The Economics of Promotion and Relegation: Incentives, Risk and Financial Survival

01. The financial incentive of promotion

The Premier League's financial dominance gives promotion enormous economic value. Its broadcasting agreements generate revenues far beyond those available to Championship clubs, while increased exposure creates further opportunities for commercial sponsorship and matchday income.

This financial gap creates a strong incentive to invest in better players. Higher-quality squads can improve a club's probability of winning matches, securing promotion and accessing the Premier League's financial rewards.

Evidence from the Championship illustrates this relationship. In 2021/22, Fulham, Bournemouth and Nottingham Forest — the three clubs promoted to the Premier League — also recorded the division's three highest wage bills, at £90 million, £61 million and £59 million respectively.

However, this does not establish that higher wages necessarily cause promotion. Deloitte reported a Spearman rank correlation of 0.45 between wage-cost rankings and final league positions, suggesting that financial resources are only one of several factors influencing sporting performance.

Nevertheless, clubs have a clear financial reason to commit substantial resources to improving their chances of promotion. The potential reward can be enormous.

02. The economics of relegation

While promotion offers substantial financial rewards, relegation creates the opposite problem.

A club dropping from the Premier League loses access to its much larger broadcasting revenues. Yet its expenses do not necessarily decline at the same rate. Player contracts, transfer instalments and other commitments can remain relatively fixed, even after the club's income has fallen.

This creates a mismatch between revenue and expenditure. A club may suddenly find itself supporting a Premier League-sized wage bill with Championship-level income.

The consequences can extend beyond the immediate season. A 2022 academic study examining four major European leagues used a regression discontinuity approach to compare clubs that narrowly avoided relegation with those that narrowly suffered it.

This way, the researchers attempted to isolate the financial consequences of relegation from other differences between clubs.

Nevertheless, they illustrate why the difference between finishing just above and just below the relegation zone can be so significant.

To soften this financial shock, the Premier League provides relegated clubs with parachute payments: temporary financial support intended to help them adjust to lower revenues.

However, these payments introduce another economic problem.

03. Do parachute payments distort competition?

Parachute payments serve an important purpose. Without them, clubs relegated from the Premier League could face an immediate financial crisis, particularly if they remain committed to expensive player contracts.

Yet these payments can also give recently relegated clubs a substantial financial advantage over their Championship competitors.

Deloitte's 2024 Annual Review of Football Finance reported that five Championship clubs receiving parachute payments contributed approximately £200 million, or 27%, of the division's total £749 million revenue in 2022/23.

This means that almost three-quarters of the division's revenue was generated by the remaining 19 clubs. The financial resources available to clubs were therefore far from evenly distributed.

Research published in 2018, examining 11 Championship seasons between 2006/07 and 2016/17, found that clubs receiving parachute payments were twice as likely to achieve promotion. The authors also found that increases in the number and value of parachute payments coincided with reduced competitive balance in the division.

However, parachute payments remain controversial rather than conclusively harmful. Their financial purpose is to prevent relegated clubs from collapsing, and the relationship between financial advantages and sporting success is not straightforward. Other research has challenged the extent to which parachute payments themselves explain the sporting advantage of recently relegated clubs.

The challenge is to balance financial protection for relegated clubs with a fairer competitive environment for the rest of the Championship.

04. The promotion spending race

Perhaps the most interesting economic consequence of promotion and relegation is the incentive it creates for clubs to spend beyond their means.

Consider a simplified example. Suppose a Championship club has a 15% probability of promotion. Its management believes that an additional £10 million investment in players would increase this probability to 20%. If promotion is estimated to be worth £100 million, the additional expected financial reward is:

The club would therefore spend £10 million to generate an additional expected reward of just £5 million. On these assumptions, the investment has a negative expected financial return of £5 million.

This is an illustrative model, not an estimate of an actual club's finances. Its purpose is to demonstrate that spending more does not necessarily make financial sense, even when it improves a club's sporting prospects.

The problem becomes more pronounced when multiple clubs behave similarly. Promotion places are limited: only three Championship clubs can move up each season. If every club increases its spending in pursuit of the same objective, their relative chances of promotion may change very little, while the division's overall expenditure increases.

This resembles an arms race. Individual clubs may rationally spend more to avoid falling behind their competitors, but collectively they can end up committing more resources without increasing the number of available promotion places.

The financial figures reflect these pressures. In 2021/22, Championship clubs collectively generated £676 million in revenue while spending £730 million on wages, equivalent to a wage-to-revenue ratio of approximately 108%.

By 2022/23, the ratio had fallen to 94%, but the division still recorded aggregate operating losses of £316 million. Deloitte also reported that no Championship club generated an operating profit before player trading.

Although these figures do not prove that promotion-related spending caused the losses, they highlight the financial difficulties facing clubs competing for access to the Premier League.

05. Competition at what cost?

Promotion and relegation is one of the defining features of English football. It gives clubs meaningful sporting objectives, creates opportunities for financial growth and ensures that performance has consequences beyond a league-table position.

However, the enormous financial gap between divisions creates incentives that can undermine the very clubs the system is designed to motivate. The prospect of promotion encourages investment, while the threat of relegation can discourage clubs from reducing expenditure even when their financial position deteriorates.

The challenge is not necessarily to remove promotion and relegation, nor to eliminate the financial rewards associated with it. Rather, football's governing bodies must consider how to preserve the competitive incentives of the system without encouraging clubs to gamble their financial futures on sporting success.

Promotion and relegation may make football more competitive on the pitch. Whether it makes the football industry more sustainable is a much more difficult question.