Contracts, Back-Loading, and the Time Value of Money

By Bill

As you’ve probably noticed by now, I’m not any kind of mathematician or economist. I may really like baseball’s numbers, and even have a solid understanding of most of them, but that doesn’t mean I’m good with numbers in any kind of larger, more useful sense.

I do know this, though: money is worth more now than it will be tomorrow. If you were to give me a million dollars right now, that would be totally awesome, and then theoretically, I could turn around and put it in an interest-bearing account that pays nightly and have, like, $1,000,020 tomorrow. So if you gave me the same million tomorrow instead, it would still be enthusiastically welcomed, but it’d be worth that $20 less to me than it would’ve been today.

Or: if you give me $1,000,000 today and I spend it all on Christmas presents right now, odds are that thanks to the inflation that almost always happens, I’ll be able to buy a bit more with it than I would if I stuffed it under my mattress, left it there for a year, and gave my family and friends a very happy 2012 holiday season instead.

This is all pretty simple stuff — or complicated stuff, explained with an annoying simplicity, but with basics that are easy enough to grasp — and I think most people get it for the most part. You might work at a job at which your pay gets a cost of living or inflation adjustment every now and then, or notice that everything costs more now than it did when you were a kid. Whatever it is, people know, if they think about it, that agreeing to pay a baseball player $25 million in ten years isn’t the same as paying him $25 million right now.

What I’m wondering is why that isn’t considered more frequently in the way fans and analysts look at baseball contracts. Because I can promise you (and you’ll see the evidence below), the teams don’t forget it.

Fans hate to see big yearly salaries paid to players who don’t deserve them, and that’s understandable. You’d like to see each player (who’s been in the bigs long enough to get out of indentured servitude and into free agent eligibility) be paid roughly what you think he’ll be “worth” in that year, and ideally for the team, each player would get a one-year deal for about what you expect him to be worth that year. But unfortunately for the teams, players have unions and rights now, and there are 29 other potential bidders for their services. So if you want a guy for this year, you’ve often got to give him the security of several more years of employment, at a figure you agree to ahead of time.

So once you’ve agreed to the total amount you’re going to offer a player, it would be best for the team in the long run to get as many years out of him as they can, and push as much of the payout as they can as far into the future as possible. If you’re going to sign Albert Pujols for ten years and $254 million, it would be pretty great if you could get him to agree to a breakdown that goes $1 million for nine years and then $245 million in year ten. That $254 million would cost the team a lot less than if they simply paid him $25.4 million a year, and certainly less than a front-loaded contract more in line with his expected value would.

And when you look at it, most teams, but not all, tend to back-load their multi-year deals, to some extent (the extent to which players’ agents will let them get away with it, mostly). Vernon Wells‘ big contract, when you work in the signing bonus (as I’m doing whenever possible from here out), went $9 million-$10-$21-$23-$21-$21-$21, so it held steady for quite a while, but at least there was some buildup at the front end. Barry Zito‘s was similar, with two lower years and then five at right around $18.5-$20 million. Joe Mauer‘s contract pays him exactly $23 million a year. Ryan Howard‘s terrible deal: $20-$20-$25-$25-$25. The details of Pujols’ deal aren’t official yet, but it’s believed to be back-loaded. Alex Rodriguez‘s first huge contract escalated in intervals — which makes some sense if you’re using the approximate value approach too, since he signed it at just 25 — but his second, from age 32 to age 41, goes $29-$33-$33-$32-$29-$28-$21-$21-$20, which only makes sense using that approach. That makes what seems like it will be a really bad contract look even worse.

It’s the same basic story on smaller deals, even for older players; I doubt the Twins believe Jamey Carroll will be better at age 39 than age 38, but his contract pays him $2.75 million, then $3.75. The Dodgers signed Ted Lilly to a three-year deal entering his age-35 year, yet structured it $7.5-$12-$13.5. Raul Ibanez‘s ill-advised three-year contract beginning at age 37 went $8.5-$11.5-$11.5.

Generally, if a team signs a player to a multi-year deal, no matter what his age or what he might fairly be expected to do over the life of the deal, they’ll pay him more in the end than the beginning, or at least go the Mauer route and keep the dollar amounts constant. Which is exactly what they should be doing. As Dave Cameron recently said in a comment: “This is how long term deals work – you accept that the player is going to be overpaid at the end to get value at the beginning.”

Here’s what the Marlins did earlier this month:

Jose Reyes Mark Buehrle* Heath Bell*
2012 $10 $6 $6
2013 $10 $11 $9
2014 $16 $18 $9
2015 $22 $19 —-
2016 $22 —- —-
2017 $22 —- —-

*there’s $4 million for Buehrle and $3 for Bell deferred without interest in there, too. Deferred how long? Who knows? It’s a beautiful thing.

It might seem strange if you glance at those numbers in a vacuum, as some did, and anything the Loria-led Marlins do is inherently, and rightly, suspect. But (in my totally unscientific, incomplete look at this) it doesn’t look that out of line with the way these contracts normally go. And the three contracts all escalate at different times, so their commitments to these three players aren’t ever totally overwhelming ($22 million, $30, $43, $41, $22, $22). I don’t really see a potential problem here, and in fact, it makes the Marlins less likely to do what people seem to expect them to do — hold a big firesale a couple years down the road when attendance lags again — since they’ll still owe the bulk of the money on these deals and would likely have to eat millions in any trade.

There are a couple more considerations here I might as well mention, while I’m meandering and all:
What’s in it for the player? If back-loading is so good for the team, why would the player and his agent ever agree to it? A couple reasons. First, back-loading is (as I just noted) kind of a de facto no-trade clause, so it gives you some security to know that you’ll be really hard for the team to move if you kind of suck a couple years down the road. But the glaring flaw in that is that it’s just much, much less favorable to the player than an actual no-trade clause, which gives him leverage he can negotiate with in the unlikely event a plausible trade situation does arise. And agents know that, of course. So I think the second reason is much more important: these deals are pretty complicated, and the agents who get to represent high-value, multi-year-contract types of player are really good at weighing all the various factors and figuring out which of a number of options is best for their clients in the long run. Mark Buehrle’s seeing only about 10% of his total pay in 2012, and Buehrle, or at least his agent, is well aware that the present value of the contract is nowhere near $58 million. But it’s not like Buehrle was going to be able to turn around and get $58 million up front from the Nationals or something, either. It’s pretty safe to assume he signed based on an informed decision that the Marlins deal — purely monetarily or otherwise, drawbacks and all — was the best for him and his family.
What about how it affects annual payroll? This is something I really don’t know. The focus of media and fans is exclusively on a team’s total payroll for a given season, and how it changes from one year to the next. That seems like a terrible way to budget a baseball team, unless you’re planning to sell quickly (and maybe not even then). Back to the whole interest issue I started with: sign a Jose Reyes to a six-year, $106 million deal, and back-load it as heavy as you please…but whatever the figures say, budget it out at a flat $17.67 million a year (which already frees up some space in those later, more expensive years, since you’re budgeting $17.67 rather than $22), and invest whatever you don’t pay directly to Reyes. After the first three years, you’ve got $17 million earning interest in the bank — interest which, hopefully, you can put back into payroll and free up even more space.
The one drawback to this that I can think of would be found where a team is bumping up against the luxury tax threshold, which is based solely on annual payroll never mind, an anonymous commenter below says AAV, which makes a lot more sense to me, so ignore this stuff. And (wild guess time), that might have something to do with why the Yankees structured A-Rod’s terrible contract as they did. Otherwise, though, I can’t think of any reason to treat the player’s actual yearly salary under a multi-year contract as part of a team’s annual budget.Do teams actually approach their budgeting in the way I described? I have no idea. I’d expect that they would, since that’s one of the major benefits of the back-loading they all do, but MLB clubs aren’t exactly upfront about their finances, so we (er, I) can only guess they do. 
So this is rambling and rather basic, and not at all as searching or instructive as the title suggests, but I just think people should be paying more attention to this. When the details of the Pujols contract do finally come out, I suspect you’re going to hear a lot of whining that he’s getting paid something like $30 million a year into his 40s!!!!! when in reality, that’s by design and for very good reason. The hope is that he’ll be worth $35-40 million per season in the early years, taking a lot of the sting out of the inevitable overpay. It would be paying him that much in those early years that would be worth whining about.


About Bill

Bill is an employment lawyer and baseball geek. Also a comedy geek, and just a geek generally.