The Future Value of Money

I studied Finance in college. One of the first things my Finance courses taught me was that a dollar today was more valuable than a dollar tomorrow. Due to the opportunity to invest today’s dollar, and because of inflation, tomorrow’s dollar is already less valuable than today’s. Sometimes, I think major league baseball teams take that a little too seriously.Oftentimes when we hear a contract was signed for 5 years, $80 million, we think that means that it’s a smooth $16 million per year payment structure. That is rarely the case – most of the time, these contracts end up being heavily backloaded. The result is that because of increasing contract payments each year, and decreasing (usually) player performance each year, the team ends up paying more for the least productive years of that player’s contract.

Backloading has been rampant this offseason, particularly by the Marlins and the Angels. For my example, I am going to use C.J. Wilson’s contract with the Angels. He received a 5 year/$75 million dollar contract with a signing bonus of $2.5 million. Assuming an average annual rate of return of 6%, the Net Present Value of that contract is $64.4M. See the chart below:

Actual                  Contract Total      Signing Bonus               2012       2013        2014       2015      2016
C.J. Wilson                    77.5                 2.5                              10.0        11.0         16.0         18.0       20.0
NPV                                64.4                 2.5                               9.4          9.8          13.4         14.3       14.9
The Angels will be paying Wilson $20 million in 2016, when he is going to be 36 years old. How many 36-year old pitchers would you be excited about writing a $20 million check to? There aren’t many.

Now, look what happens if we completely flip the payment structure of this contract:

Revised Strucutre        Total            Signing Bonus       2012       2013       2014       2015       2016
C.J. Wilson                    77.5                      0.0                 20.0         18.0        16.0        12.5        11.0
NPV                                66.4                      0.0                 18.9         16.0        13.4         9.9          8.2
This structure would cost the Angels $2 million more in NPV, or today’s dollars, which is significant. But, in the back end of the contract, they would not be over-committed to a 35 or 36-year old starting pitcher, giving them additional roster flexibility to supplement the team with younger, and at that point, better players. And if you told Wilson that you were going to pay him $20 million in year 1 of the contract, the extra $2.5 million signing bonus may not even be necessary.

As it is, the Angels have $82 million committed to four players in 2014 (Wilson – $16M, Weaver – $16M, Wells – $24M, Pujols – $26M), and $66 million committed to three players (Wilson/Weaver – $20M each, Pujols – $26M) in 2016. That’s a pretty heavy anchor to carry for players who will be well past their primes.

There are reasons to backload a contract besides NPV. One may be that a team is presently cash-strapped, and expect their financial standing to improve in future years. Another is that heavily backloaded contracts are said to be used like a no-trade clause, in that it is more difficult to move an older player with a huge contract to another team.

The danger of backloading a contract is that you can end up in the awkward scenario where one of your franchise’s great players may no longer be as heralded, or welcome on the club because his production has diminished but his contract now appears to be an albatross that limits the club.
Just one time, I’d like to see a cash-rich team bite the bullet and frontload a contract, if only to see what happens.

Peter Ellwood

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