Max Scherzer and When $210 Million Isn’t $210 Million

Scott Boras has done it again. After months of what appeared to be mild interest from the clubs one would assume would be in the bidding for the best free agent on the market, Boras found an unexpected bidder with $200 million burning a hole in their pockets. Or, more precisely, $210 million in this case, as the Nationals joined the club of teams paying $30 million per year for premium talent.

Or, at least, they did on paper. Scherzer signed a seven year contract, and in exchange for pitching for them for those seven years, the Nationals have agreed to pay him $210 million in salary. Divide $210 million by seven years and you get $30 million in AAV, which is how this deal will be reported. But because of how this deal was structured, it’s not really $30 million per year.

Instead, the Nationals will pay Scherzer $15 million per season, but do so for 14 years; essentially, they’ve deferred half of each season’s salary seven years into the future. Effectively, they signed Scherzer for $105 million over the seven years that he’ll pitch for them, and then they’ll pay him the next $105 million after the contract ends, making this the most deferred money contract in baseball history.

Teams have been deferring money in contracts forever — the most famous case is Bobby Bonilla‘s deal with the Mets that has them paying him through the 2035 season — but never before have we seen this size of a deferral, and so this deal serves as a nice reminder that the payment terms of a deal can have an impact on the actual value of contract. And in this case, the significant deferral has a pretty big impact.

For a lot of reasons, money today is worth more than money in the future, and the further in the future you go, the less money is worth. To translate various schedules of annuities into a scale so that they can be compared side by side, financial analysts use Net Present Value to calculate the value of deals like this. In other words, what amount of money would you need to be handed in cash today to roughly equal the value of the structured payout over time?

NPV calculations are pretty simple, with the primary variable being the discount rate you apply to those future dollars. Just for the sake of argument, let’s assume Scherzer’s discount rate is 7%, roughly the expected long-term rate of return on investing in the stock market. If you take $210 million spread out over 14 years and apply a 7% discount rate, then the contract is worth about $131 million in today’s dollars. Still a lot of money, obviously, but a lot less than the $210 million figure.

Of course, every contract is an annuity with scheduled future payments, so we need to compare that NPV to what the NPV of this deal would have been had the Nationals not deferred half the contract into the future. So, below is a table of various NPV calculations that show the differences in contract valuation based on the payment structures. The first column is how Scherzer’s deal is going to be paid, followed by a more normal backloaded contract that we regularly see, then a completely flat payment structure with even payouts each year, and finally, the NPV equivalent if the salaries were paid on a flat basis.

Year Scherzer Backloaded Flat EqualNPV
2015 $15,000,000 $20,000,000 $30,000,000 $24,341,000
2016 $15,000,000 $25,000,000 $30,000,000 $24,341,000
2017 $15,000,000 $30,000,000 $30,000,000 $24,341,000
2018 $15,000,000 $30,000,000 $30,000,000 $24,341,000
2019 $15,000,000 $35,000,000 $30,000,000 $24,341,000
2020 $15,000,000 $35,000,000 $30,000,000 $24,341,000
2021 $15,000,000 $35,000,000 $30,000,000 $24,341,000
2022 $15,000,000 $0 $0 $0
2023 $15,000,000 $0 $0 $0
2024 $15,000,000 $0 $0 $0
2025 $15,000,000 $0 $0 $0
2026 $15,000,000 $0 $0 $0
2027 $15,000,000 $0 $0 $0
2028 $15,000,000 $0 $0 $0
Total $210,000,000 $210,000,000 $210,000,000 $170,387,000
NPV $131,182,020 $157,976,085 $161,678,682 $131,180,693

The first two columns are maybe the most important. Here, you can see that if the Nationals had simply signed Scherzer to a normal backloaded deal, the kind of contract we see all the time in MLB, the contract would have been worth almost $27 million more to Scherzer than the one he signed. If he had gotten a flat payout structure, we’re talking about $30 million in additional value. Generally, deferred money doesn’t make a huge difference, but when you’re deferring half of the second largest contract for a pitcher in baseball history, the timing of the payments can make a big difference.

And that’s where that last column of that table comes into play, as it shows what an equivalent flat payout AAV would be to this deal: $170 million. If Scherzer had signed for 7/$170 with an equal payout in each season that he actually played for the Nationals, that contract would be roughly equivalent in value to the $210 million deferred compensation contract he actually signed.

You know what the crowd projected Scherzer to sign for this winter? $168 million over seven years. I guessed $175 million. Pretty much everyone else did too. The $210 million figure is going to grab headlines, but this is essentially the contract that we all thought Scherzer would get this winter; it’s just structured differently than we anticipated.

And, as Jeff wrote last night, $170ish million is probably about what we should expect Scherzer to be worth over the next seven years. The extra $40 million in guaranteed money is just there to offset the fact that so much of it is being paid far off in the distant future.

One last comparison, and then I’ll let you get back to the baseball side of baseball. On the surface, Scherzer’s deal dwarfs what Jon Lester got from the Cubs, but that deal is actually somewhat frontloaded, and so it has a very different payment timeline than the Scherzer deal. Let’s look at the NPV of both deals side by side, based on their per-season payouts.

According to Cot’s Contracts, Lester’s $30 million signing bonus is paid out in four installments; half of it coming next April, and then the other half spread out over the last few years of the deal. I’ve added those signing bonus payments to the annual salaries paid out in each season, as well as including the $10 million buyout of the seventh year option. Here’s how the two contracts stack up by NPV.

Year Scherzer Lester
2015 $15,000,000 $30,000,000
2016 $15,000,000 $20,000,000
2017 $15,000,000 $20,000,000
2018 $15,000,000 $22,500,000
2019 $15,000,000 $25,000,000
2020 $15,000,000 $27,500,000
2021 $15,000,000 $10,000,000
2022 $15,000,000 $0
2023 $15,000,000 $0
2024 $15,000,000 $0
2025 $15,000,000 $0
2026 $15,000,000 $0
2027 $15,000,000 $0
2028 $15,000,000 $0
Total $210,000,000 $155,000,000
NPV $131,182,020 $121,373,821

In terms of guaranteed dollars, Scherzer got $55 million more than Lester did, which makes the gap between the two contracts seem enormous. When you factor in the payout structures, though, the value of the two contracts is actually only $10 million apart; the Nationals didn’t actually pay all that much more for Scherzer than the Cubs did for Lester.

Whether the Nationals needed Max Scherzer is up for debate, and I think there’s a strong case to be made that a team with the Nationals rotation could have spent this kind of money more efficiently on other things, but don’t let the initial shock of the $210 million price tag scare you. Scherzer really only needs to justify about $170 million in salary over the next seven years, because the rest of it is just there to account for the fact that the Nationals are forcing Scherzer to make them a long-term loan in order to keep their payrolls at a manageable level while he’s actually on the team.



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Dave is the Managing Editor of FanGraphs.


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Andrew
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Andrew
1 year 4 months ago

Scott Boras is so petty. All so he can say he got more than $200 million

j6takish
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j6takish
1 year 4 months ago

Or Max decided he would rather collect checks for nearly a decade after he retires…

Andrew
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Andrew
1 year 4 months ago

or he could collect the same present value in a normal contract…It’s a combination of taxes and ego.

jo
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jo
1 year 4 months ago

Scherzer: youjelly?

a eskpert
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a eskpert
1 year 4 months ago

It’s not nearly so simple. As we saw with the insurance policy thing, Max is more than somewhat risk averse. He might have a lower discount rate, and see expected returns on savings as being very different from guaranteed dollars.

Andrew
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Andrew
1 year 4 months ago

no I’m actually a big Scherzer fan and Nationals fan

Richie
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Richie
1 year 4 months ago

Offhand, don’t see how taxes matter really. $14 mill is still way above the top bracket, so you’re just getting another 7 years of up to wherever the top bracket kicks in. Chump change when you’ve already collected all that Max will have by then.

haishan
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haishan
1 year 4 months ago

Maybe he’s trying to mitigate the risk of Barack Hussein Obamacare creating a new bracket for the ultra-high-income.

James Hogg
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James Hogg
1 year 4 months ago

Apparently it has to do with the tax structure in DC where there may already be a millionaires tax … which, yeah, should be coming in the rest of the USA since basically even Mitt Romney is saying the ultra rich have too much money (see today’s news)

Wags (@wags721)
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Wags (@wags721)
1 year 4 months ago

Really doubt his taxes go down because he’s only making $15 million.

Jason B
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Jason B
1 year 4 months ago

“Really doubt his taxes go down because he’s only making $15 million.”

I would hope his taxes go down if he’s making $15M rather than $25M or $30M. But his tax rate probably won’t change regardless.

Mike
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Mike
1 year 4 months ago

A big thing that everyone’s missing is that Scherzer might not retire at the end of the deal. He’ll be 37, so he might have 2-3 years left in him. At that point, he can collect two paychecks at once.

Furthermore, he probably wants to win a championship, and at $15 million a year for a front-of-the-rotation guy for the next seven years, the Nats will be able to more aggressively pursue talent than most teams that sign such high-profile contracts. Remember, we’re talking about a guy who took out an insurance policy on his arm after his Cy Young season. Scherzer is financially savvy.

Pennsy
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Pennsy
1 year 4 months ago

Exactly. $15m is a pretty negligible amount for as long as Scherzer is able to be, more or less, a league average pitcher. Every year he’s better than league average is just a bonus on the “pension” payments the 7 years after. This contract can still go awful, as these kinds of contracts go, but this seems like about as reasonable a contract I would have expected Scherzer to get barring some how of sudden injury concern.

arc
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arc
1 year 4 months ago

How can you be annoyed with Boras and not Scherzer here? Do you think Scott hired Max? The players go get the guy and he performs his duties at their direction.

bdhudson
Member
Member
bdhudson
1 year 4 months ago

Why are we annoyed with anybody?

August Fagerstrom
Editor
Member
1 year 4 months ago

Because someone else earned $210 million and we didn’t!

arc
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arc
1 year 4 months ago

Why did the guy I’m replying to become a we?

Catoblepas
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Catoblepas
1 year 4 months ago

Also, how can you be annoyed with any player/agent for getting as much money as they can? Get that guap! Moving money from owners to players is a just and noble cause, and Scott Boras advances it more than any other individual in baseball.

Andrew
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Andrew
1 year 4 months ago

who said anything about the actual value of the contract??

Richie
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Richie
1 year 4 months ago

Given that it’s almost always ownership ‘groups’ that are put together, you’re probably mostly moving money from a group of multi-multi millionaires to a single multi-multi millionaire. Even if moving money from a single billionaire to a quarter-of-a-billionaire, still think that’s one quirky definition of nobility you got there.

randplaty
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randplaty
1 year 4 months ago

shrug, a lot of people don’t believe in capitalism.

Pennsy
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Pennsy
1 year 4 months ago

@Richie Don’t let dollar values disallow you from seeing the difference between “worker” class and “investor” class. Athletes make millions but you have to consider that a rare few players live to make even a hundred million dollars off their athletic accomplishments while many investors live long enough to earn a billion dollars through business and capital investment efforts. Because you can only make money playing baseball for as long as you’re among the world’s best at it. You can get return from investment projects well past you reach senility so long as you have an adequate trust taking care of your wealth.

Your average player is going to come out of his MLB career earning about as much as a guy working a upper-middle-class career all his life might. Sure you’d rather live the ballplayer’s life, but don’t fool yourself into thinking either of them are in the same financial strata as those who are able to invest in MLB baseball for (at least a portion of) their livelihood.

chuckb
Member
chuckb
1 year 4 months ago

What the hell is a guap?

Richie
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Richie
1 year 4 months ago

Well, that’s still the thing then. Scherzer ain’t the average major league baseball player. I don’t really care what class anyone decides to divide us into, there’s very little noble about whatever sum of money going from the top .001% to someone only in the top .002%.

And, of course, Scherzer joined the ‘investor’ class a few arbitration awards ago.

Tom Cranker
Member
Tom Cranker
1 year 4 months ago

You know it’s not Boras’ signature going on that contract, right?

Woop it up!
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Woop it up!
1 year 4 months ago

Did this help the Nationals stay under the luxury tax threshold? If so, I don’t think Boras was petty, I think it was just a necessary part of negotiations.

Kevin
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Kevin
1 year 4 months ago

Except that, if the luxury tax remains in place (even if it increases in threshold), this may be regrettable 8 years from now.

John
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John
1 year 4 months ago

MLB uses the AAV of guaranteed contracts for luxury tax purposes. Their calculation has nothing to do with deferrals, payment structures (front-loaded vs back-loaded), etc. For Scherzer’s contract, it will be the full $30M for each of the 7 seasons for which he plays (unless the payroll tax penalties are abolished in the next CBA).

Steve
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Steve
1 year 4 months ago

Yeah, because you know baseball owners would lower prices if they didn’t pay the players so much.
/sarcasm

RobM
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RobM
1 year 4 months ago

That’s not petty. That’s business and the marketing of his business. The deal is for $210 MM.

Goat Fondler
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Goat Fondler
1 year 4 months ago

or because the Nationals preferred this structure because it allows them more payroll flexibility during their current window of opportunity.

Andrew
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Andrew
1 year 4 months ago

how does the present value of the Tigers offer compare to 131?

JoeThomas
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JoeThomas
1 year 4 months ago

It’s the same deal as the Tigers offered with one additional year at $24 mill

arc
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arc
1 year 4 months ago

How does this apply to the payroll for luxury tax purposes, though? My understanding has been that deferring payment does not change anything there. In other words, from the league’s perspective, Scherzer’s contract counts against payroll at a rate equal to the total value of the contract divided by the number of years. Is this correct?

If so, I think the value of the money saved by deferment is less certain.

Ian R.
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Ian R.
1 year 4 months ago

Luxury tax is calculated based on the AAV of the contract, so it shouldn’t matter whether it’s front-loaded, back-loaded or (as in this case) deferred. However, that only matters if the team has a high enough payroll to get into luxury tax territory in the first place, and the Nationals aren’t there.

JoeThomas
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JoeThomas
1 year 4 months ago

They may be there soon, though. This will likely bring them up to around $170-$175 mill for ’15 and then they have a number of FA’s in ’16, along with arbitration eligibles.

LHPSU
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LHPSU
1 year 4 months ago

The luxury tax threshold is $189MM. Taking arbitrations and the Tyler Clippard trade into account, the Nationals’ payroll is probably around $170MM, so still comfortably below the threshold.

Doug Fister, Jordan Zimmerman, Ian Desmond and Denard Span represent roughly $35MM in AAV, so the luxury threshold is also not likely to be a significant issue in the near future.

LHPSU
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LHPSU
1 year 4 months ago

Also the $170MM figure includes Jordan Zimmerman’s back-loaded 2-year contract, so the payroll for luxury cap purposes is even lower.

tz
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tz
1 year 4 months ago

Which means they could afford the $25MM per year for Zimmermann and still have money left over, plus a draft pick as compensation for Desmond’s QO. (Or keep Desmond and get a comp pick for Zimmermann).

And, they could even afford for Fister or possibly Span to accept a QO if the Nats decide to offer that to them. Bottom line is that even after signing Scherzer, I don’t see the Nats in danger of paying the payroll tax.

Patrick
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1 year 4 months ago

Ken Rosenthal tweeted that the present value of the contract is used for luxury tax calculations, citing “a rival exectutive”. I don’t see that in the language of the CBA, but it changes things when calculating. It would mean a lower lux tax AAV hit to the Nats.

The luxury tax expires after the 2016 season, and the current CBA has a “sunset” provision, ensuring that the next CBA does not have a competitive balance tax.

John
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John
1 year 4 months ago

Unless I’m reading it wrong and it’s just semantics, Rosenthal is wrong. The AAV of the contract is used for luxury tax purposes, meaning a very simple 210M / 7 = 30M. There is too much subjectiveness when calculating the NPV of a contract with deferred payments (mainly in agreement of what discount rate to use). There is manipulation of rates that could be used in order to make terms more or less favorable.

Brian S
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Brian S
1 year 4 months ago

A+ work here, Dave.

Matthew
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Matthew
1 year 4 months ago

Dave is finally putting that Economics degree to good use.

mockcarr
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mockcarr
1 year 4 months ago

That 15 million will still hamper things in seven years.

John C
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John C
1 year 4 months ago

In seven years, $15 million might be the going rate for a run-of-the-mill, 1-2 WAR type player, in which case the Nats would care less about paying Scherzer through 2028.

Believe me, the Mets aren’t having to be cheap because they’re still paying Bobby Bonilla. It’s because they’re still paying back their stolen Bernie Madoff largesse.

Cool Lester Smooth
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Cool Lester Smooth
1 year 4 months ago

Guess how much 89 year old majority owner Ted Lerner cares about how this move is going to limit his flexibility seven years from now?

Eminor3rd
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Eminor3rd
1 year 4 months ago

It also makes the contract more difficult to trade as it goes along, to the point where it’s going to be pretty much IMPOSSIBLE to move toward the end, right?

Inflation or not, can you imagine anyone ever picking up a year or two of Scherzer for say, $120-$135m?

Andrew
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Andrew
1 year 4 months ago

or if deferred payments are treated differently, it would be easier to trade him and his “15 million” salary

Otter
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Otter
1 year 4 months ago

Oh the face of it, I agree. But have to assume that the teams would work something out. If Scherzer is moved after four years in DC to say Toronto, then the Nats and Jays could agree to the something like Nats paying years 2022-2025; Jays 2026-2028. But sure does seem like it makes it harder to move.

Ian R.
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Ian R.
1 year 4 months ago

It would be no different from moving any other large contract, in that the teams involved would just work out who makes which payments and the Commissioner’s office would sign off. Odds are that the Nationals would just make one deferred payment for each year he actually plays for them, and the receiving team would absorb the remaining deferred payments, but either side could offer to put in more or less money to make the deal work.

If anything, the deferred payments could make this contract easier to move, just because there’s more money to potentially move around.

Chicago Mark
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Chicago Mark
1 year 4 months ago

Are we certain there is no interest payments on the deferred money? Just wondering

munchtime
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munchtime
1 year 4 months ago

Its tough to say without a copy of the contract. The Brewers have been doing deals with a similar structure (less total dollars) for several years now, and they don’t include interest.

Patrick
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1 year 4 months ago

The $ 50 million bonus is possibly meant to offset the fact that so much is deferred, without wreaking havoc on the AAV of the total contract.

lorecore
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lorecore
1 year 4 months ago

Wouldn’t this contract structure penalize team for luxury tax calculations? I guess if the Nats never think they’ll approach the tax, its a non-issue.

tz
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tz
1 year 4 months ago

Not sure I buy the 7% discount rate. Stock market returns are loaded with risk (because the future value of any company is volatile), but the cashflows in Scherzer’s contract are fixed. Something like a bond yield (say 3.5%) might be a better point for the analysis.

Still, you make the key point about the value of the deferral. Even at 3.5% the NPV of the deal is $164m, or the equivalent of a level $26.8m per year for 7 years.

Bernie Madoff
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Bernie Madoff
1 year 4 months ago

No, you can get at least 7-8% guaranteed return, guaranteed. How do you think the Mets were able to afford the Bobby Bonilla deal?

LHPSU
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LHPSU
1 year 4 months ago

Frank Wilpon named chairman of MLB’s finance committee would have been a nice April Fool’s joke, except it isn’t.

Joe
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Joe
1 year 4 months ago

Wait, aren’t we actually factually concerned that their drawdown is them not being able to pay for the team? They may not be able to meet obligations. Has that happened before?

kevinthecomic
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kevinthecomic
1 year 4 months ago

Joe, I think something like that happened to Mario Lemieux of the Pittsburgh Penguins in the NHL. If I recall correctly (and I may not), Mario had a ‘personal services’ contract with the owner (not the club). The owner went bankrupt, and Mario ended up owning some portion of the team.

Not sure what would happen if the team went bankrupt. Maybe MLB has a bailout provision (either implicit or explicit).

tz
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tz
1 year 4 months ago

Good points on what happens if the team goes belly up. Actually, the 3.5% I mentioned is in the ballpark of corporate bond rates, which factor in the outside chance of the company defaulting (due to bankruptcy etc.) If the payments were risk-free (like US Treasuries in theory), the interest rate would be even lower (below 3% in the current environment)

I’m not sure what the actual default risk is for a major league ballclub, but there clearly is one.

Erik
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Erik
1 year 4 months ago

Didn’t we see something like this happen with the Dodgers? Rumor was that McCourt couldn’t make payroll, so MLB stepped in.

Eric
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Eric
1 year 4 months ago

Completely agree with you tz as I said almost exactly the same thing 10 min after you…

eh
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eh
1 year 4 months ago

For you and me, 7% is relatively optimistic. For someone as wealthy as a MLB owner, not so much (they are able to make larger, riskier, and more illiquid investments).

Joe
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Joe
1 year 4 months ago

even with hidden indexing those assets are gonna return about 12%

Patrick
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1 year 4 months ago

The 1% can get 7%, no problem.

a eskpert
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a eskpert
1 year 4 months ago

Very funny. The difference between us and the super rich isn’t that they get systematically higher returns, it’s that they did – but usually in one thing, unless they’re a trader/money manager.

Erik
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Erik
1 year 4 months ago

Now I don’t follow the market all that closely, nor do I read conspiracy theory / socialist blogs but… Economic theory would say that the richest don’t get a higher return than anyone else, rather that they get a greater overall return because they can afford to take a lower return at higher volume.

John Thacker
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John Thacker
1 year 4 months ago

A lower rate is probably more appropriate for Scherzer, since we’re talking about the vast majority of his income. The 7% rate is maybe a bit high but not entirely crazy when talking about a larger organization like the Nats with more income and assets. (I’d prefer to use something 5.5 or 6%.)

Indicidentally, discount rates above seven percent are distressingly common in pension plans, even with fixed cashflow going out. CalPERS uses a 7.5% discount rate, for example, and Los Angeles uses 7.75%, though understandably both have been the subject of criticism. Chicago and New York use 8 percent.

Joe
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Joe
1 year 4 months ago

I can understand the rationale though. Figure a historical return of 12-18% on their alternative investments (which is conservative, considering that these are the guys that mostly own early RenTech) and you get to 7.5% pretty quickly. Though their mandate is such that they might not be as heavily invested in alternative products as I would think.

tz
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tz
1 year 4 months ago

And changes in pension cost accounting have been leading a lot of private employers to swap those liabilities out for annuities covering the cost. The discount rate for pricing those is far less than 7% – I’d hate to see CalPERS’s balance sheet using a realistic discount rate.

kevinthecomic
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kevinthecomic
1 year 4 months ago

And, of course, the company (or local government) can just cut back on the benefits if it turns out liabilities > assets, so their assumptions aren’t so terribly important.

AF
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AF
1 year 4 months ago

The question isn’t what Scherzer’s personal discount rate is. The question is what is the market value of the stream of payments he is receiving. Since the payments are guaranteed by the Washington Nationals, the discount rate should be that of an equivalent-term corporate bond, which is probably in the 3-4% range.

plasmaj
Member
plasmaj
1 year 4 months ago

I agree with this. The Buffett quote of expecting 7% return over the long run is (1) related to equities, and (2) outdated . To get that, he cites expected GDP growth of 3% per year. Since 2000, the average is sub 2%. Regardless, since this is a fixed income stream as opposed to an uncertain long-term performance (equities), you need to use fixed income comparables which are corporate bonds. Even for the high yield market, 7% is too high. At the high end, 5% is possible, but probably sub 4% is the right area.

Noah Baron
Member
Noah Baron
1 year 4 months ago

I think you mean $186.7 M. Which is what most of us thought he would be making anyway.

tz
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tz
1 year 4 months ago

The $186.7M is the sum of the payments. The $164M I quoted was the NPV of those payments at 3.5% (comparable to Dave’s last column, the one labeled “EqualNPV”)

RobM
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RobM
1 year 4 months ago

Correct. I agree with the point Dave is making, but the guarantee of 7%. No. Unless Bernie here in the thread can help us with that one.

Carson's Johnny
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Carson's Johnny
1 year 4 months ago

Yeah the 7% seems awfully high. This isn’t 1998, people should be smarter now.

Plucky
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Plucky
1 year 4 months ago

7% is probably a decent approximation. Not because that’s a stock market-type return, but rather because that’s probably in the neighborhood of an MLB team’s cost-of capital (and a team’s cost-of-capital is the proper benchmark for discounting). There’s no way MLB teams or ownership groups place debt at 3.5%. They are private, have opaque accounting, and there is real credit risk- creditors (including A-Rod!) lost money in the bankruptcy of Tom Hicks’s Rangers ownership group and came very close in the McCourt and Wilpon fiascos. Teams have also developed large credit concentration risks to RSN’s, which is (or ought to be) a worry for their creditworthiness. Only if a team has no leverage whatsoever in its capital structure should it use a lower discount rate.

For an individual person, the discount rate one should use when there are no special tax considerations is typically your highest interest rate- if you have credit card debt (WHICH YOU SHOULD NEVER HAVE UNLESS YOU HAD NO CHOICE), use that rate. If you don’t but have a mortgage or a car financing, use that rate. For amount this large though, that doesn’t really matter (I am assuming Scherzer does not have a $50M mortgage taken out)- Once the money exceeds any liabilities you have, the appropriate discount rate for time-value-of-money purposes is more like 2%, or wherever 10-year treasurys are. What then becomes relevant is the investment choice- would you rather have $130m in a single fixed-income investment yielding 7% (if that is the implied rate the team is using), or in some other investment? That’s a pretty solid rate, but the big risk for an individual is how concentrated it is, and as mentioned above there is very real credit risk in a sports franchise. This is not a basket of corp bonds but 1 big one.

For Scherzer though, what probably makes this a good deal is precisely what we set aside- tax considerations. DC has a ~9% tax rate on income over 350k. If he is collecting the last 7 years of this deal as a resident of Florida (or Texas), then he will save $810k/year in taxes (9% of $15m, giving back 40% of the savings to the feds by losing the deduction). If you do the same discounting at 7%, that’s an extra $2.7m NPV, which relative to a $130m investment base is roughly an extra 2% return. That converts his 7% rate-of-return investment into a 9% one. That’s a pretty compelling risk/reward. Jeff Passan indicated the tax savings over the life of the contract may be as high as $20m (nominal), in which case it would be a complete no-brainer for Scherzer to do

Anon
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Anon
1 year 4 months ago

If the stories I’ve read are correct, the non-resident tax savings would also apply to his signing bonus, which may be as high as $50M (payed in multiple installments).

jonblazethis
Member
jonblazethis
1 year 4 months ago

Rolling 25 year returns on the S&P 500 are more often in double-digits than they aren’t. At his age, and for the foreseeable future, there’s little reason Scherzer wouldn’t be heavily invested in equities and alternatives for the next 25 years. 7% is pretty darn conservative for somebody with Scherzer’s investment profile.

Admittedly, I know nothing about what the rest of the MLB market looked like for Scherzer, but at first glance this is worse than what I would have expected Boras to get.

Tyson Lo
Guest
Tyson Lo
1 year 4 months ago

As an ex-finance guy 7% is too high of a discount rate – I would say 5% and that changes your calculation. For that size of deal you could get a big ass bank (like a big very of the 1-800-cash-now) guys to take the credit risk of the Washington National owners at 5% (although maybe there is some risk that Scherzer goes Michael Vick and somehow gets their contract nullfied (or dies)

Matthew
Guest
Matthew
1 year 4 months ago

I also don’t understand the incentive for a player and Boras to do this. If it pretty common knowledge, if one was to hit the lottery, you should take the lump sum because inflation, you need to invest that money in at least treasuries to counter inflation or the stock market at aim for that 7% to make some money.

Wouldn’t it be better for Scherzer to ask for the flat payout of $171M himself and then get that 7% for himself?

AMB
Guest
AMB
1 year 4 months ago

Apparently because there is a significant tax advantage to doing it this way. I know nothing about tax law but this Jeff Passan column from Yahoo Sports seems to indicate that the tax savings from structuring the deal this way could save Scherzer “more than $20 million”

http://sports.yahoo.com/news/sources–max-scherzer-s-7-year—210-million-deal-with-nats-contains-historic-deferrals-164857543.html

tz
Guest
tz
1 year 4 months ago

Matthew, also note that the folks running the lotteries know that the average lottery winner isn’t a financial whiz, and that the majority of them would take the lump sum even though it’s actually the less favorable deal.

And that’s before any consideration of any tax benefits from leveling income.

Matthew
Guest
Matthew
1 year 4 months ago

Actually, it is the more favorable deal because the amount that inflation will impact the annuity is going to be greater than the difference in the payout. If you take the lump sum, you have capital you didn’t have before. You would probably put some in safe treasuries. Consider this: If you placed that $24M in a treasury, you could be making $300K more a year in intrest compared to the $15M. And that is the safest low reward investment you could make. In a index fund, you could earn 7% intrest(Where I believe Dave is pulling the NPV from). Not only are you not making as much money as you could with the higher up front payment, you are are losing money to inflation at say 2% as year.

Steve
Guest
Steve
1 year 4 months ago

Lottery winners, of course, tend not to actually follow said financial advice. For winners of particular large payouts, say 30 million+ it probably would’ve been better to think of the annuity as a 20-30 year lottery promotion job.

John Thacker
Guest
John Thacker
1 year 4 months ago

There’s two things going on there. The first is how state income tax is treated when you reside in another state than where you live. In the absence of a reciprocity agreement between states, you can essentially end up paying the higher rate of the two states. (You owe tax to both, and can deduct paid to one from the other.) However, many neighboring states have agreements so that people only pay tax to where they live so that, say, those who live in VA and work in MD only pay tax to VA, and vice versa. DC, thanks to provisions in the Home Rule Act, has that status with all 50 states.

The article is assuming that Scherzer will make his permanent residence in some state with no income tax (that’s the max savings), or at the very least a state with a lower income tax than DC’s very high tax. (Very high partially because so many people who work there don’t live there.) This means that essentially the Nats have the same advantages as teams in Florida or Texas when it comes to income tax hits.

The part about deferred income seems to be claiming that there’s some possibility that Scherzer will establish residency in DC while he’s playing there, meaning that any income during the 7 years of the actual contract might be subject to DC tax, but the income during the latter 7 years will not be.

TKDC
Guest
TKDC
1 year 4 months ago

How exactly do you reside and live in two different states?

And a person can’t make their permanent residence in another state to avoid state taxes. If he lives in DC, VA, or MD he has to pay that state’s income tax.

You can’t just claim you live somewhere else. Ask Cap’n Giftbasket how that worked out

Otter
Guest
Otter
1 year 4 months ago

I kind of doubt this. There’s not much variance state-by-state in total tax burden in the lower 48. Obviously 1% on seven figures matters, but I kind of doubt it makes or breaks that many deals.

I think Boras wanted the $200m headline. And it’s possible Scherzer’s really bad with money and liked the idea of 14 years of $15m more than 7 at, say, $25m.

Sn0wman
Member
Sn0wman
1 year 4 months ago

That’s just not true. The top rates in states range from no state income tax in 9 states to 10.55% in California, and pretty much everywhere in-between. That’s a hell of a wide variance.

Steve
Guest
Steve
1 year 4 months ago

I thought lots of states had passed “entertainer taxes” so that athletes essentially pay some sort of tax in every city they play in. That should flatten the tax advantage, no?

Paul G.
Guest
Paul G.
1 year 4 months ago

Otter, the difference in income taxes between states can be very large. Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming have no state income tax. (Tennessee does not tax wages, but it does tax interest and dividends.) Several states have a high bracket of 10% or more once you reach a particular threshold and with this contract it will hit that high threshold very easily. For instance, let’s use California which has a 10.55% rate for all income over 1 million. For the next million the difference between Texas and California is over $100,000. Multiply that by 14. It’s a large number.

Now that’s not to say that state income taxes are the only taxes to consider and there are deductions on the federal and state level to consider and all sorts of other things that keep tax accountants and lawyers very well paid. But when you are talking about very large contracts tax concerns can be a big deal.

Paul G.
Guest
Paul G.
1 year 4 months ago

Also, New Hampshire does the same thing as Tennessee.

Otter
Guest
Otter
1 year 4 months ago

@Sn0wman and Paul G.
Income tax is just one form of local taxation. There are also property taxes, sales taxes, and fees to consider (not to mention additional income taxes in some cities, New York being the most famous). Just because a state has a low income tax, doesn’t mean all taxes are low. I can’t speak for tax policy of each state (aside from Illinois and a few neighboring states), but usually the deal is something like:
low income taxes = higher sales and property taxes
high income taxes = lower property taxes

And sales taxes are a whole other thing, since the tax base is as important as the tax rate. Narrow base with a high rate may actually be cheaper than low rate, broader base. Property taxes obvious rage by location within the state. And then there are fees… how much to register a car, etc.

Anyway, sure there are differences, but I don’t think it’s nearly as great as people make it out to be due to the fact that Scherzer has to live somewhere and will buy things, and usually if he’s not paying much in income taxes, he’s gonna pay a lot on his property and the stuff he buys. The income tax is just the easiest to look at and compare because it’s the most obvious and static.

Of course, we’re also talking about someone making $15m, so paying a few points less in income taxes will probably be a decent amount less than the higher property/sales taxes.

Either way, these a good problems to have if you’re Scherzer (and I’m happy he’s no longer in the AL Central) imo.

Paul G.
Guest
Paul G.
1 year 4 months ago

Otter, I agree there are other taxes to consider. I have the joy of paying all three! But sales tax does not apply unless he buys something, which is his choice to do or not, save the essentials like food. Property taxes are again a choice of what property or properties he wants to own, and there are some fun ways to work around such things. Farm assessment anyone? So he has some control over what he pays and what he invests. Income tax comes off the top. It’s gone before you ever touch it more or less. There is no spend/invest choice available with it which makes avoiding such much more of the benefit. Invest what would have been income tax, then use the return to pay those other taxes as you see fit. Somewhere an accountant smiles.

There are reasons when states employ millionaire taxes that the rich people relocate, or at least change the home address.

John C
Guest
John C
1 year 4 months ago

I wonder what MLB and the union would say if some guy signed a free-agent deal with the Yankees or Dodgers (the only teams who could pay such a deal) with a $150MM signing bonus, to be paid immediately, and then played at the minimum salary for the length of the contract–basically the opposite of what Scherzer just did.

You could conceivably get a superstar at a lower AAV by structuring a contract this way, since the immediate payout of basically the entire guaranteed sum would make that money much more valuable to the player. But I have a feeling MLB would disallow it, and the union wouldn’t like it either, because it would be signing at a below-market AAV.

jhgklsd
Guest
jhgklsd
1 year 4 months ago

So long as they are concerned for their members’ well-being, I don’t see why the union would have any complaints with this. The number on the contract doesn’t matter, what it’s worth is what matters.

But the team would never go for it. There’d be the risk that the guy just doesn’t really like playing baseball, or would rather spend time with his kids, or whatever, and would retire after that first season. No reason to keep playing for the minimum for nine more years or whatever.

Richard Hidalgo
Guest
Richard Hidalgo
1 year 4 months ago

I jacked 44 bombs in 2000. I would eat this rotation alive.

Bip
Member
Member
Bip
1 year 4 months ago

nice

Eric
Guest
Eric
1 year 4 months ago

Regardless of what Warren Buffett says, 7% rate of return seems somewhat optimistic given the volatility of recent markets and I would expect responsible financial advisers of athletes to recommend bond or money market funds as their clients primary concern would likely be safety. 3-4% sounds like a much more realistic rate to use in this case, which would have a significant impact on the NPV calculation.

kevinthecomic
Guest
kevinthecomic
1 year 4 months ago

That’s exactly the wrong advice. The more money you have, the more ability you have to take risk, as noted by someone above.

Dustin
Guest
Dustin
1 year 4 months ago

Yeah. Max probably has more than enough money in the bank right now to set up himself and his children for life. Now is the time to maximize his rate of return.

ThePuck
Guest
ThePuck
1 year 4 months ago

‘Regardless of what Warren Buffett says’

I have a hard time taking financial advice when it starts off by telling me to disregard the advice of a man worth over 70 billion.

Eric
Guest
Eric
1 year 4 months ago

Point taken regarding Buffet, but I would still expect a responsible financial adviser to do all they can to hedge risk in an athlete’s portfolio. As a group, athletes are notorious for having poor spending habits and should value a high degree of financial oversight and predictability over an extra 2-3% rate of return.

dirtbag
Guest
dirtbag
1 year 4 months ago

This is terrible, this advice.

Max Scherzer
Guest
Max Scherzer
1 year 4 months ago

Move over ARod and Ryan Howard, I have the worst contract in baseball now!

Brian
Guest
Brian
1 year 4 months ago

BJ Upton

Malcolm-Jamal Hegyes
Guest
Malcolm-Jamal Hegyes
1 year 4 months ago

Win: Verlander

@bobbleheadguru
Guest
1 year 4 months ago

Verlander had a lower FIP than Fister and a very respectable fWAR even with core surgery recovery. His book is far from being closed.

TKDC
Guest
TKDC
1 year 4 months ago

UPton’s contract may go down as one of the worst WAR per dollar deals ever, but he just didn’t get enough money to compete here.

Prince Fielder
Guest
Prince Fielder
1 year 4 months ago

Man you ain’t got nothin’ on me!

Albert Pujols
Guest
Albert Pujols
1 year 4 months ago

Not even close

Barry Zito
Guest
1 year 4 months ago

Just win a World Series game in 6 or 7 years and all will be forgiven.

kevinthecomic
Guest
kevinthecomic
1 year 4 months ago

Josh Hamilton says hello.

Arte Moreno
Guest
Arte Moreno
1 year 4 months ago

Contract value is subjective.

John C
Guest
John C
1 year 4 months ago

Actually, Scherzer’s contract is about as team-friendly as you could expect to get a FA of his caliber for these days, especially one who has Scott Boras as his agent.

Vernon Wells
Guest
Vernon Wells
1 year 4 months ago

I’m pretty sure I was one of the 15 highest paid players last year and I’m basically retired because I’m terrible.

Will
Guest
1 year 4 months ago

For luxury tax purposes, this deal turns a $30mn AAV into approximately $26.4mn, but that’s only relevant to a luxury tax payer, which the Nationals presently are not.

Although for illustrative purposes, we can use standard factors to determine net present value, more relevant to the conversation for the Nationals are their expected ROI as well as player salary inflation. Meanwhile, for Scherzer, the amount he is giving up will depend on his ROI and income tax rates.

The bottom line is deferred and backloaded deals always work best for the team unless there is salary deflation, the ROI turns out to be negative, or tax rates decline, among other less likely variables.

James
Guest
1 year 4 months ago

My understanding is the AAV for luxury tax in this case would be $15M (over the next 14 years). Can someone confirm? If so this is a big potential savings going forward for the Nats.

Andrew
Guest
Andrew
1 year 4 months ago

I believe MLB calculates the value by converting the 210 in future payments into equal installments over the next 7 years. Some have said 26.4

Will
Guest
1 year 4 months ago

That’s incorrect. The AAV is $105 million /7 plus $105 million discounted at Chase Prime + 1% rounded to nearest full number discounted annually seven years. That leads to $105 million + $79,791,370.40, or a total of $184,791,370.40. If you divide that by seven years, the AAV is $26,398,767.20

Patrick
Guest
1 year 4 months ago

So, if Miguel Cabrera makes $ 292 million over ten years, none of it deferred, that’s an AAV of 29.2 million. The present value has no impact on his Luxury tax value because no money is deferred, right?

Will
Guest
1 year 4 months ago

Correct. AAV is basically all of the guaranteed compensation (bonus, certain options and buyouts, salary, etc.) divided by the terms of the deal (i.e., the years the player is under team control). Also, incentives are added to the AAV in the year they are earned.

M. Incandenza
Guest
M. Incandenza
1 year 4 months ago

What this analysis neglects to mention is that the marginal utility of money above, oh I don’t know, bunches of millions of dollars, is basically zero. Having 200 million dollars rather than 100 million dollars just does not appreciably improve your quality of life. What super rich people seem to care about are positional goods – making more than other super rich people so that they can seem like the super richest. To that end, the $200 million+ number is really all that matters.

kevinthecomic
Guest
kevinthecomic
1 year 4 months ago

The difference would be whether the great-great grandchildren or the great-great-great grandchildren get to live off of the interest on the interest.

M. Incandenza
Guest
M. Incandenza
1 year 4 months ago

Oh, I have full faith that one of the intervening generations would manage to squander the wealth regardless.

Patrick
Guest
1 year 4 months ago

Unless Max wants to, like maybe, buy a baseball team some day!

Matthew
Guest
Matthew
1 year 4 months ago

I’ve always been curious if a team would every offer a percentage of ownership to a player as part of a contract for a franchise player.

Bob
Guest
Bob
1 year 4 months ago

Pretty sure there was at least speculation that when Albert Pujols was a free agent to be that the Cardinals offered a % ownership stake as part of the deal

SABRphreak
Guest
SABRphreak
1 year 4 months ago

That’s not permitted.

John C
Guest
John C
1 year 4 months ago

Can’t do that, it’s not allowed. But there have been times when a player has been allowed to buy in after his retirement. I’m pretty sure George Brett owns a stake in the Royals, for example.

Executives can do this. Billy Beane owns part of the A’s.

munchtime
Guest
munchtime
1 year 4 months ago

In terms of daily living expenses, the marginal utility value may be approaching zero. In terms of investment/business opportunities, that extra $100 million is going to provide a lot more value.

M. Incandenza
Guest
M. Incandenza
1 year 4 months ago

I guess if Max Scherzer’s sense of personal well-being depends, in the long run, on having an exciting second career in financial investment, then yes.

a eskpert
Guest
a eskpert
1 year 4 months ago

It isn’t basically zero. People don’t act like it’s basically zero. You buy bigger things. My great uncle for a while owned a yacht that cost 12 M$ A YEAR TO RUN. There are always things you can spend (or donate) money on, and additionally, there is a very very strong effect on utility of having money invested/saved for most people.

M. Incandenza
Guest
M. Incandenza
1 year 4 months ago

Haha. $12 million a year could have raised perhaps ten thousand families out of poverty in a developing country. Your great uncle used that amount of money to “run” (?!) a boat. Do you see how this kind of makes my point for me?

Erik
Guest
Erik
1 year 4 months ago

Your view of the world is too small. $200 million is a drop in the bucket of the global economy. Perhaps it’s true for a lot of people but having more money beyond that isn’t about racking up a high score.

If you just plan on living off your funds in retirement then you only need to save up several million dollars, as the interest alone can provide a comfortable living. If you can dream a little bigger though, and consider trying to leave your mark on the world, make it a better place than when you entered it, well then $200 million is ‘a good start.’

a eskpert
Guest
a eskpert
1 year 4 months ago

Not really.

Jim S.
Guest
Jim S.
1 year 4 months ago

Ooops. There’s a 50 million-dollar signing bonus, according to the AP.

cappy
Guest
cappy
1 year 4 months ago

So Stanton’s $325 million contract is actually how much in NPV?

Eric Weinstein
Guest
Eric Weinstein
1 year 4 months ago

Dave,

I’d like to continue a Q&A I’ve had with you in chats about the Cubs evident preference of Lester over Scherzer now that Scherzer has signed.

This is from one of your chats several weeks ago:
“Comment From Eric Weinstein
The other day I asked you why the Cubs seem to prefer Lester over Scherzer and your response was “He costs less.” At 7/170 (I know I’m assuming vesting of the option but Lester’s issue has never been durability just performance), Lester may not cost less by much. Why don’t you think the Cubs seriously engaged Scherzer simultaneously with Lester, and why would they prefer Lester over Scherzer? Scherzer seems like the unambiguously superior pitcher

Dave Cameron: You can’t assume the option vests. The contract is 6/155. Scherzer is asking for $200M+. He’s going to get a lot more than Lester did.”

First things first, I understand that it is a matter of doctrine that you don’t assume an option year vests. But the odds that the 7th year vests certainly are not 0%.
So the expected payout on the Lester deal is greater than $155 million.
With Lester’s durability, the expected payout on the deal may be closer to that $170 figure than $155.

Regardless of how you figure in the likelihood of Lester’s 7th year vesting, as you so ably demonstrated in your article, the value of the Lester and Scherzer contracts despite the $210 million headline figure for Scherzer. So at the end of the day Scherzer did not “get a lot more than Lester” as you said he would in the chat.

So I’m back to asking – why don’t you think the Cubs more seriously engaged Scherzer?
I accept that the Cubs may have expected Scherzer would end up commanding more money. But there were many reasons that were apparent even a month or two ago to think that Scherzer’s market was limited.

Based on the Cubs behavior I can only assume that they actually preferred Lester to Scherzer. That preference doesn’t seem defensible to me based on performance. Scherzer is demonstrably the better pitcher.

So what gives? Why do you think the Cubs went all in for Lester and not Scherzer? Is it really just the Red Sox connection? Perceptions of durability?

JayT
Guest
JayT
1 year 4 months ago

Pitchers that stay with their current team tend to outperform pitchers that leave as free agents. The Cubs front office might have believed that they knew enough about Lester to feel he was the safer bet than Scherzer.

Of course they also had no idea what Scherzer would end up going for, and if they thought he would end up signing for 7/$185, they may have just wanted to save that $30 million.

Blueyays
Member
Blueyays
1 year 4 months ago

Both of those guys were leaving their teams as free agents… Also, what evidence do you have for that?

JayT
Guest
JayT
1 year 4 months ago

There are lots of articles out there about free agents that stay with their teams outperforming ones that leave. I don’t think that is a terribly controversial statement.

My point was that the Cubs’ front office has had a long history with Lester, so they may have felt they had a better idea of what he was compared to Scherzer who was a bit of a black box to them. Obviously, this is all speculation, but I don’t think it’s unbelievable that it was a factor as to why the Cubs liked Lester more than Scherzer.

Bip
Member
Member
Bip
1 year 4 months ago

They may have just wanted to avoid committing too much for a pitcher. They may have wanted to avoid a bidding war with Boras. They may feel Scherzer has a greater risk of injury. They may have stock in Lester’s playoff performance. Scherzer may not have wanted to go to the Cubs. They may feel Scherzer isn’t really that much better than Lester.

I mean who knows. There are too many factors we don’t know to actually deduce a team’s course of action.

jhgklsd
Guest
jhgklsd
1 year 4 months ago

One important consideration is that Lester is a ground ball pitcher and Scherzer is an extreme fly ball pitcher. That might make a difference to a team that plays in Wrigley.

Hoosier
Guest
Hoosier
1 year 4 months ago

What’s the advantage to the Nationals, and why would Scherzer agree, to the backloaded deal instead of just straight up $24~ for seven years? If the contract he just signed is essentially the same value, why go through the trouble of structuring it as such?

I’m assuming from what I have seen in the discussions above, the luxury tax is not relevant.

JayT
Guest
JayT
1 year 4 months ago

The advantage to the Nationals is that they have more money to spend each year over the next seven, and with every year that goes by they are paying him less and less. Imagine taking a deal like this to an extreme. If you’re the team would you rather pay someone $24 million a year for seven years, or would you rather pay them $2.4 million a year for 70 years?

Bip
Member
Member
Bip
1 year 4 months ago

Regardless of your point regarding the advantages of a deal structured that way, there might be an additional advantage if baseball salaries continue to inflate at a faster rate than the dollar overall.

indyralph
Member
Member
indyralph
1 year 4 months ago

Essentially the Nats are taking advantage of being in an economy where inflation is high, while the rest of the public must invest at much lower rates. The Nationals operate in an economy where inflation is 7%, maybe higher. Which means that any money not spent now will be worth 7% less next year and so on. The result is that their discount rate is at least MLB inflation (>7%), while Scherzer’s is maybe 7% at stock market risk levels, but probably lower if he is not (or doesn’t want to be) a particularly savvy investor. This means the NPV to the Nationals is potentially less than what Dave states, while it’s the same or more to Scherzer. The risk to the Nationals is that they are wrong about MLB salaries continuing to go up at that rate.

Hoosier
Guest
Hoosier
1 year 4 months ago

So this is a bet by the Nats that salaries will continue to dramatically increase (higher inflation) and by Scherzer that they won’t?

indyralph
Member
Member
indyralph
1 year 4 months ago

I’m way late so you may never see this, but that is not exactly right. It IS a bet by the Nationals that salaries will continue to inflate. Scherzer does not care if salaries inflate or not because this is likely his last contract. What Scherzer cares about is how much interest he thinks he could earn on the money if he were paid over 7 years instead of 15. He could earn 7% if he invests well in the market. As noted elsewhere, wealthy people can earn more than that if they are savvy and interested. But maybe he’s not, and only wants to invest in less risky options that earn 4-5%. If the Nationals think MLB inflation is 7% or higher and Scherzer is willing to take a lower discount rate, then the NPV is higher for Scherzer than it is for the Nationals. They don’t necessarily have the same NPV.

jim fetterolf
Guest
jim fetterolf
1 year 4 months ago

Informative work, Dave. It has been suggested in KC that the Royals look at deferring money in contracts to 2020 and beyond when they get a new local TV contract but the NPV makes it even more useful for small market teams dealing with an agent more about ego than actual value.

Joseph
Guest
Joseph
1 year 4 months ago

It gets the point across and picking a rate is a bit of an art, but 7% seems high and using a flat rate is overly simple. Ideally one uses a yield curve, discounting 7% in year one is very high, using the Treasury High Quality Market corporate Bond Yield Curve you get 178M discounting all 14 year and 184 only discounting 13 years (assuming the first 15M is at PV)

RT
Guest
RT
1 year 4 months ago

I have to take issue with two parts of this analysis:

The first is that this ignores the $50M immediate payment as a signing bonus, which obviously affects the NPV.

The second is that most deferred money deals are not deferred without interest, and I have a hard time believing Boras would do so for Scherzer.

JayT
Guest
JayT
1 year 4 months ago

The $50 million is being reported as spread out over several years. Obviously, it will matter, but with the information that was available when this article was written, the report was that it would be $15 million a year for 15 years.

While it’s possible, there’s no reason to think the Nationals will be paying interest. As far as I know, no backloaded deals have ever given interest. Do you have an example? The closest I can think of would be Bobby Bonilla or Andruw Jones, where their teams gave them interest when buying them out of their contracts, but that was a completely different thing.

Dragbunter
Guest
Dragbunter
1 year 4 months ago

Dave, I work with NPV and long term investments for a living and I’ve never had anyone explain it so clearly as you. Excellent analysis.

@bobbleheadguru
Guest
1 year 4 months ago

Dave,

MLB Trade Rumor poster claims you have not computed the value of his “$50MM Bonus”. Can you comment?

Fergie348
Guest
Fergie348
1 year 4 months ago

If you think you can average 7% yearly ROI in the stock market over the next 14 years, you should be running a (very successful) fund. CALPERS wants to talk to you..

Sean Randell
Guest
Sean Randell
1 year 4 months ago

“the value of the two contracts is actually only $10 million apart; the Nationals didn’t actually pay all that much more for Scherzer than the Cubs did for Lester.”

So in YOUR world $10 million isnt much of a difference? Really? This is everything that is wrong with people who do not understand numbers. Using your 7% discount rate (which is fine, but NOT guaranteed) and all things being equal $10 million is more than 8% larger than Lester’s. Only in deluded world would 8% more be close enough

Bip
Member
Member
Bip
1 year 4 months ago

Uh, we’re talking about $10 million over 14 years, which buys nothing in baseball terms. Even for one year, that’s like one below-average free agent. That’s how much the Dodgers are paying for Brett Anderson to possibly not pitch for them.

Detroit Michael
Guest
Detroit Michael
1 year 4 months ago

So how does this work going forward. Scherzer is a significant unsecured creditor of the Washington Nationals. Did he analyze GAAP financial statements to assess the credit risk he was taking on? Does he buy insurance to protect himself from the risk of nonpayment in which case the insurer would want access to the Nationals’ financial data?

It wasn’t that long ago that Alex Rodriguez was an unsecured creditor of the bankrupt Texas Rangers, so the likelihood of this risk is not too small to worry about.

John C
Guest
John C
1 year 4 months ago

I’m sure Scott Boras’ staff did all of the work for Scherzer before Max signed the contract. Say what you will about Boras and his ego, but he does try to get the best possible deal for his clients.

Players don’t just hire an agent for the ego trip of getting the highest possible number on their contract. Good agents do all of this legwork to cover their clients’ backsides before they have the player sign anything.

And it worked out fine for A-Rod, anyway. He got all of his money.

Bip
Member
Member
Bip
1 year 4 months ago

Yeah, a major league team might go bankrupt, but it’s not going to go bankrupt right? The league will intervene somehow and try to placate everyone involved right?

tz
Guest
tz
1 year 4 months ago

And bankruptcy doesn’t necessarily mean you’re out the whole enchilada. Even in the worst case scenario where the league can’t make up any shortfall in the team’s obligations, there’s a real good chance he’d get say 80 cents on the dollar vs. what he was owed from the contract.

dirtbag
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dirtbag
1 year 4 months ago

Rodriguez was paid the full amount he was owed when the Rangers were sold for $575M.

jhgklsd
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jhgklsd
1 year 4 months ago

This has come up a couple times and MLB guaranteed all of the payments both times. He’s not betting that the team won’t go bankrupt, he’s betting that MLB won’t go bankrupt. That’s a pretty safe bet.

Bip
Member
Member
Bip
1 year 4 months ago

For Scherzer, the relevant figure is the value of the dollar in the overall economy, because that is where he is spending it. However, for the Nationals, if we assume player payroll continues to inflate at a higher rate than the overall economy, which it has for a while seemingly, then the actual impact of those dollars to them will deflate at a faster rate than it does for Scherzer, giving them even more incentive to like a backloaded deal like this.

The real question is, would they still have been able to sign him if they refused to defer money? Was that a condition Scherzer/Boras requested, and if so, how big a contract would they require in order to accept a contract without deferred money?

Let’s say that everyone involved is using the figures above, and that Boras said “give us $131,180,693 in NPV, distributed how you like.” They could sign him for $170,387,000 over 7 years, but if they are betting on player payroll continuing to inflate, they may have actually wanted to defer money, thinking their burden will decrease disproportionately to how the money will lose value in the overall economy.

Bip
Member
Member
Bip
1 year 4 months ago

Another interesting thought: will a player ever sign a contract without a guaranteed amount, but instead will calculate the amount each year by some designated NPV calculation method? So for example, the player will sign a five-year contract in 2016, and the yearly salary will be the equivalent of $20 million in 2016 dollars based on some objective estimate that takes into account inflating and GDP growth or something? So, in pure dollars, the player might make something like 120 million over 5 years.

pft
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pft
1 year 4 months ago

Why would a player want to take such a risk? Taking into account the estimated real value of a contract is always part of the calculus, but these are estimates that can be wildly off in a short period, as anyone who lived through the late 70’s and early 80’s can attest. MLB salary inflation in the post collusion era of the 80’s was very high, double digit in fact, up to 2002, before falling to 5% for most of this century (with a few years of minimal inflation in the aftermath of the financial crisis). In fact in real dollars, the 2 biggest contracts were given out in 2001 (Manny and Arod) and the Yankees payroll is down 50 million compared to 2003-2009 years

Owners tend to profit from players focus on nominal guaranteed dollars and realize that wile a 24 million AAV for Cano today seems high at the end of his contract it will be equivalent to 15 million a year, which will hardly be crippling should he not perform well.

Bip
Member
Member
Bip
1 year 4 months ago

I guess I’m not sure why it would be such a risk. I’m not talking about the average MLB salary as the baseline, I’m talking about the economy overall, which should be less risky I would think. As to why they would take it, why does anyone take a risk in any financial transaction? If the reward is worth it, they’ll take it.

pft
Guest
pft
1 year 4 months ago

Scherzer is not going to be able to invest the entire 210 million in the stock market, Taxes will take over 40% leaving him with 126 million. With 63 million deferred I guess you can argue that he loses half that value by deferring it 7 years, or about 31 million less 23% for capital gains tax when he cashes in, so call it a loss of 24 million (ball park)

Also, depending on the timing of the next stock market crash and financial crisis, deferring it may actually save him money. Can’t say at this point.

Tim
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Tim
1 year 4 months ago

If tax rates don’t change, deferral changes nothing for Scherzer, tax-wise. He gets no capital gains here, deferred income is still income.

Timing the market – who knows? It’s very very likely that the lowest point “the market” will see over the next 14 years is some time in the first seven years.

Mike Green
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Mike Green
1 year 4 months ago

“Scherzer really only needs to justify about $170 million in salary over the next seven years”

So, the $/WAR this off-season is what- $7.5 million would be my guess. So, he’s got to produce about 22 WAR over the next 7 years. I am pretty sure that the odds of that happening are about 30 per cent. The problem is that the odds of him producing less than 5 WAR over the next 7 years (i.e. a flame-out with injuries undoubtedly contributing) are much, much higher than the odds of him producing 39 WAR or more over the next 7 years (a terrific bargain).

If you run comps to Scherzer from the post (very successful from age 27-29 with league-topping K rates but not league topping IPs), you get basically a 3 ways split from age 30- flameouts within 2 seasons or less, players who give 3 and 1/2 to 5 good years, and the Hall of Famers who keep going through their late 30s. The first two categories are (unsurprisingly) larger than the 3rd.

Gerald
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Gerald
1 year 4 months ago

These kinds of deals almost never become “terrific bargains” — that’s pretty well understood going in.

ThePuck
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ThePuck
1 year 4 months ago

remember that one WAR won’t be worth 7.5 every year, it will go up.

Noah Baron
Member
Noah Baron
1 year 4 months ago

I don’t think that 7% figure is a given. I’d imagine that once the new TV deals stop coming in MLB spending will correspondingly slow down.

Biggs league chew
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Biggs league chew
1 year 4 months ago

Shields only Ace left. Getting 7/150 for sure now. Front loaded to pay him 144 in year 1 and 1 mill per each year after.

Stefan
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Stefan
1 year 4 months ago

I wrote a vba program a while back to estimate these and I can say the one thing that is not considered with these defered payments or backloaded contracts compared to what lester got was the concept of the value of flexability. The nice thing about lesters contract is that it will be very easy to DFA lester if his floor falls out, because his contract pays him for his estimated performance. IMO

Scott Boras
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Scott Boras
1 year 4 months ago

grrr money
grrr baseball
fear me, mortals
bwa ha ha ha ha

Steven
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Steven
1 year 4 months ago

How much Scherzer does $210 mil get you? Max Scherzer.

Hank
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Hank
1 year 4 months ago

I think the NPV is being applied inappropriately here – this isn’t an independent expenditure.

Most teams operate on a yearly payroll so front-loading/backloading/deferring money is I think primarily much about flexibility, not saving money.

The theoretical NPV gains here will likely never be realized (on the team side) because they are likely operating on a team level and aren’t taking the 105mil and saving/investing it.

Bip
Member
Member
Bip
1 year 4 months ago

It is still appropriate. In fact they are saving an reinvesting the money. They reinvest the money in other players. If they spend less total actual value because of the structure of the deal, that means they can spend more total value over the course of the deal than they could over the same time period had the deal not been deferred.

jhgklsd
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jhgklsd
1 year 4 months ago

That’s a good point. The other option is that the owner could just pocket the money, in which case it also gets re-invested. (For the owners benefit, which, when you get down to it, is what this is all about.)

Hank
Guest
Hank
1 year 4 months ago

They aren’t.

Just to use arbitrary numbers… if the Nats are spending 160 mil in 2015 and 220 mil in 2024 it makes no difference who specifically is receiving that money, Whether it’s a 15mil check to “Scherzer, Max” in 2014 and 2024 or a 30mil check to “Scherzer, Mas” in 2014 and $0 in 2024, they are still spending 160mil in 2014 and 220 mil in 2024. From a team perspective the actual cost basis doesn’t change.

The NPV savings is only ‘real’ if they are actually adjusting payroll based on backloading the contract. I believe most teams don’t actually do this and instead work on yearly payroll targets (or a specific range). In the real world the NPV savings occur when you actually adjust your capital(or cost) expenditures – if you are simply shifting it from one budget to another there is no realized savings if you are still spending the same total amount.

With this much deferred money it is possible that the Nationals don’t count future 15mil payments toward their payroll targets, but most teams just have yearly payroll targets (or rough ranges) and stuff like deferred money or money shipped out in a deal is part of the payroll budgeting process.

Tim
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Tim
1 year 4 months ago

But what if spreading it across 14 years makes it possible to fit it into an existing budget? i.e., their choice was Scherzer with deferred money, or Ervin Santana without a deferral. They rob future teams to improve this one.

Your position is unrealistic, BTW – the payroll budget grows/shrinks based on the opportunity set of players available. At least, for good organizations it does.

Brennan
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Brennan
1 year 4 months ago

A 7% discount rate for Scherzer seems quite high. A guaranteed risk-free 7% return rate is nearly impossible to achieve. Even if the expected stock market for Scherzer were 7%, the returns would be highly volatile. It’s insane to not think of this in risk-adjusted terms for both Scherzer and the team (though Scherzer should probably be more risk averse than the team).

If I were Scherzer (and Boras), I’d much rather take the actual deal than the “equal NPV” deal Cameron cites.

Bip
Member
Member
Bip
1 year 4 months ago

It doesn’t have to be risk-free or guaranteed though. If 7% was guaranteed, then that would imply that one could probably get more than that with very little risk added. In that case 7% would be the floor, not the expected value.

Brennan
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Brennan
1 year 4 months ago

Hey Bip, my point is that given a choice between the Scherzer contract and the “Equal NPV” contract Dave cited, you would choose the Scherzer contract if you give any weight at all to minimizing volatility. The “Equal NPV” contract assumes 7% annualized returns to match the future value streams of the Scherzer contract. You can’t get 7% annualized returns without taking substantial risk. So the “Equal NPV” contract involves taking on more risk for the same expected return in future dollars.

Bip
Member
Member
Bip
1 year 4 months ago

I think that the Equal NPV assume 7% as the expected return though, meaning there is approximately equal chance of getting more or getting less, if the estimate is good. So it’s not like the choice is between 7% with risk and 7% without risk, it’s between 7% flat and 7% with risk but also with the potential to exceed 7%.

Max
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Max
1 year 4 months ago

Brennan is right here. 7% discount rate makes sense when applied to risky cash flows. In this case the likelihood of Sherzer not getting the cash is extremely low. Makes a lot more sense to discount it at an equivalent risk less interest rate (i.e. the Treasury Curve), in which case the differences between backloaded and front loaded contracts would be far less severe.

Insider
Guest
Insider
1 year 4 months ago

Max won’t have to pay taxes on the last 7 years, as you don’t pay taxes on money you make in DC if you live in DC.

burrwick
Member
burrwick
1 year 4 months ago

Would someone please address the reported $50 mil signing bonus and how that is being paid? If that report is correct doesn’t it make the contract worth $260 mil? No matter what argument you use to justify the value of the $210 because it’s spread out over 14 years, doesn’t that $50 million loom large in any discussion?

Bip
Member
Member
Bip
1 year 4 months ago

I heard it was spread out. Either way, it’s included in the 210 figure though, so it’s definitely not 260 million.

burrwick
Member
burrwick
1 year 4 months ago

It’s a puzzle to me, reports keep saying there is a $50mil bonus yet everything you read also says the contract is for $15mil a year for 14 years. Where is the bonus in that?? A bonus is usually an amount seperate from the yearly contract amount.

stockmarketperson
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stockmarketperson
1 year 4 months ago

I would argue that the highest discount rate would be around 9% or so. The S and p 500 has returned about 10.5% pretax over its history–that includes the great depression and the recessions.

And this is with relatively stable low expense ratio index mutual funds that aren’t actively traded. Long-term capital gains costs should be included and the individual investor’s tax liability situation incorporated into the analysis.

Max
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Max
1 year 4 months ago

This makes Scherzer borderline untradeable for the Nationals, right? Even in year seven, he’ll have $105mil on the books.

Bip
Member
Member
Bip
1 year 4 months ago

Yeah I wonder how that will work. Would a team trading for him necessarily be only trading for the actual years he’s under contract, or are they necessarily trading for the whole contract?

Jimmy Buffett
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Jimmy Buffett
1 year 4 months ago

You need to use the risk-free rate for a risk-free cash flow stream. If the Nationals are not expected to go bankrupt, then the correct discount rate is the risk-free rate. Bonilla got paid, Scherzer will too.

KCDaveInLA
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KCDaveInLA
1 year 4 months ago

As populations explode and resources become scarce, Scherzer is hedging against a future economic and societal collapse. Or maybe I read and watch too much sci-fi.

Robert
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Robert
1 year 4 months ago

I thought that I read that Max received a signing bonus of $50 million and that half of the $210 million contract was paid out over the 14 years. I was hoping to find out how the $50 million signing bonus was to be paid out. I am wondering what that would now look like in NPV.

Tim
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Tim
1 year 4 months ago

I’m sure Fangraphs will be willing to spend 20-30% more on their new employees as long as they sign longer term contracts.

Gooner
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Gooner
1 year 4 months ago

As always Dave, great analysis and thinking. And as always, you are pushing much needed conversation forward. A lot of back and forth in the comments about what discount rate to use, and I wanted to put my two cents worth in. I think it is the only area in this analysis that needs discussion. The question really, is from who’s standpoint are we trying to value this contract. The question Scherzer has to ask himself is “what is the value of having the money now vs. later”. From the team’s perspective, the question is “what are the real financing costs and opportunity costs of the money I am committing”. These questions will yield (even if slightly) different discount rates.

Let’s assume for a moment that we care about whether this is a good deal for the Nationals, and especially relative to the Cubs’ Lester deal. The place to start is the cost of capital for the franchises. It is safe to assume that the cost of capital for both teams are very similar. Lets assume both are AA rated. Yields on 10 year AA corporate bonds right now are about 3%. Let’s also assume that we are going to add on a “risk premium” to each cash stream given we are investing in a starting pitcher. Let’s say a 100 basis point premium, bringing the discount rate to 4%.

And finally, lets adjust for the fact that in the second seven years, you are paying Scherzer even though he isn’t playing. At this point, you are literally just dealing with the financing costs. So the discount rate for the second seven years should really be back to 3%.

All this gives a NPV of Scherzer’s contract at $166 mil and Lester’s at $134 mil. It could be argued that Lester deserves a slightly higher discount rate given Scherzer is a bit of a safer bet to see out his contract. But in reality, the difference in discount rates will be at most a quarter of a percentage point (I have neither the time nor inclination to even determine what the true alpha is between their performances). Either way, the difference is substantial, if you ask me. And probably not worth the increase in quality you are getting.

Brian Woj
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Brian Woj
1 year 4 months ago

The last 3 years are now reported to be worth $35M per year. Can we get a new value for this contract?

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