Rebuilding NHL teams vs. the endowment effect

After a third straight season outside of the playoffs, even the most faithful Flames fans in Calgary are starting to ask the same question pundits and others outside of the city have been asking for several years:

Why don't the Flames rebuild?

The organization hasn't won a playoff series since 2004 despite boasting one of the most expensive rosters in the league. Calgary's prospect pool is middling and it's marquee players are aging. They remain competitive enough to routinely challenge for a playoff spot, but are as far away from elite now as they have ever been post-lockout. It's a grim, uncertain future for the team. A clearing of the decks and reboot seems in order: trade the aging stars for kids and picks, up the club's cap flexibility and prepare for a few rough years.

That's easier said than done, however. There are reasons — both rational and psychological — why teams in Calgary's position are typically hesitant to burn it down and start again.

Let's first establish that NHL organizations very rarely engage in a full rebuild voluntarily. Invariably the reason a club decides to start trading stars for picks or marketing prospects to their fanbase in June is they have crashed and burned in their efforts to succeed. Meaning — teams rebuild when the rotted foundation collapses under foot and there is nothing to do by dig their way out.

This can seem either shortsighted or delusional from the outside. However, keep in mind that while it's easy to build a terrible team, it's far more difficult to create a winner from scratch — even with the NHL rewarding the league's barrel scrapers with high picks every year. There is therefore very real risk to tearing down a club, which men who are hired and paid to win must be painfully and consistently aware of.

From that angle, the gamble of tinkering with a middling team might seem like the better bet versus fire-bombing everything and starting from the bottom of the conference.

This is especially true because people have a cognitive bias towards avoiding loss. Known as loss aversion, almost everyone tends to feel and anticipate the pain of loss more keenly than that of the pleasure of gains.  This bias lead to the creation of a behavioral economic model called Prospect Theory by Daniel Kahenman. In his book Thinking, Fast and Slow, Kahneman notes through prospect theory that "in mixed gambles, where both a gain and a loss are possible, loss aversion causes extremely risk-averse choices."

Trading stars like Jarome Iginla or Miikka Kiprusoff for prospects or picks is clearly a mixed gamble — the potential gain of acquiring new potential players or stars is offset by the very real loss of the stars on-ice contributions as well as their value in the dressing room, in marketing the team, etc. And because people fear loss more than they value gain, the result is hesitance to pull the trigger.

Dealing stars and cleaning house is made even more difficult by a related tendency known as the endowment effect, which is a bias where people often demand more to give up a possession than they would be willing to pay to acquire it.

Kahneman, Knetsch and Thaler illustrated the endowment effect in their simple but famous "Mug" experiment in 1990. In the study, half of the participants ( "the Sellers") were randomly given a university mug. The other half of the participants ("The Buyers") was given the option of offering The Sellers a price (using their own money) to purchase their mug. The Sellers, of course, could set their own sale price for the mug.

Notably, The Sellers average price was approximately double that of the average Buyer price, meaning those in possession of the mugs seemed to value them twice as much as those who weren't.

Kahneman and company conducted a similar experiment later that included a third group of participants called "The Choosers". Choosers were given the option of taking either the good in question or an amount of money that they would consider as equally desirable the mug. The average prices across the groups were: $7.12 (Sellers), $3.12 (Choosers) and $2.87 (Buyers). As Kahneman notes:

"The gap between the Sellers and Choosers is remarkable, because they actually face the same choice! If you are a Seller you can go home with either a mug or money, and if you are a Chooser you have exactly the same two options. The long-term effects of the decision are identical for the two groups. The only difference is in the emotion of the moment. The high price that Sellers set reflects the reluctance to give up an object that they already own…"

The endowment effect has obvious ramifications for Jay Feaster if he considers trading Iginla or Kiprusoff — it's entirely possible his demands as The Seller will far outstrip what potential Buyers would be willing to pay. Thus, beyond entirely practical matters like cap and budget constraints, this mismatch between Buyer and Seller valuations is why it's especially hard to trade notable players in the NHL. Appropriately enough, the endowment effect is also known as "the status quo" bias.

The Flames and other clubs teetering on the brink of a rebuild face a number of difficult decisions and uncertain gambles. The possibility of trading still functional stars is significantly impeded by loss aversion and the endowment effect as well as a whole host of more pragmatic concerns like finding willing trade partners and trying to market a team lacking a "face of the franchise" should a deal occur.

So if the Flames once again choose to stay the course and remain competitive this coming season, rather than move their stars and start anew, it's not merely a symptom of cowardice but likely an expression of common psychological processes.