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Getting Value Up Front

This morning’s poll results on “How Much Is Too Much For Albert Pujols” make it a clear that a lot of you are out and out against long term contracts that will end with a player being drastically overpaid and underproductive at the end of the deal. More than 1/3 of our readers said they would not give Pujols a 10 year deal at any price, even when presented with an option as low as $150 million.

While I understand the desire to not guarantee big money to a 41-year-old first baseman, that kind of risk aversion is simply too extreme. Put simply, you can’t look at the expected return on investment in only the latter part of a long term contract and determine that it’s a bad deal if the player is not earning his keep at the end of the deal.

Because of the time value of money, Major League teams structure long term contracts in a way that makes most of these contracts winners at the front end and losers at the back end. This is by design, and is true of even the best contracts for the best players – in fact, if a team is getting positive ROI on the final year or two of a free agent contract, the player likely exceeded expectations to a tremendous degree.

Let’s use the rumored 10 year, $220 million offer to Albert Pujols as an example. Here is a year by year breakdown of salaries and value, based on how these things are often structured.

Year Salary $/WAR Inflation Exp WAR Req WAR Value Diff
2012 $17.50 5.0 5% 6.2 3.5 2.67
2013 $18.50 5.3 5% 5.7 3.5 2.15
2014 $19.50 5.5 5% 5.2 3.5 1.63
2015 $20.50 5.8 5% 4.7 3.5 1.13
2016 $21.50 6.1 5% 4.0 3.5 0.43
2017 $22.50 6.4 5% 3.3 3.5 (0.26)
2018 $23.50 6.7 5% 2.6 3.5 (0.94)
2019 $24.50 7.0 5% 1.9 3.5 (1.61)
2020 $25.50 7.4 5% 1.2 3.5 (2.28)
2021 $26.50 7.8 5% 0.5 3.4 (2.95)
Total $220.00     35.0 35.0  

Using the $5 million per win/5% inflation assumptions, $220 million over 10 years essentially requires Albert Pujols to be worth 35 wins over the life of the deal in order to make it a fair contract. I set the expected WAR to match that exactly so that we could have an example of what Pujols would need to be in order to justify the dollars exactly.

As the table shows, Pujols begins to return negative value beginning in year six, and is a below average player for the last three years of the deal. The end of this contract is clearly an albatross. However, even with the expected overpay at the end of the contract, this is still a scenario where the contract works out, because the deal is setup to provide enough value at the front of the contract to make up for the expected negative return at the end.

You have to analyze a deal by the total value it will return and not simply focus on the latter years of a long term deal. Those final years will almost always be bad for the organization handing out the contract, but the idea is to get enough value up front to make it worth giving up those years on the back end.

Don’t judge contracts by how they are viewed at the tail end of the deal – judge them by what a team gets in totality.