Major League Baseball Player Contracts Are Non-Linear

It is no secret that Major League Baseball player contracts are getting larger every year. The question is, are these big contracts really worth it? Justin Gorman and Tony Kosinski explore the value of signing an expensive high-profile player to an organization.

In Volume 1, #15 of the Marvel comic Amazing Fantasy, it is written “[w]ith great power there must also come – great responsibility!” In the world of baseball, a modified version exists when it comes to player contracts, and it reads “with great sums of money there must also come – increased scrutiny!”

According to Forbes, the average MLB salary was $3.82 million during the 2014 season. The league minimum salary for 2015 is $507,500 – almost ten times higher than the median household income in 2013 ($52,250) as reported by the U.S. Census Bureau. There is a market for talented baseball players and a very limited supply of impact talent. Fans also prove that there is a high demand to watch the best players in the world play baseball – by buying tickets and merchandise at increasingly inflated prices. The dichotomy in income, while staggering, is not surprising.

When disproportionate sums of money are being exchanged, fans take notice and look a little closer. When a team signs a free agent to a monumental long-term deal, the entirety of which is guaranteed money, fans demand accountability. They expect results.

Tom Wright’s article on the James Shields trade drilled down to the central issue around MLB contracts when he stated:

Sometimes, a second-division team needs to overpay for dependable veterans to establish credibility for their franchise.”

The 30 major league teams each have their own set of obstacles to overcome – larger markets include more media scrutiny, smaller markets have traditionally lower payrolls. Large markets also have the added benefit of reputational goodwill. For example, when the Boston Red Sox have a down year they still boast strong attendance numbers, which allows for their larger payroll. In 2014, the Red Sox finished 71-91, good for last in the AL East, but they were 3rd in total attendance among 15 American League teams, drawing more total fans than in 2013 when they won the AL East and the World Series.

The free agent market itself is extremely variable from year to year – in 2015, the two most expensive starting pitchers on the market were 30-year-olds Max Scherzer and Jon Lester, their values determined to be $30M/year and $25.8M/year, respectively. In 2016, the most expensive free agent starting pitcher will likely be 29-year old David Price, and there is little doubt he will fetch a larger contract than either of the aforementioned, due to limited supply and constant demand.

One complexity of analyzing baseball contracts based solely upon their dollar value is that Major League teams operate with considerably different budgets to spend on player payroll. A hypothetical $20 million contract would only represent 7% of the Los Angeles Dodgers current payroll. However, it would eat 22% of the Pittsburgh Pirates’ 2015 payroll. Considering both teams are in the stage of their winning cycle where they are playing for a championship, we can assume they are operating at or near their budget (if the Dodgers even have a budget). MLB player contracts should always be viewed as a percentage of team’s budget available to spend on players. Raw numbers greatly overlook the discrepancy between large and small revenue teams.

Scherzer’s astronomical contract includes $105M that is deferred without interest through 2028, and included a signing bonus of $50M. The deferred structure bears a vague resemblance to the infamous Bobby Bonilla contract with the Mets, with the exception of the interest and the Ponzi scheme.

The economics of baseball are complex and so are the thought processes surrounding free agent signings. The reason for Scherzer’s contract structure is not because the Washington Nationals truly believe he will be a $35M/year pitcher during his age 37 season. There are many other economic factors – including the time value of money lowering the cost for the team and the ability to defer taxes for the player – at play when entering into this sort of contract, and the nature of some of those factors makes the value of the contract non-linear.

In one scenario, the Nationals put out an offer that Scherzer couldn’t refuse – where he will be financially set for life – hoping that the team wins a World Series during the first few years of the contract. Right now, the organizational talent in Washington is such that competing for a World Series Championship is the goal. They are loaded with major league talent with five excellent starting pitchers and a solid lineup led by Bryce Harper and Anthony Rendon. Paying big money for a legitimate ace during this part of their winning cycle makes sense. A World Series win would solidify the label of a “successful franchise” and would translate into a boost in ticket sales for several years. In addition, it would raise the profile of the Nationals and broaden their fanbase, reaching outside their current regional radius and creating a more popular team, in the vein of the Red Sox, New York Yankees, Dodgers, and San Francisco Giants. By increasing their fan base, they would generate more revenue from ticket sales and more fans will watch the team on MASN. That would also generate more revenue for the team.

The same applies to Jon Lester – the Chicago Cubs already have that national profile, but have not won the World Series since 1908 and have had very few playoff appearances to go along with it. If Lester can come in and bolster an already strong, young and cheap team – with the likes of Kris Bryant, Addison Russell and Jorge Soler – and the Cubs can make the playoffs or win a World Series during the term of that contract, then the return on investment could be enormous. Only once since 1983 have the Cubs ranked in the bottom half of National League attendance numbers – in 2000, they ranked 9th out of 16 teams. The lovable losers, who still draw impressive numbers while basking in futility, would become a revenue generating behemoth with a World Series win under their belts.

Even if the Billy Goat once again bleats its ugly head in October, as long as the Cubs project to be a team just a few wins away from a division title or wild card berth, then the acquisition of Lester could have immense additional value to the Cubs. In 2012, SABR President Vince Gennaro estimated the value of one playoff appearance as between $25 million and $70 million. If Lester provides the Cubs the extra wins necessary to boost the team into the playoffs, the non-linear value of his contract could be substantially more lucrative to the Cubs than to one of his other suitors.

Another factor that complicates the analysis of contract value is that the value of impact talent is similarly non-linear. The marginal value provided by a superstar-level talent is exponentially more valuable than the value provided by an above average player. This is true because a team’s innings pitched and at-bats within a season are limited. One player worth 4 wins is more valuable than 2 players that can each contribute 2 wins. Thus, the 2 win players should be compensated less than half of the 4 win player.

Basically, Lester may or may not be worth his $155 million over 6 years based upon an analysis looking at the cost of one win on the free agent market. Scherzer could provide that value over his 7 year, $210 million contract. But whether or not they provide this value is irrelevant. Contracts are not linear; different values must be placed on superstars by different teams with different payroll budgets and in different places in the winning cycle.

Follow Justin and Tony on Twitter @j1gorman and @T_Bone9999.

About Tony Kosinski 4 Articles
Tony lives in Quincy, Massachusetts with his loving, beautiful wife Dawn, his amazing son Cam, and his black lab/pot bellied pig mix, Doog. When Tony is not practicing tax law at DeFranceschi & Klemm, P.C., he's probably listening to music, BBQing low and slow, practicing yoga, or watching the Red Sox, Bruins, or Patriots.

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