a relatively poor bargaining position because it wants to off-load the stadium and declare the Olympics a success. West Ham is in a much more strong bargaining position because it can carry on using its current ground and does not have cash lying around to pay for the stadium. Its no surprise, therefore, that West Ham gets the better deal.
     This situation can be viewed in terms of the ultimatum game. West Ham offered to give the taxpayer £15 million of the £200 million the stadium is worth to them. The taxpayer can either accept or reject the offer. It makes sense to accept, because £15 million is better than nothing. But, it's annoying to accept because West Ham do very, very well from the deal. So, it's a matter of interpretation whether you think the taxpayer got a good or bad deal.

  

Comments

Post a Comment

Popular posts from this blog

Honesty around the world

In my last post I looked at dishonesty in the banking industry. Sticking with a similar theme, this time I will at dishonesty across different countries.        Let us start with a study by David Pascual-Ezama and a long list of co-authors on 'Context dependent cheating: Experimental evidence from 16 countries'. They asked 90 students in 16 different countries to perform a very simple task: toss a black and white coin and record the outcome. If the coin came up white the student obtained a red Lindt Lindor Truffle. If it came up black they got nothing. Crucially, the coin toss took place in private and so the student could report whatever outcome they wanted. If they wanted a chocolate then they simply had to report white. (The study contrasted three different methods of reporting - form put in a box, form given to the experimenter or verbally telling the experimenter - but I will skip those details here.)           The chart below summa...
Post a Comment
Read more

Prisoners dilemma or stag hunt

Over Christmas I had chance to read The Stag Hunt and the Evolution of Social Structure by Brian Skyrms. A nice read, very interesting and thought provoking. There’s a couple of things in the book that prompt further discussion. The one I want to focus on in this post is the distinction between the stag hunt game and the prisoners dilemma game.    To be sure what we are talking about, here is a specific version of both type of game. Adam and Eve independently need to decide whether to cooperate or defect. The payoff matrix details their payoff for any combination of choices, where the first number is the payoff of Adam and the second number the payoff of Eve. For example, in the Prisoners Dilemma, if Adam cooperates and Eve defects then Adam gets 65 and Eve gets 165. Prisoners Dilemma Eve Cooperate Defect Adam Cooperate 140, 140 65, 165 Defect 165,...
Post a Comment
Read more

Revealed preference, WARP, SARP and GARP

The basic idea behind revealed preference is incredibly simple: we try to infer something useful about a person's preferences by observing the choices they make. The topic, however, confuses many a student and academic alike, particularly when we get on to WARP, SARP and GARP. So, let us see if we can make some sense of it all.           In trying to explain revealed preference I want to draw on a  study  by James Andreoni and John Miller published in Econometrica . They look at people's willingness to share money with another person. Specifically subjects were given questions like:  Q1. Divide 60 tokens: Hold _____ at $1 each and Pass _____ at $1 each.  In this case there were 60 tokens to split and each token was worth $1. So, for example, if they held 40 tokens and passed 20 then they would get $40 and the other person $20. Consider another question: Q2. D...
Post a Comment
Read more