What Is a Compensation Pick Worth?

Last week, we spent some time talking about players that may or may not receive a qualifying offer when they hit free agency this winter. The qualifying offer is an important decision, because it grants the original organization a compensation pick at the end of the first round if that player changes teams through free agency. However, it requires teams to be willing to make an offer of at least $14 million in salary for 2014, so it can’t just be handed out to every free agent in hopes of stocking up on draft picks.

On the other hand, draft picks do have value, and especially with the rules that now govern draft spending limits, the extra pool allocation that comes along with that pick gives significant flexibility that can be used to pursue various strategies in the draft. Last year, the six compensation picks that were handed out came with pool allocations between $1.7 and $1.8 million, and the Rays were able to use the pick they got for losing B.J. Upton to draft Ryne Stanek, who had been considered a potential top five pick before a disappointing junior season.

Certainly, these picks have some value, and there is incentive to make a qualifying offer in order to land one of these selections and the draft money that goes along with it. However, if a team is taking a calculated risk in making the offer to a guy on the bubble, they have to first put a value on the pick so that they can know whether or not the reward is worth it at various levels of expectation that he might accept the qualifying offer. So let’s try and help them answer the question of what a compensation pick might actually be worth.

As Jeff Sullivan noted a few months back, the rules restricting team spending on amateur signings inflate the value of a dollar to something more than its face value. We saw this in several trades over the summer where teams swapped international signing slots, and perhaps the Carlos MarmolMatt Guerrier trade is the most instructive in helping us see how teams valued the dollars that came with those slots.

In that deal, the Cubs and Dodgers swapped bad overpaid relievers, with the Cubs also sending LA the rights to spend an additional $210,000 on international free agents. In order to acquire the rights to that spending allowance, the Dodgers essentially took on an extra $500,000 in Major League salary this season, which was the difference in cost between the two once the cash payments were taken into account.

Basically, the Dodgers took on $2.38 in big league salary for every dollar they added to their international spending allocation. The Dodgers used their financial flexibility to essentially buy extra money in a market where money is restricted, but because of those limits, they had to pay a premium in order to buy those dollars.

In some ways, the draft and international markets can be looked at as having their own currency, and there’s a non-even exchange rate between dollars that can go to big league payroll and dollars that can be allocated to signing amateurs. Just like the Dollar is only currently worth .75 Euros, a dollar from a team’s big league budget is only worth some fraction of a dollar in amateur signing money. If we were to accept the valuation from the Dodgers-Cubs trade — and assume that neither team actually put any value on the relievers getting exchanged, which may or may not be true — then this summer, one big league dollar equaled approximately .42 international dollars.

However, that’s an sample of one, and one of the parties involved in the transaction was the franchise that has been more aggressive in throwing cash around than any other over the last year and a half. It wouldn’t be fair to take the Dodgers valuation of money and apply it to every other team in the sport, since most teams don’t have the Dodgers resources.

However, the trade is still illustrative of the effects of restricting spending in these markets. If the Dodgers could have bought international spending money for a lower price from another team, they would have. The fact that there weren’t any sellers undercutting the Cubs price speaks to some level of market valuation for those dollars from the other 28 teams. While we might not have seen other teams buy international spending money in the same way, the decision to not sell an item you already have for a particular price can be assumed to be a similar valuation decision.

So, just for ease of math, let’s say that the league as a whole valued international dollars at roughly double the rate of big league dollars. We’re rounding down a bit, but we’re also regressing for sample reasons and because the Dodgers were our buyer. Should that 2X valuation carry over to draft dollars as well?

It’s not an easy thing to figure out, honestly. There are a lot of differences between the two markets.

For one, the overall spending pools for international free agents and drafted players are not the same size. Last year, MLB teams were given $78 million in international signing allocations, but they were given $202 million in draft spending allocations, so draft dollars aren’t as scarce as international dollars. On the other hand, teams are allowed to trade international pool allocations freely during the summer, and can increase their own individual pool by up 50% through transactions with other teams. So, while the dollars themselves are more scarce, MLB has setup an official exchange in which they can be bought and sold, and acquiring international spending money isn’t that difficult.

Draft selections cannot be traded, however, and there’s really no method of inflating your own draft pool other than by receiving a compensation pick for losing a free agent. So, while the number of draft dollars is larger, the ability to acquire more of them is far more limited. If we stick with the currency exchange analogy, imagine what you would have to pay to convert your dollars into Euros if no one was allowed to sell you Euros. Because of the scarcity that is attached to adding marginal dollars to a team’s draft pool, the valuation on receiving increased draft funds should theoretically be higher than it is with international allocations.

Beyond just the market to acquire the spending rights, teams also have to deal with different shapes in the talent pool. In the draft, there is no question that the value of players is a very steep curve, with the best players available returning exponentially more than the players in the middle to late rounds. In the international market, it is not clear at all that teams are able to positively identify the best players with the same success rate, and since there is no structured selection process, a team could acquire $200,000 in international money and use it to sign the prospect that they felt was the best talent on the market.

Compensation picks come with nearly $2 million in extra draft allocations, but a team can’t receive those funds and then use them to outbid the team with the #1 pick. You can only use those funds to sign players that you can actually select, so a team that picks towards the end of the first round might not get as much value from the dollars associated with a compensation pick as a team with a high selection that can use it to sign a premium player who might have slid a few spots.

For instance, having a few extra million in spending room would have been very helpful to the Pirates in 2012, when Mark Appel fell to them at #8, but they didn’t have a large enough allocation to make him the kind of offer he felt he was worth. At the top of the draft, increase your pool allocation is likely to be very valuable, while a team who is going to be picking in the 20s might not see the same kind of return on getting an extra $1.8 million to spend, since by that point, there won’t be the same kind of talent available as there is at the top of the draft.

In reality, teams are probably going to place very different values on those compensation picks. There probably is no single number that will apply to all 30 organizations. However, because of the inability to acquire draft allocation money in any other way, I have to think that some teams are going to put a premium on obtaining those selections, perhaps even pushing up to a 3X or 4X valuation, which would translate to $5 to $8 million in big league dollars.

But, even once you have that valuation, there’s a bit of a problem in how you approach the qualifying offer decision with that figure in mind. You can’t just take a $6 million player and make him the $14 million qualifying offer because you value the pick at $8 million; the player would take the QO every single time, and your valuation of the pick would be useless because there would be a 0% chance of receiving it. Forcing a QO onto a non-worthy player in hopes of acquiring a draft pick is a great way to get stuck with an overpaid player.

But, with players on the margin, the valuation of the pick could make the difference between an offer or not. Last week, a number of Red Sox fans disagreed with the notion that making Drew the offer is too risky, pointing out that he’ll be the best SS available in free agency and got $10 million coming off a poor season last year, so offering him $14 million coming off a good season is totally reasonable.

Of course, he got $10 million when compensation was not attached, and the markets for compensation players and non-compensation players are quite different, so that is not an apples to apples comparison. But, say the Red Sox internally valued Drew as an $11 million player, and they valued the potential draft pick at $5 million, they would only need to believe that there was about a 50/50 shot at getting the pick to make him the offer.

The actual odds of another team giving up their own pick to sign Drew is out of the scope of this post, which has already wandered slightly from the original point. But, these are the kinds of questions teams are going to have to ask themselves this winter. What kind of valuation do we put on acquiring draft dollars that we can’t acquire any other way? What do we think the chances are of actually getting the pick?

These answers aren’t so straight forward, but they’re required calculations for a team to really take advantage of the qualifying offer system. If a team wants to maximize the assets they’re stockpiling for both the short term and long term, they have to know what kind of value they put on a compensation pick.

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Dave is the Managing Editor of FanGraphs.