If you don’t know what the title of this post means, don’t bother reading further — it won’t make sense to you.
It’s been a strange MLB off-season. Many free agents — David Price, Jason Heyward (2!), and a bunch of others have signed new deals with new teams, but with the right for the player to opt out of the deal well before it would otherwise come to term. When even Scott Kazmir (three year contract, opt-out after year one) on that list, you have to wonder why.
My guess: teams see post-out out years as non-years, and use them as an accounting trick to make short contracts seem like long ones.
For background, it’s my understanding that the current free agent negotiation process starts with a discussion around the number of years; conversations around the annual salary (and therefore, total value) come later. This makes sense because “years” is effectively a multiplier and one that reduces the risk incurred by a player. If Team A is willing to go to five years while Team B is only willing to commit to four, it’s going to be really hard for Team B to match A’s offer in total dollars, and therefore in risk management as well.
For teams, though, long-term commitments are not a good way to manage payroll. As a Mets fan, I see this all too often — the team regularly balks at signing free agents to market-length deals. (Per the rumor mill, this has come up in regard to Yoenis Cespedes, Denard Span, Tyler Clippard, and a few others — and that’s this off-season alone.) Signing a 31-year-old to a one year, $16m deal is often a smarter move than signing that very same player to a three year, $37.5m one, even if the latter is much cheaper on a per-year basis (and with some fun accounting tricks, you can easily halve the cost of that contract in year one). That’s basically the mix that Daniel Murphy faced.
So for sake of discussion, let’s break his options down, putting aside that he had to decline the first option before the second was even on the table.
Team 1: A one-year deal for $16m.
Team 2: A three-year deal, in total, worth $37.5m, paid out as $8.5m, $12.5m, $12.5m, plus $4m deferred (with no interest) until what would be year four.
That’s pretty close to even, although I think most players would go with Team 2. Let’s add a third team to the mix:
Team 3: A three-year deal, in total, worth $36m, paid out as $12m a year,.
Relative to Team 2, that’s a tough decision. Team 3 is worth less, but only $1.5m less, and because it’s not back-loaded, is probably the one that wins. Still, it’s close.
But now, Team 1 sees an opening. They call up the agent and say that they, too, are willing to go to three years — and are ready to talk dollars.
Team 1A: A three-year deal, in total, worth $37.5m, paid out as $16m in year one, $7.5m in year two, and $8m in year three, plus $4m deferred (with no interest) until what would be year four. The contract also comes with an opt-out after the first year, so if the player wants to walk away from that last $19.5m over two years (payable over three), he can.
This is easily the best deal of the group. You get the $37.m million you’d get from Team 2, plus the time-value of the money from Team 3 — or, at least, most of it.
Realistically, though, the player is almost always going to opt-out. Unless he has a catastrophically bad first season, he’ll likely make more than $10m per year for two or more years. He’d be a fool to remain with Team 1. (And, if he does have a really bad year and rebounds, the team has him pretty cheaply for that last year.)
In practice, teams are going to be close to indifferent between offer 1 and 1A — so from the team’s perspective, the post-opt out years are for show, and aren’t expected to be realized. We haven’t hit the extreme example (with the front-loading) that I’ve articulated above, but as front-loading is economically less preferable than the alternatives, that’s not a strike against my argument. But, in effect, I bet that some teams are seeing the lengths of these contracts as only as long as the pre opt-out part. That’s bringing more teams to the negotiating table, which is what I think is driving the opt-out craze.
Originally published on December 31, 2015