A Recipe for Competitive Imbalance

A new collective bargaining agreement is currently in the works. There are many issues that need to be addressed, from drug testing to the international draft, but today I am going to focus on a somewhat obscure mechanism in free agent compensation.

To call the free agent compensation system and Elias rankings anything but sucky would be sophomoric to say the least. I am sure that many of you, as forward thinking saber-nerds, have looked with disgust at how the Elias Sports Bureau ranks ball players. Elias uses stats like AVG, RBI, Total Chances (defense), Fielding-Percentage, Assists, Wins, W-L Percentage, ERA and Saves. They also use OBP and K/BB, so at least they use some worthwhile metrics, but unfortunately the list ends there. It is also important to note who is responsible for this compensation system. I called the Elias Sports Bureau, and they made it clear that they had nothing to do with the equation used to rank players, they were simply given an equation by Major League Baseball and asked to calculate the final rankings. Don’t blame the Bureau; blame MLB.

Compensation pick are nothing to pshaw about as they are very valuable to teams. According to Victor Wang at the Hard Ball Times, compensation for a Type A player is worth between $3-5 million in surplus value. What interested me most about Wang’s article is the situation he chose to ignore; what happens when teams sign more than one Type A free agent?

In the case that a team signs multiple Type A free-agents, its draft choices are distributed to the losing teams in descending order of the respective free agents’ rankings. For example, in 2009 (2008-2009 off season) the New York Yankees signed three Type A free-agents; they signed Mark Teixeira from the Anaheim Angels, CC Sabathia from the Milwaukee Brewers, and AJ Burnett from the Toronto Blue Jays. Teixeira had an Elias ranking of 98.889, Sabathia had a ranking of 98.11, and Burnett had a ranking of 89.729, meaning that Anaheim received New York’s first round pick, Milwaukee received their second round pick, and Toronto received New York’s third round pick. Again, referring back to Wang’s analysis, the Yankees first round pick was worth about $5 million, their second round pick was worth just under 1 million, and their third round pick, (I am extrapolating here) far less. It can be informative to speak in averages, but it is also nice to look at the actual players the Angels, Brewers, and Blue Jays received. The Angels drafted some kid by the name of Michael Trout with the Yankees’ first round pick. The Brewers drafted Maxwell Walla with the Yankees’ second round pick, and the Blue Jays drafted Jacob Marisnick with their third. Trout is an absolute stud, the other two remain as big question marks. All this is to say that first round picks (on average) are worth way more than second round picks, and second round picks are worth way more than third round picks (aren’t you glad I told you this).

When the Yankees signed their first Type A free agent, it cost them a draft pick worth about $5 million in surplus value. When they signed their second Type A free agent it cost them a draft pick worth about $1 million, and by the time they signed their third Type A free agent, the value of the forfeited draft pick became largely trivial.

What we see here is an “economy of scale.” The more Type A players a team signs, the lower the marginal cost of forfeiting a pick. This, in theory should encourage wealthier teams to sign more Type A free agents. On the other hand, because the cost of compensation diminishes as a teams signs more and more Type A free agents, the value of compensation to the teams that lost said Type A free agents diminishes, by definition. What Major League Baseball has unintentionally created is a recipe for competitive imbalance, which ironically is exactly what free agent compensation was designed to mitigate.

Signing three Type A free agents is a rare occurrence, but never the less, it is clear that the compensation mechanism needs reform. One possible solution would be to treat Type A free agents like Type B free agents. This way teams that lost a Type A free agent would still get compensation picks in the sandwich round, but the signing team would not forfeit any picks (there would be no “economy of scale for the signing team”). Another option would be to get rid of compensation all together.

Compensation also has an adverse affect on the free agents themselves. Because the team that signs a Type A free agent has to forfeit a pick, the team typically will adjust their offered salary to take that added cost into account. Many players feel that their Type A status is burdensome financially and have added clauses to their contracts where teams are not allowed to offer them arbitration, thus circumventing compensation all together (a team cannot receive compensation picks if it does not offer the departing free agent arbitration). Those players include Orlando Hudson, Brad Penny, Justin Duchscherer, Ben Sheets, Javier Vazquez, Kevin Correia, Carl Pavano and most notably, Carlos Beltran.

Major League Baseball and the Players Association have a lot to discuss in the coming weeks, I just hope they can agree that it would be beneficial to both parties to reform the current compensation system.