Financial Reporting and Analysis

Refer to the Kansas City Zephyrs PDF file that has been attached. For each of the 5 areas in dispute, answer the following:? ________________________________________________________________________________________________________________ Professors Kenneth A. Merchant and Krishna Palepu and Research As sociate Joseph P. Mulloy prepared the original version of this case, œKansas City Zephyrs Baseball Club, Inc., HBS No. 187-088. This version was prepared by Professor Krishn a Palepu with the assistance o f Senior Researcher James Weber. This case and the company and characters depicted are fictit ious. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serv e as endorsements, sources of primary data , or illustrations of effective or ineffect ive management. Copyright © 2009, 2 011 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545- 7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/ed ucators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or tr ansmitted, without the permission of Harvard Business School. KRISHNA PALEPU Kansas City Zephyrs Baseball Club, Inc. 2006 On April 17, 2006, Bill Ahern sat in his office and contemplated a difficult judgment he had to make in the next two days. Two weeks before, Bill had been asked to be an arbitrator in a dispute that had surfaced in collective bargaining negotiat ions between the Owner-Player Committee (OPC, the representatives of the owners of the 30 major league baseball teams) and the Professional Baseball Players Association (PBPA, the players’ union). A Baseball Accounting Dispute The issue Ahern had to resolve was the profitability of the major league baseball teams. The players felt they should share in the teams’ profits; the owners maintained, however, that most of the teams were actually losing money each year, and th ey produced financial statements to support that position. The players, who had examined the owne rs’ statements, countered that the owners were hiding profits through a number of accounting tr icks and that the statements did not accurately reflect the economic reality. Ahern’s decision on the profitability issue was important because it would affect the ongoing contract negotiations, pa rticularly in the areas of minimum salaries and team contributions to the players’ pension fund. On April 9, Ahern met with the OPC and the representatives of the PBPA. The two sides explained they wanted him to focus on the finances of the Kansas City Zephyrs Baseball Club, Inc. (a disguised name). This club had been selected for review because both sides agreed its operations were representative, yet it was a relatively clean and simple example to study: the baseball club entity was not owned by another corporation, and it did not own the stadium the team played in. Furthermore, no private financial data would ha ve to be revealed because the corporation was publicly owned. Ahern’s task was to review the Ze phyrs’ financial statements, hear the owners’ and players’ arguments, and then reach a decision as to the profitability of the team by Friday, April 19. Major League Baseball Major league baseball in the United States compri sed a number of components bound together by sets of agreements and contractual relationships. At the heart of major league baseball were the 30 110-022 Kansas City Zephyrs Baseball Club, Inc. 2006 2 major league teams. Each team operated as an independent economic unit in such matters as contracting for players, promoting games and sellin g tickets, arranging for the use of a stadium and other needed facilities and services , and negotiating local broadcasting of games. The teams joined together to establish common rules and playing schedules, and to stage championship games. The business of most teams was limited exclusivel y to their major league activities. Very few integrated vertically by owning their own stadium or minor league teams. Most teams were organized as partnerships or privately held corporations, although a few were subunits of larger corporations. While baseball was often thought of as a big business, the individual teams were relatively small. For most of them, annual revenues were between $200 million and $300 million. Each team maintained an active roster of 25 players during the playing season, plus another 15 players who were either minor league players œon option who might see major league action during the season, or players on the disabled list. This ma de a total of up to 40 players on major league contracts for each team at any one time. Each team played a schedule of 162 games during the season, 81 at home and 81 away. Collectively, the team owners established most of the regulations that governed the industry. The covenant that bound them was the Major League Agreement (MLA), which included the Major League Rules. The rules detailed all the procedures the clubs agreed on, including the rules for signing, trading, and dealing with players. Under the MLA, the owners elected a commissioner of baseball who acted as a spokesperson for the industry, resolved disputes am ong the clubs and the other baseball entities, policed the industry, and enforced the rules. The commissioner had broad powers to protect the best interests of the game. The commissioner also administered the Major Le agues Central Fund, under which he negotiated and received the revenues from national broadcast contracts for major league games. About one-half of the fund’s revenues were passed on direct ly to the teams in approximately equal shares. Within the overall structure of major league baseball, the 30 teams were organized into two leagues, each with its own president and administration. The American League had 14 teams and the National League had 16 teams, one of which was the Kansas City Zephyrs. Each league controlled the allocation and movement of its respective franchises. In addition to authorizing franchises, the leagues developed the schedule of games, co ntracted for umpires, and performed other administrative tasks. The leagues were financed through a small percentage share of club ticket revenues and receipts from the World Se ries and pennant championship games. In addition to the major league teams, U.S. baseball included about 250 minor league teams located throughout the United States, Canada, and Mexico. Minor league teams served a dual function: they were entertainment entities in thei r own right, and they were training grounds for major league players. Through Player Development Contracts, the major league teams agreed to pay a certain portion of their affiliated minor league teams’ operating expenses and player salaries. Meeting with the Zephyrs’ Owners Bill Ahern spent Tuesday reviewing the history of major league baseball and the relationships among the various entities that make up the majo r leagues. Then he met with the Zephyrs owners’ representatives on Wednesday. The owners’ representatives gave Ahern a short hi story of the team and presented him with the team’s financial statements for the years 2004 and 2005. (See Exhibits 1 and 2 for financial data from Who is right?? and Why?

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