Pooling Risk: Quantitative Analysis of Income Pooling Agreements in High Volatility Careers

Abstract

The overall goal for this thesis is to explore income pooling agreements, which are a type of financial product offered by an early-stage startup called Pando. Created to help minor league baseball players decrease the risk of pursuing professional baseball careers, income pooling agreements stipulate that each individual in a participating group contribute a percentage of their annual earnings into an income pool. The pooled income is then split evenly and redistributed to pool members at the end of each year for a period of time set by the terms of the contract. In practice, the incomes of highly successful individuals that increase their earning power significantly while in the income pool generate large returns for the other members of the income pool. Pando also has a stake in each income pool, taking a small cut of total pooled income as a fee. By sharing incomes between participants, pooling agreements diversify the income streams of pool members and reduce income risk. Because they also provide potential for significant upside, income pooling agreements also serve as an investment vehicle for participants to speculate on the future earning power of their fellow pool members.

This thesis investigates two essential areas. First, it questions the nature of labor markets that have use cases for Pando’s product. Currently, Pando offers income pooling agreements for professional baseball players, entrepreneurs, and MBA students. This thesis hypothesizes that the labor markets that Pando currently has use cases in are competitive industries in which top earners are substantially outnumbered by average earners, but are paid significantly more. To address this hypothesis, this thesis focuses on the professional baseball use case, as data on player salaries over the last 30 years is readily available online. Quantitative analysis is performed on MLB salary data to understand how incomes have changed over time, characterize the overall distribution of income within professional baseball, and justify Pando’s decision in offering its product in this industry among others. Next, this thesis also explores the value that Pando’s income pooling agreements provide to customers. It hypothesizes that the main value proposition of income pooling agreements is their ability to reduce income risk through diversification and provide higher expected utility to pool participants. To answer this hypothesis, a single-period stochastic model is used to represent the incomes of potential contract participants, analyze and calculate expected utility under different contract terms and underlying participant income distributions, and compare expected utility with and without participation in income pooling agreements.