The Future Value of Money
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 14.9The 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 8.2This 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.