EBITDA is a commonly used financial formula that is calculated by subtracting a company's operating expenses such as payroll, administrative costs, travel and other items from gross revenues. Baseball's debt service rule limits a team's debt to 10 times its EBITDA, except in the cases of teams that are financing new stadiums, in which case the multiplier is 15.
Essentially, Selig has the power to force teams to prove they make enough money to fund their payrolls. A team with huge expenses, such as the Yankees, could be left with a low or even negative EBITDA, which would put its debt level in violation of league rules.
In April 2004, Forbes Magazine calculated the Yankees' EBITDA for fiscal 2003 as minus-$26.3 million -- an operating loss that was the second-highest in the game that year, behind the Texas Rangers'.
Although specific language in the basic agreement makes clear the rule was not designed to inhibit spending on payroll, Rob Manfred, baseball's executive vice president for labor relations, conceded it can have that effect.
"Everyone understood it could have an effect on payroll," Manfred said, "but that [the owners] wouldn't intentionally use the rule to drive payrolls down."
Although player compensation is not counted as part of a team's debt, it is a significant figure in calculating a team's EBITDA. So an out-of-compliance team could be inclined to lower its payroll as a way of improving its EBITDA figure and getting into compliance.
Baseball officials would not say how many teams are currently out of compliance with the debt service rule. However, Jonathan Mariner, baseball's chief financial officer, told CFO Magazine last year that 15 teams submitted financial plans to the commissioner's office that appeared to leave them out of compliance, and that, after revisions and pledges of additional equity, fewer than five teams remained out of compliance.
One high-ranking official from another team called the rule "a home run" for the owners that, in effect, acts as a "soft" salary cap. Although spending on free agents has risen throughout the industry this winter, total spending over the last three years, since the basic agreement went into effect, has dropped considerably from previous winters.
Another ownership source predicted that the union will fight to get rid of the rule when the basic agreement expires in 2006, but, the source said emphatically, "We're not changing it."