On Opt-Outs and Risk Mitigation
On Tuesday, David Price signed the largest contract for a pitcher in baseball history, getting $217 million over seven years to join the Red Sox. But the value of his deal isn’t just the $217 million dollars he’s now guaranteed; he also obtained an opt-out which gives him the right to hit the free agent market again in three years, if he believes he’ll be able to get a raise at that point. If he pitches well over the next few seasons and opt-outs, he may very well be able to replace the final $127 million of this deal with another $175 to $200 million commitment, pushing the total he’d collect between the two contracts close to $300 million.
Yesterday, Eno Sarris looked at the opt-out from a few different angles, estimating that it added something like $10 to $15 million in value to Price’s deal. Clearly, the opt-out is a perk to the player, as it allows them to reset their salaries if they play well and the market inflates, but doesn’t give the team the same option if they struggle or get injured. The team assumes the full risk of the guaranteed money, but does not get the same potential return if the investment goes well, as the opt-out reduces the upside for the team.
But could an opt-out clause also reduce a team’s risk? Over the last few days, both on Twitter and in (and after) my chat yesterday, a significant number of people have argued that including the opt-out increases the odds that the Red Sox avoid the riskiest years of this deal, and that the opt-out could help the team if they’re willing to let him leave after he opts out. After all, at that point, they’d have signed the best pitcher on the market for $90 million over three years, which is obviously a pretty great outcome for the team.
This assertion often conflates correlation and causation, though. While it’s true that getting three years of Price at $90 million without carrying the longer-term risk is a good outcome for the Red Sox, Price only opts out in situations where his market value is greater than the remaining $127 million left on his contract. In other words, at that point, the Red Sox wouldn’t be able to replace Price’s expected future performance by spending $127 million; they’d either have to pay more to keep him in Boston, or pay a lesser player (or players) that amount in order to fill the hole that the opt-out created. The opt-out occurs at a point when the original contract has turned out well for the Red Sox, but the opt-out is not the cause of the contract turning out well, and it does not improve the team’s situation at the point the opt-out is exercised.
From a purely accounting standpoint, the only way including an opt-out can be a positive for the team is if the player takes a larger discount in guaranteed money than the value of the opt-out is expected to provide. For instance, if Price would have demanded $250 million without the opt-out, then signing him for $217 million and including an opt-out is very likely a better decision for the Red Sox, since the math suggests the value of the opt-out is less than $33 million. For a team, whether to include an opt-out should mostly be a calculation based on the difference in guaranteed money the player is willing to leave on the table in order to have the opt-out included.
But while I’ll disagree with the sentiment that including the opt-out without getting a financial offset can ever be a net positive for a team, I do think a few interesting counterpoints were raised about the difference in expected long-term outcomes for a team when an opt-out is included. In particular, this comment from Josh yesterday explained a somewhat different perspective pretty well.
Certainly, if Price opts out, it’s because there’s a market for his services that may or may not include the Red Sox. In theory, if he had positive value, the Red Sox could trade him to one of those other teams interested in picking up the back end of his deal, no doubt.
The problem is that the market doesn’t work that perfectly. There are relatively few teams that can absorb a $32M pitcher and it’s possible that they are undesirable trade partners (division rivals, poor relationship between front offices, etc). If there is a trade partner, there’s no guarantee that the available return is greater than the value of a qualifying offer. There’s also a chance teams would be less than excited to acquire an asset at full price that’s only being dealt because of the risk he’s about to decline. If he opted out, it’s likely more teams would get involved at a sub-32M AAV in exchange for years. Perhaps he’d take 6/150 rather than 4/128.
I tend to think along the same lines as Dave on this — that the opt out is obviously player friendly — but the argument that there is no conceivable benefit to the team is a little too black and white for me. They definitely won’t be able to acquire a package of players from an interested trade partner this way(versus “might have been able, otherwise) but I’m sure the Red Sox would get over the grief of being out from under pricy decline years and their newfound payroll flexibility and draft pick quickly enough.
In the scenario where Price opts out, it is a given that there’s a market for his services that would result in a larger payday awaiting him in some other city. I’m not particularly convinced by the annual average value argument, as if a team was willing to pay him 6/$150M, they’d likely be willing to trade for Price at 4/$127M and then sign him to an extension that pushed some of the present money back into the new years of the deal; Price doesn’t have to be a free agent for an acquiring team to re-work his contract, after all, and plenty of trades are made contingent upon a player agreeing to a contract with their new team as part of the deal.
But I think Josh raises a point about the potential frictional costs of making a deal that are worth considering. In the scenario where Price has positive value in three years, he’s clearly pitched well to that point, and teams are often reluctant to trade star players who are performing at a high level, even if you could argue that there are signs that point to it being a rational decision in order to do so. The opt-out could force a rational decision upon the Red Sox where irrationality would prevail otherwise. While a team owning a positive-value contract without an opt-out always has the option of essentially forcing an a similar outcome if they so choose — MLB has the waiver system, and any player claimed on waivers could always be given away at any point, so a team is never really stuck with a long-term contract that has positive value relative to the market rate — often contracts at this valuation come with no-trade clauses, which complicates the ease of making a trade, even if a team decided they wanted to do so.
There are frictional costs to trying to trade highly paid star players, and regularly, teams end up hanging onto expensive aging players beyond their sell-by date because of the perception backlash that comes with trading a face-of-the-franchise type of talent. So, perhaps the theoretical upside of the potential trade value is overstated, if a team isn’t willing to act on that trade value. And the point about the qualifying offer is completely correct; even though a team doesn’t get to trade a player who opted out, in the current form, they are compensated with an asset valued at roughly $10 million in exchange for the player leaving for another organization.
We don’t know that the qualifying offer system will survive the next round of CBA negotiations, so a team signing a player to a deal with an opt-out this winter shouldn’t count on the fact that they will get draft pick compensation if the player outs out, but it is a potential benefit that could be realized by a team that has a star player opt-out in the future. The draft pick isn’t going to wholly compensate a team for the entirety of a player’s positive trade value in most cases, but we shouldn’t also assume that a team who has a player opt-out gets nothing in return; it’s the marginal gap between the potential crop of prospects and the draft pick that matters.
But beyond that, the increased likelihood of the team’s ability to walk away from an extension versus choosing to trade the final years of a deal also have to be factored in. And when we look at how irregularly teams choose to trade these types of players, it’s a fair point to suggest that the opt-out may force them into a good decision more frequently.
Overall, the opt-out is still always going to be a player-friendly perk, and one that benefits the player more than it benefits the team. But given the frictional costs involved with actualizing the trade value of a star player versus receiving compensation if the player forces the team into walking away from the risk of the longer-term commitment, the marginal cost of an opt-out to a team may be diminished somewhat. And if a team can get a player to leave $15 or $20 million in guaranteed money on the table — especially by taking a lower annual salary up front, and pushing more of their compensation to the end of the deal, after the opt-out decision has to be made — in order to obtain the opt-out, then it can be a perfectly rational decision to include one in a contract.
Dave is the Managing Editor of FanGraphs.
There’s another option that makes an opt-out valuable for a team. Price pitches well, opts out, signs with another team, and then gets injured or becomes ineffective.
The operating assumption for many saying the opt-out is only good for player is that if Price is good and exercises his opt-out, that he will continue being good for the subsequent 4 four years.
Imagine if Roy Halladay had a clause that let him opt out after his 2011 season. He opts out, signs with another team, signs for crazy bucks after putting up a 9 WAR season, and we all know what happens next. For reference, Price can opt out around the same age Halladay fell off a cliff.
That’s attributing things to the opt-out that the opt-out didn’t cause though.
That’s like saying that if Jose Bautista was declared a free agent today, it might be valuable for the team because he could get injured and provide no on-field value for the Jays tomorrow, and therefore the Jays would have save $14m.
Nobody is saying the opt out caused those things, it’s just a possible (in fact, probably) outcome that’s not being accounted for.
But if we are accounting for the opt-out (as this article is doing) why should we account for outcomes that aren’t caused by the opt-out? It’s a different discussion.
You cite the Halladay example, but opposites exist out there. If Hamels had an opt-out and went elsewhere, the Phillies don’t get the trade return they just got. If Pedro had an opt-out and went elsewhere, the Sox probably don’t win the 2004 world series. Etc…
Why shouldn’t we discuss it if it’s not causing it? Hedging risk isn’t strictly about cause and effect, it’s about possible outcomes.
Sure, we should discuss it. But you said it “makes the opt-out valuable for the team” – that’s implying a relationship that doesn’t exist.
That outcome IS being accounted for because the the market value of the player opting out includes risk of injury.
The operating assumption is that if Price exercises his opt out then he’s worth more on the open market than he has remaining on his contract. Even if the Red Sox do not believe that, they could trade him to an organization that does think Price is worth more than his remaining contract.
An important distinction: Price is worth more to a market that historically overestimates the value of pitchers in their mid-30s.
The willingness of a team to pay more than is left on the contract doesn’t mean that the Red Sox are hurt by the departure of Price.
They are only “hurt” in that they let him go without using a trade recoup Price’s hypothetical trade value, which, for reasons of friction Dave Cameron describes in the article, may not amount to as much of a loss as people think.
Meanwhile, the Sox get back 4/$127MM to reinvest in something that the market may value more accurately than it does mid 30’s pitchers.
If the Red Sox were ahead of the curve when it comes to not overvaluing a pitcher’s mid-30’s seasons, they wouldn’t have signed him a contract that guarantees him over $30 million a year through his age-36 season, that they have pay unless Price himself doesn’t want it. In order for them to “get out” of that commitment, they have to be betting on his early 30’s performance, which, if we continue the beginning premise, means they are overvaluing his early-30’s in order to not overvalue his mid-30’s?
The Sox choice to offer 7/212 definitely did not show them to be ahead of the curve. But that’s exactly why an opt-out releasing them from the second half of the contract confers a tangible benefit.
One can certainly make the argument that, since the Red Sox gave price that contract in the first place, they’ll be among the teams ready to irrationally award him a contract in the event he opts out.
But at that point, we’re no longer be debating whether the opt-out afforded the Red Sox with a beneficial opportunity, we’d be debating whether or not the Sox make the most of the opportunity, which is a very different thing and effectively concedes the main point that this entire thread is about.
“In order for them to “get out” of that commitment, they have to be betting on his early 30’s performance, which, if we continue the beginning premise, means they are overvaluing his early-30’s in order to not overvalue his mid-30’s?”
That’s an interesting logical house of cards, but that doesn’t follow. There’s no contradiction in believing Price won’t be as good in his late 30’s as he was in his early 30’s.
The Red Sox have no way to get out of it. Price, his agent, and all the teams, know players are worse in their mid-30’s than early-30’s. No one will pay for his mid-30’s expecting exactly what his early-30’s was like. Therefore Price will not “let Boston off the hook” due to some totally naive notion that he should expect his next four years to be exactly the same as his last.
The scenario you’re imagining is nonsense. In order for your logic to work, you have to believe this: Price’s 30-32 is worth the original 3/90. His 33-36 will NOT be worth the remaining 4/127. Despite this mismatch, either Price will foolishly opt out or a team will foolishly sign him to more than 4/127.
I can’t believe this comment received so many minuses. Ben is absolutely correct. No one here would rather have David Price for $217 million over seven years than $90 million over three years, and it’s precisely because we fear what the final four years may look like as he gets older and his arm accumulates even more mileage. Price being dominant for the first three years in no way guarantees that he will continue being worth that money over the next four. So if Price opts out, it has a very significant chance of being a good thing for the Red Sox no matter how good he has been to that point.
…buuuuut, if he opts out, the Red Sox are left with nothing but a compensation draft pick. If he was unable to opt out, then the team could choose to trade him.
The entire idea that a depreciating (but still positively valuable) asset being taken away from the Red Sox if that asset doesn’t depreciate quickly is not something the Red Sox would like. As Dave said in his chat ‘if I sold you my car for $10k today, and three years from now repossess it from you, you may have got some good use out of it while you had it, but you probably would prefer to have sold it to someone else. Plus, if the car breaks down after two years, I don’t repossess it, and you have to keep making the payments on it.’
that metaphor might make a fraction of sense if the car is brand new with no mileage. Throw 50,000 miles on it and expect to use it heavily for those three years, and you get out of it without having to take it to get the engine repaired, oil changes, and other remedies that will likely result in getting a reduced return on an increasingly inferior product…yeah, you can have your car back, dude.
Exactly this. He’s completely right.
I’m amazed at some of the comments that get downvoted to oblivion. Really representative of the declining comment quality here at FanGraphs.
Whether or not you think he’s right, it’s not like he’s trolling; he’s literally just providing a different point of view.
Sabermetrics is dependent on open-mindedness in order for it to be spread and understood further, yet FGs’ comments section is hilariously closed-minded, collectively. It’s quite amazing.
That’s not my issue with the opt out, the issue is two fold: he basically only opts out if he pitches well, if he doesn’t opt out, there’s a high probability something in the first three years has gone horribly wrong, so you basically are saying, “here, if you pitch well the first 3 years, this is akin to a 3 year deal for you with an option to seek an even bigger payout over the last 4, if you don’t pitch well or get hurt, we guarantee you a lot more money than you’d get on the market for the likely decline years of your career.” This, to me, doesn’t appear rational. Unless the Red Sox really think Price is going to be an Ace for the next 3 years with little to no risk of falling off and are gambling on him to pitch well and opt out.
This brings me to the second issue. If he opts out, the Red Sox will be under both external and internal pressure to bring him back A La Sabathia, which would make those 4 years look far more desirable to what they end up giving him if they do another deal. Granted, this scenario is hardly 100%, but I think the two issues I’ve presented at least illustrate why the opt-out is heavily, heavily player favorable.
The part that confuses me is the idea that just because he pitched well enough for the first 3 years to make using his opt out a good decision means that he is going to continue to be pitch well enough from age 33+ to justify another 4 years 127 million (or more).
Isn’t it entirely likely that he is significantly worse/less healthy from 33-37 then he was from 30-33? Which means is a significantly worse idea to sign him for that much money?
But you shouldn’t be comparing the 2nd half of the contract to the 1st half. You should be comparing the 2nd half of the contract to not having the 2nd half of the contract.
If he’s good enough to command a 5/$165m contract at the time of the opt-out, the Sox (as a big market team) would want him at 4/$127m. That would be an asset even though, just like all player contracts that are assets, it might not turn out to be worth it.
I’m not really comparing halves. I’m just saying (much like the first poster) that people seem to be completely discounting the idea that Price can be really good for the first three years and then terrible for the next four.
They seem to be functioning under the assumption that 3 good years means 7 good years. Which seems incredibly naïve.
I don’t see that assumption. I’m seeing this assumption: if Price is good enough to opt-out after 3 years, the Sox would want the next 4 years enough to guarantee big bucks to get them.
Just like the Dodgers really want Greinke’s next 3 years. But they don’t assume he will be really good. I think everyone realizes that there are no guarantees with pitchers. That’s already baked into what teams are willing to pay for them.
@Atreyu
I think that assumption amounts to something very similar, if not trivially different from what is being criticized.
It’s basically “well, Price has been good these past 3 years. Therefore we have reason to believe he’ll be good these next 4 years. Therefore we want to pay for him.”
Historically those judgments tend to be wrong, even if the market continues to be makings them.
glenstein, I don’t think those judgements tend to be wrong. Predicting the performance of the next few years based on the prior 3 years and other information which will be available is pretty much the how everyone projects players.
Greinke, for example; don’t you think there’s reason to believe that he’ll be good the next 4 years?
@Atreyu
I’m sure that Dombrowski said the same thing prior to extending Verlander (which admittedly raises the worry that he’d be one of those willing to overpay Price in the event of an opt-out), and Brian Cashman said the same thing prior to signing and then extending Sabathia, the Giants said that before signing Barry Zito and again with Matt Cain, the Rockies said that before signing Hampton.
Grienke certainly looks like a good bet now. But it won’t do to say there’s an exception to the trend here or there. Make an argument that the trend itself is different.
You are basically saying that you should never expect any pitcher to be good over an ensuing 4-year period!
Even if that were literally true, it wouldn’t change the fact that teams need pitchers. The Sox are going to need pitchers, and if Price opts-out they are going to have to enter the supposedly inefficient market.
@glentstein
I think you make a good point re: one team’s valuation as opposed to market valuation. The problem, however, is that *if* the market does over-value Price (at least as in the eyes of Dombrowski), the Red Sox would prefer to have him and trade him than have him walk. Of course, the trade market is not frictionless, and BOS would have a QO coming back if Price walks. But is a QO better than shipping Price and covering salary to a small-market team for a number of good prospects? Is it better than shipping Price with no money to a well-heeled team for a few established prospects? That, I’m not sure.
@Atreyu
No, I am not saying that “you should never expect any pitcher to be good over an ensuing 4-year period”, I’m saying that, as a trend, they tend not to be good. And I’m not saying that about “any pitcher”, I’m saying it about pitchers in their mid to late 30’s. And I’m saying it’s supported by evidence of how pitchers awarded huge contract in the past have typically performed.
I’m not denying that Price could be an exception to that trend. I’m saying it’s unwise to push your money to the center of the table and declare that it’s the most likely outcome.
But most of the players you list were given the big money years and years in advance of their mid-to-late 30’s. The relevant list would be guys who were awesome from roughly 30-32 (the Greinke and hypothetical Price situations).
@Randle
“The problem, however, is that *if* the market does over-value Price (at least as in the eyes of Dombrowski), the Red Sox would prefer to have him and trade him than have him walk.”
I don’t think that’s as big a problem as it’s made out to be. If the Sox fear that Price will be another CC Sabathia, they avoid a huge disaster by letting him walk.
If someone wants to trade for Price, so much the better for the Red Sox. Say yes to the trade, and reap the trade value in addition to the freedom from the contract. As was pointed out in the article and multiple times throughout this comment section, there is a friction to that kind of trade that may make it difficult to execute in practice even if the value seems to be there theoretically.
But even if the Sox don’t put the cherry on top with a trade, they nevertheless reap the benefit of freed up resources they may commit to other priorities.
And if we grant that the Sox “lost” by not getting whatever they would get in trade, in exchange for a half season of pre-opt out baseball from David Price in 2018, that is just a small negative on the balance sheet next to the huge positive of having resources that are no longer tied up to an impending disaster contract. So the opt-out comes out as a net positive even in the event that the Sox fail to capitalize on Price’s perceived trade value.
@Atreyu
The Justin Verlander contract covers his age 30-39 seasons. The CC Sabathia contract (including his extention) covers his age 28-35 seasons. The Barry Zito contract covered his age 29-35 seasons. Matt Cain’s contract covered his age 28-32 seasons. Mike Hampton’s contract covered his age 28-35 seasons.
If you’re going to dispute whether those technically count as mid-30’s or late 30’s or whatever, that’s asinine, and to the extent it has any relevance to the argument, it’s to show the contracts are even more risky than I was stating since the risk pertains even to pitchers in their early 30’s.
And I as said before, the one off example of Grienke doesn’t prove anything unless you think it illustrates a general trend. That assumes Grienke will continue to pitch well (he may, but it’s an assumption, whereas my examples are hard evidence), and a one-off example is not an illustration of a trend.
No, you misunderstood. The Hampton, Cain, Zito, and Hampton contracts were offered and signed far in advance of the player’s mid 30’s. I am talking about predicting Greinke and Price’s mid-thirties at the moment directly preceding their mid 30’s. Greinke had an awesome season last year and so we expect him to be good in 2016 and beyond. If Price is awesome in 2018, we expect him to be good in 2019 and beyond.
@glenstein
As I note in a comment below, however, any of that “benefit” would be realized without an opt-out. If Price is willing to walk, he can similarly be traded or waived if there’s too much friction. (Of course there are comparisons to the value of a QO pick if they trade or waive, so there’s that small consolation or penalty, depending on what they get in return.)
It only provides value for the team to the extent that Price opts out despite no team being willing to so much as pick him up on waivers. But presumably Price is smarter than that, unless he’s so unhappy in Boston as to exercise the opt-out and take a pay cut. (But in that case we can assume he would have been willing to negotiate mutual termination of a deal anyway.)
But I think there is a difference between “he’s good enough to command a 5/$165m contract” and “he’s good enough to be WORTH a 5/$165m contract.”
I think the first is possible, but the second is highly unlikely.
I think the optout essentially has a chance to save the Red Sox from themselves. Let some other team overpay for his declining years.
I’m not really convinced by the “save them from themselves” idea. If they don’t spend the money on players and just sit on it, the team will be worse. And if they spend it, they will be participating in the same market in which pitchers command the very over-payments that they are supposedly being saved from.
But if that is the case then the Red Sox can simply place him on waivers and let the team willing to give him more choose to claim him. No need for the opt out – same result.
Whether he earns the contract is entirely immaterial. Whether he has positive value to other teams is the question at hand.
Matt, in fairness to the “save them from themselves” idea, the whole point of that idea is that the team wouldn’t be willing to place him on waivers.
Yes, they could simply put him on waivers and hope some other team claims him. I would argue that’s exactly what they SHOULD do if he opts in, regardless of how good these first 3 years are. If they did that very act with every pitcher they signed to a contract like this, they would, in the long run, likely wind up better (assuming they don’t just sit on the extra money).
The problem is that the Red Sox WON’T do that, OR no team will claim him thinking that he’s “damaged goods” somehow. The Sox may still want to pay him more than 4/127 (or whatever), but if other teams also want to pay him that, they may be saved from themselves.
I think the Red Sox SHOULD put him on revocable waivers every year from 4-7 of this deal if he opts in, and they should count their lucky stars if someone takes him.
@Atreyu
You say that as if the only things avilable on the market are David Price and clones of David Price. There are also younger pitchers- that 4/127 could go to the first half of free agent Sonny Gray’s contract. Younger pitchers are a better bet to make good on the investment committed to them.
There are position player free agents, who also tend to be better bets. There’s the opportunity to extent young players currently with the team, be they pitchers or position players. Those tend to be the best bets of all.
There are a number of things that can be done with that kind of flexibility besides just extending Price or a clone of Price.
glenstein, but if we don’t trust the Sox to recognize that spending on older pitchers is less efficient (setting aside whether that’s true for the moment), why would we trust them to spend the savings elsewhere efficiently?
@Atreyu
Let’s start by making clear that you’re pushing the argument back a step. No longer is it “the only opportunity to spend money is to spend it on a Price-like overpayment.” Now, acknowledging that there are other things to do than pay Price or a player like him, the argument appears to be that even if the Sox don’t *have* to make a Price-like blunder, perhaps they will do so anyway.
Well maybe they will. And maybe they won’t. At a bare minimum, we can recognizing that having the opportunity to reinvest the money in something that is not an overpayment is better than not even having the opportunity at all. And that’s a benefit that will be provided to the Sox in the event of a Price opt-out.
I’m saying that if Price at 4/$127 is cheaper than what he would get as a free agent at that monet, in general that 4/$127 is a better bet to NOT be a blunder than what they could instead spend that money on in the market – especially if spending on a pitcher but even if spending on other things.
@Atreyu
“is a better bet to NOT be a blunder than what they could instead spend that money on in the market ”
I just gave 3 examples of things that are better bets to spend the same money on: younger free agent starting pitchers, position players, and extensions for players on the roster who have yet to reach free agency.
Well, it appears we’ve reached the endpoint of this thread. It was nice discussing this with you. I gotta run.
He’ll only opt out if he can get more on the open market.
yes its a good outcome the problem is it isnt symmetrical. your downside is the whole contract. your upside is the excess value of 3 years.
Isn’t it entirely likely that he is significantly worse/less healthy from 33-37 then he was from 30-33? Which means is a significantly worse idea to sign him for that much money?
That’s not realistic.
If Price opts out, the Sox could replace his expected production with an internal option that cost less than $127M. It would be a win for the Sox and Price.
You may be right but that doesn’t mean the option itself is a win-win because it still gives the Red Sox the risk that he underperforms and doesn’t opt out.
That risk isn’t created by the option. That risk is a function of the 7 year commitment. The only impact the option can have is to lessen it.
I disagree. Yes there is that risk inherent in a 7 year deal without an opt out, but that risk is lessened by the potential for Price to continue to play at a level greater than his contract. When you include the opt out (and assume rational actors) then the probability of him outperforming his contract throughout all 7 years is zero thus eliminating all potential benefit which in turn increases the risk.
But if he opts out, it’s because he is worth more, so the Red Sox would prefer to trade him for something
But the point is that such a trade is extremely unlikely — first because if he’s performing well, the Sox probably wouldn’t trade him until it was too late, and second, as I saw mentioned elsewhere, if the Sox try to trade him, other teams may see that as a signal that something is wrong with him and reduce their own willingness to provide fair value in exchange.
I think Dave’s article about gets it right. The opt-out is a benefit to the player in all cases, but there are several scenarios in which the opt-out ends up being a benefit for both player and team — enough scenarios, especially with a potential raft pick factored in, that it makes the opt-out a relatively minor part of the overall deal from the team’s perspective.
Ahem, or a draft pick. I don’t see any scenario where the Red Sox put Price on a raft. A duck boat, maybe, but not a raft.
Did you read this article? His exchange value isn’t identical to his monetary value on the open market. Being able to trade him for value is not a safe assumption.
It’s because he’s worth more in the eyes of a market that historically overvalues pitchers in their 30’s.
How do you know that? If he is opting out, it’s like he projects to be at least a 4 WAR pitcher. That seems an unlikely thing to be able count on. And, even if they could replace him, they would still rather have that internal option AND Price. After all, a team has more than one starting pitcher.
even if they could replace him, they would still rather have that internal option AND Price.
That just isn’t necessarily true at all. There are way too many assumptions in this thread that markets function with perfect efficiency and acquisitions are made on napkin-math value calculations in a vacuum.
Even if they forecast Price to have non-zero surplus value at that time, teams do not simply acquire every asset with surplus value without regard for other variables.
How their roster is constructed, what their payroll looks like, where they are in the win curve – these are just three of probably a dozen factors that speak to a teams willingness to gamble with that much money on a 33 y/o pitcher.
The Red Sox will never have a problem with paying a guy like Price what he is worth. Based on how they operate, they will never object to paying $30 million a 4-WAR starter. They are not going to turn into the Marlins and cut payroll to $50 million, and they will never do a full Astros tear-down, so as long as they are spending money, which they will, spending market-value for an asset that is also a very efficient allocation WAR for his roster spot is always something they will want to do.
So, for them, the only reason that makes sense that they would assess Price’s market value to be above his option years, and yet not want him is if they just think his performance will end up not being worth the money. So, what this then reduces to is counting on them having figured out the inefficiency in the mid-30’s pitcher market. This I simply don’t buy. If the market is valuing Price at over 4/127 at age 33, it’s because it has seen enough performance and health from him (and the market has inflated enough) that it is actually a good value for him.
If Price projects to be worth less than 4/127 at that time by whatever amazing projections the Red Sox have, then other teams and Price himself will have similar projections and he will not opt-out.
The Red Sox will never have a problem with paying a guy like Price what he is worth.
In addition to being completely unknowable in the abstract (at least with the certitude you’re representing here), this is explicitly ahistorical. The Red Sox actually have a track record of refusing to do exactly this. The Price signing is unusual.
They have avoided contracts like this because they are risky and usually not worth it. I’m assuming their own assessment of what the player will be worth over the course of the deal was usually less than the player eventually got. If they could be assured a player would be worth the value though, they would obviously want him, which was my premise.
The fact that they signed this deal obviously shows a willingness to project a player’s performance and pay him accordingly. Over 7 years, that is quite difficult, but over 4 it’s a lot easier. Which is why I said: if they assess Price’s value to be higher than they 4/127 remaining, they would want him. In fact, shorter-term high-AAV deals seem like exactly what they have been inclined towards lately. Based on their history, even for a 33-year-old pitcher, I’m sure they would love a chance to sign a guy for only 4/127, if they project him to be worth it. They gave Porcello 4/88 for goodness sakes. I’m certain most teams were offering Porcello more years and less per year.
I’m not sure where the Red Sox are going to simply find an unused asset within the organization that can replace what David Price brings to the table. The whole reason he is being paid $200M is that his skills are extremely unique and not a lot of people can do what he does.
The Red Sox would have the benefit of using not just their own assets, but also the $127MM in freed up money to replace David Price. And they won’t be replacing the in-his-prime Price, they’ll be replacing the age 33-36 Price.
No, it would be a win for Price but a loss for the Sox.
They are not getting to keep someone worth more than $127M/4 and only pay him $127M/4.
That is a loss (when compared to keeping him and paying him that money).
so is the scherzer contract now a lot below market given a better pitcher, deferred money and no opt out
The tangible benefit for the team is giving the player extra motivation to perform over the first three years so he can cash in during another round of free agency. Some players might not need the extra motivation, but overall I think there’s a real benefit in keeping players motivated for another pay day. It’s still clearly more player friendly than team friendly.
Two points.
Not all actors in this system (e.g. Price, the Red Sox, random other teams, random free agents, etc) are acting with the same motivations. Absent soft factors (like “wanting to hit”), Price is trying to maximize his guaranteed money. It’s tempting to think of this as being the same process as affixing a market value to his services, often thought of as $$/WAR, and under that line of reasoning, the Red Sox would be strictly disadvantaged if he opts out, since they are then compelled to replace Price’s contributions at a now-higher market value.
However, for the Red Sox, the question is not so clear-cut. They’re not specifically trying to optimize their $$/WAR ratio: they’re trying to put together a winning team. Right now, that means signing Price. After three years, will retaining Price be the optimal thing? It’s hard to say. We often talk about this as “opportunity cost”, since Price’s contract reduces financial flexibility. Price is very very good, but in a magical world where Rodriguez, Owens and Johnson all somehow turn into top-of-the-rotation starters (hint: that world isn’t going to happen), Price is suddenly a very expensive affix eating up money that would be better spent on something other than a starter. Under those circumstances, Price could walk, and the Red Sox would be perfectly content since they wouldn’t *need* to replace his contributions at market value.
This also hints at another major factor in this discussion: cost-controlled young talent. Modern baseball is built on the foundation of extracting value from players just-barely pre-prime at hilariously below market rates. If Price walks, it isn’t fair to say that the Red Sox would be on the hook to replace his contributions at now-inflated rates, because they may have more cost-controlled options available to them. Espinoza, for example, should arrive in the majors right around the time Price opts out (maybe a little later). Is he likely to be as good as Price? Not remotely, but the possibility has to be considered. If he is, and if Price does opt out, then the Red Sox are effectively trading a four year, $31M AAV contract for a five year, league minimum plus arbitration contract.
In other words, because of the different motivations and resources of the respective parties, it’s completely conceivable that the parting could be mutually beneficial, if and when Price opts out. Put another way, just because the opt out adds value for Price doesn’t mean it necessarily subtracts value for the Red Sox.
The problem is, as you say, that it’s not so clear cut that retaining Price is the optimal decision for the Red Sox. However, because it’s a player option, the Sox don’t get to make the decision based on what’s optimal for them. The risk that Price stays (which would almost definitely be a sub-optimal decision for the Red Sox) is a very real negative for them that can’t be ignored. You’re right in that it may turn out Price opts out in a manner that is a win-win for both parties, but that doesn’t mean the inclusion of the opt out doesn’t still subtract value for the Red Sox.
In any case, as far as I know employment contracts can usually be voided by mutual agreement.
If there were no opt out, and in three years the Red Sox wanted to get rid of Price, and Price wanted to test the open market, I doubt the player’s union or anyone else would be able to tell the two parties, “No! You can’t simply void that contract!”
Even if the union or other owners did somehow block a mutual voiding of a contract, it’s easy enough to release or trade him and state that it’s by mutual agreement. (Trade and sign is common enough after all.)
So, again, the use of the option only really has meaning if the Red Sox WANT to keep Price, and he wants to go.
because it’s a player option, the Sox don’t get to make the decision based on what’s optimal for them. The risk that Price stays (which would almost definitely be a sub-optimal decision for the Red Sox) is a very real negative for them that can’t be ignored.
…Who is ignoring it?
That outcome is not a feature of the opt-out clause. It’s a feature of the 7 year commitment into which an opt-out clause was built.
If you focus solely on potential benefits to the Red Sox in the event of an opt out you are ignoring the risk that he doesn’t opt out. That risk is larger than that of a 7 year deal with no opt out because the Red Sox are theoretically losing all potential upside. I agree with the point that the end result of an opt out can produce positive value to the Red Sox. However, the probability/value of such an event is too small and is outweighed by all the negatives making the expected value of the option a negative for the Red Sox. And with no knowledge of the future, expected value is the only way we can evaluate it.
f you focus solely on potential benefits to the Red Sox in the event of an opt out you are ignoring the risk that he doesn’t opt out.
We’re not trying to determine whether the opt-out disproportionately favors the Red Sox. It doesn’t. We’re trying to figure out of it could benefit them at all. It does.
Again, the 7-year commitment is *not* a feature of the opt-out in any way. The 7-year commitment necessarily precedes the opt-out into which it’s built.
“However, because it’s a player option, the Sox don’t get to make the decision based on what’s optimal for them. ”
However, what’s optimal for David Price (throwing himself into the arms of a market willing to overpay him) may coincide with what’s optimal to the Red Sox (freeing up the resources to reinvest in whatever they please).
Considering he’s a starting pitcher, there is no scenario I can think of where the Red Sox would rather not have an elite starting pitcher on a below-market contract. Which, if he opts out, it is because he’s still performing at an elite level and 4/127 is below market. Unless the Red Sox have five other above-average starting pitchers and the best rotation depth in baseball at that point, I can’t imagine there is any chance of diminishing returns on that.
I disagree slightly. It’s theoretically possible that the surplus value on his remaining contract is less than the value of a comp pick from a QO (assuming they still exist). Under this scenario, it would be ideal to the Red Sox that Price opts out so they can QO him (although Price has no incentive to opt out in this case as his new contract will factor in the value of the lost draft pick I’m focusing on the Red Sox right now). That being said, the probability of that is low enough that the option would still carry negative value to the Sox.
But whether Price opts out has no impact on Espinoza’s development. In this scenario, the absolute best outcome for the Sox, were there no opt-out, would be having that cost-controlled asset AND having a still-elite Price at 31M/yr. Espinoza is basically a red herring in this calculation, since we’re not talking about a starting catcher, where the team only has room for one.
“Under those circumstances, Price could walk, and the Red Sox would be perfectly content since they wouldn’t *need* to replace his contributions at market value.”
If Price is good enough “to walk”, he’s also probably good enough to trade or at the very least good enough to waive and have another team pick up the full value of his remaining contract, so I don’t think this makes much sense. The Sox don’t need Price “to walk” to get out from under his contract if Price has pitched well enough to want to exercise his opt out. Dave makes some good arguments for why the opt-out isn’t strictly a bad thing for the Sox, but I don’t think this is one of them.
The large point the article makes though is that even though Price may have that value on paper, finding a team that makes a good trading partner for him is a much much harder task. If not impossible.
The article didn’t really focus on that point. The frictional costs of making a trade Dave talks about had less to do w being able to find a trade partner than the irrational inertia attached to dealing a star player. Regardless, I don’t buy that argument much, anyway. How hard would it be for the Dodgers to find a trading partner for Greinke if he didn’t have the opt out?
There’s no way you read the article and still made that comment.
There’s no way you read the comment I was replying to if you made that comment. The OP wasn’t suggesting that “friction” or “irrationality” (which was what Dave was saying) would keep the Sox from moving Price, but rather that changes in personnel might make Price expendable for the Sox, in which case they’d be happy to see him go. The rejoinder to that is unless some of the things that Dave mentioned keep the Sox from being able to move Price, then they don’t need Price to help them out by exercising the opt out. (I honestly don’t buy the argument that they couldn’t find a trading partner for Price if he’d pitched well enough to opt out. There would be tons of interest on Greinke if he didn’t have the opt out, and the Dodgers were trying to trade him. The Sox not wanting to piss off the fanbase by dealing a star pitcher, and as a result acting irrationally, seems a more plausible scenario to me.)
Confucius say: “If Price is good enough “to walk”, he’s also probably good enough to trade or at the very least good enough to waive and have another team pick up the full value of his remaining contract.”
If Price performs well enough in years 1-3 “to walk” (and get a new contract over and above 4/127) the odds that the BoSox would willingly waive him after year three are 0.0000000000000000000%.
(With error bars, +/- 0.000000000000%, just to account for the uncertainty.)
Maybe you didn’t read the OP’s comments, either. In the scenario he was talking about, Price (1) pitches good enough to opt out, and (2) The Red Sox still want to get rid of him. That was the hypothetical world he set up.
So from a risk/reward perspective – people are estimating the opt-out to be worth $10-$13M to the player; and guessing (since we can’t know) that the player left $15-$20M on the table for it (the logic already seems shaky there) — what’s still missing is the risk to the team. If Price pitches 2.95 great years and then his arm goes, leaving the team on the hook for a dead $127M – that’s worst-case; but what’s the percentage/odds to be put on that? And working up the outcomes change, if he stays and is just an average pitcher those last 4 years, say a $15M/year value guy, the team’s only out $67M. If you add it all together, what would be the realistic price-tag to put on that team-risk? Is it higher than the $10-$13M the opt-out was worth the player, or whatever amount we guess the player left on the table? If we feel the happiest-path for the team is “3 great years and then he opts out”, have they really made a smart move?
And — I wonder if Lloyds’ sells insurance on such things? 😀
So, when Tanaka signed with the Yankees, the consensus seemed to be that the opt-out was a disaster for the Yankees. Is there something structurally different with Price’s contract that makes his opt-out different, or has the thinking about opt-outs changed since Tanaka’s signing?
The difference is the amount of upside on the second half due to age. Tanaka, being a young pitcher who had never pitched in the majors, had a reasonable chance of having his best years in the second half. Price, and established 30 year old pitcher, will almost certainly not improve over the life of this contract.
Ah, makes sense. Thanks!
Not really; opt-outs (as Dave shows) exclusively benefit the player, although that cost may be embedded in a reduced contract (which would benefit the team). It’s just a matter of degree as to how much the opt-out benefits the player, but it’s always, exclusively, to their benefit (the option to opt-out itself; again any benefit to the team is not created by the player opt-out but by the reduced cost of the contract).
I prefer to think of opt-outs like this:
Price has signed a three-year, $90 mil contract w the Red Sox.
The Red Sox have also awarded him an option (a put) which gives Price the right, but NOT the obligation, to sell his services to the Red Sox in years 4-7 for $127 million.
If at the end of year 3, Price can “sell” his years 4-7 services for more than $127 million, he will. The option expires worthless.
If, however, due to injury or underperformance in years 1-3, Price cannot sell his year 4-7 services for $127, the option is “in the money”, and economically he should stay w the Red Sox.
So Price has sold his services for three years for $30 mil cash per year (perhaps lower than market price of those years.) However, he is also being paid/awarded an option, which has significant value (hard to estimate; call it $X mil).
So in my mind this contract is really a THREE-year contract with average annual value of $30 + $X/3 mil per year.
Going with the option metaphor, this is more like an Option “Short Strangle.” The money earned from the Put is applied to downside insurance. Boston gives up the value of exceptional performance and hedges some downside risk.
I wonder what a secondary insurance market would bid on the downside risk of years 4-7? How much cheaper does that insurance become if you give Price an opt-out (since it reduces the odds of him being around for years 4-7 versus a normal contract)?
If Sox got a $24million discount (over what they were willing to pay) for opt out, how much insurance can they afford on Price’s potential underperformance during years 4-7? A lot, right? Maybe half his salary? How much does the existence of the opt out decrease the cost of insurance? Substantially (like 10%), right?
Obviously, this is just a thought experiment – the Sox don’t have to go to market to buy the insurance – they can self insure too. John Henry does (did?) have a lot of experience in the custom financial products market.
I’m obviously digging this comment. Since the option value is not part of the AAV of the contract, this formulation even helps the Sox stay under the luxury tax. If the option is worth $24M, then instead of an AAV in the first three years of $39M, they get to record just $31 – which is definitely a lie.
Good point on the luxury tax avoidance aspect (again, considering it as a three year contract). And, even if it leads to the second three-year contract promised by the put… then there’s still a small luxury tax benefit! (217-90)/4 = 31.75 > 31
As for the Red Sox hedging… I’d think every team which has paid out large long-term contracts would want to insure that risk. It seems so concentrated. (Well, maybe not for teams with several such large contracts on the books.)
I need to think some more about your “short strangle” concept. I can’t identify the call the Red Sox have sold along with the put. Which party has the right, but not the obligation, to buy Price’s years 4-7 at a fixed cost? I could say the other 29 teams, at the cost of a draft pick, but I’d think there should be a salary-related strike price.
Great point on the luxury tax avoidance. Even in the potential “second” three-year contract, there’s a little bit of benefit. 217/90 = 31.75 > 31
As to the Red Sox hedging the risk, I’d think every team would want to hedge the risk of any long-term large contract. It seems way too concentrated (except for those teams with several such contracts!)
I need to think a bit more about your short strangle concept. I can’t identify the call component: who has the right, but not the obligation, to purchase Price’s years 4-7 performance at a fixed cost? (Under the CBA, the other 29 teams could have a fixed cost of a draft pick, but I think there should be a salary-related strike price as well.)
Can we get Sean Dolinar to create a decision tree for this? There are some useful points being made about frictionality but most people making the “opt-out is a win-win” argument are just getting lost in the decision process.
In regard to motivation, these are professional athletes we are talking about, so I personally don’t think contract status plays a huge role in their daily play. For those that do, the narrative is usually reflective of the kind of year a player is having when he approaches free agency, i.e. if he is playing poorly he is pressing and the future contract is a distraction (think Ian Desmond for the first half of the year), and if he is playing well the future contract is a motivation (Greinke, perhaps).
I think the assumption that the Red Sox are losing the transaction if Price opts out because his market value is above 4/127 is a faulty one.
Let’s say using his WAR aging curve at that point that he’s worth $110mil over the next 4 years. Is it really that crazy to think that he could opt out and a team would overpay him a bit due to past success and his name? The idea that he’ll only opt out is his true value is over $127 million assumes there are no teams out there that would conceivably overpay him for the next 4 seasons.
Then the market is imperfect and $110mil isn’t his market value.
To me, the draft pick and the potential of developing low-cost talent in the intervening three years are good points for a team offset. I didn’t realize that opt outs result in draft pick compensation.
I’m still flummoxed that many rational people seem to favor the fact that teams are better off without a long-term relationship with a player even if ithe deal is favorable for the team vs. the market.
Favorable for the team compared to the market doesn’t necessarily mean that the deal is good, because it’s possible that the market isn’t set correctly.
Context. Teams have to manage several variables in roster construction. “Does this player project to be worth the financial risk his contract represents” is simply not the final question. It’s the *initial* question. The answer to that question can be “yes” and the answer to the question “should we commit to that financial risk right now” can still be no.
You are right that we have to factor in the context.
In this particular context, the Sox almost certainly will be a big-payroll team and the player (if he opts out) will be a starting pitcher who is playing like a superstar. Big-payroll teams are almost always willing to commit to the financial risk of paying a superstar SP less than FA rates, even if he is in his mid-30’s. Not always, but almost always.
The difference between always and not always is literally the entire point of this entire conversation.
If it’s always, then the folks saying opt-outs universally do not benefit the team are correct. But since it’s not always, they’re incorrect.
The potential “value” of a team to having a player opt out is best considered (IMO) through the lens of the Coase Theorem, which holds that an asset/right will always migrate to the user that values it most highly in a world with zero transaction costs. A key insight is that in scenarios where transaction costs are positive (or especially high), mutually beneficial trading may not occur because for at least one party, the transaction costs outweigh the benefits of the bargain. It is right as a matter of theory that Price opting out (which means his market value is higher than his contract) is bad for the Red Sox in that they are unable to capture any portion of the delta between his market value and his contract value through a trade. But the market for $30+ million/year pitchers is pretty thin, and the fact that few such trades occur suggests that transaction costs for trading this type of asset are high (you identify some of these reasons in the article).
From the Sox’s perspective the opt-out can be analogized to a liquidated damages provision (which specifies the amount one party to a contract gets in the event the other party breaches). Although there’s no breach if Price opts out, the parties are specifying ahead of time that the Sox will get a draft pick if Price opts out (with the caveat about the CBA changing that you point out). This value may be lower than what they would get by trading Price in a world with zero transaction costs, but it could make them better off by facilitating a transaction – Price goes somewhere else in three years – that would otherwise not occur because of transaction costs.
Also, the following statement is too strong: “Overall, the opt-out is still always going to be a player-friendly perk, and one that benefits the player more than it benefits the team.”
It is true that the same contract with an opt-out is always going to be more player friendly than the same contract without an opt-out. This is different from saying that the opt-out is always going to benefit the player more than it benefits the team. That will depend on the discount the team is able to extract by including the player friendly contract term.
I think it’s entirely reasonable to suggest that ANY opt-out may benefit the club. That doesn’t mean that opt outs are good the club. Of course, it should go without saying, if Price opts out and then is promptly injured and performs poorly, it’s a win for the club. But that’s just dumb luck – not a solid strategy.
What we need to look at is how the opt out has been leveraged to date. Think the Yankees are thrilled with A-Rod’s or Sabbathia’s opt out? Or the Dodgers and Greinke? No way. The teams were forced to pay more money (or extend the terms of the existing contract) to retain the player or watch the player leave.
Yeah, this. A star opting out puts political pressure on a GM to “SIGN HIM!!!” even where the GM may rationally conclude ‘y’know, he’s really just not quite worth THAT much’.
More pertinently, this is how you best measure anything. How HAS it worked out, rather than ‘for this-and-that reason how ought it to work out?’. We’ve got a very short history of opt-outs, but what are the initial returns regarding it? CC and ARod were 2 big ‘owies!’ Any other ‘opt out’ precincts that have already reported in?
Sabathia could go both ways though. He parlayed his opt-out into an extra year and a little extra money yearly over his original seven year deal. But the opt out gave the Yankees a chance to walk away after 2011. 2012 was Sabathia’s last year in which he was worth his contract, so they would have left that on the table, but would not have been on the hook for his predictably poor 2013-2015.
But the Yankees didn’t walk away. So the end result here was ‘Opt Out Work Bad, 1 point’.
Doesn’t the fact that sox offered the most money (some 30ish million above the Cards) and included the opt-out clause contradict that any discount is given to the team offering the deal? Also, sure you may be relieved to get that salary off your books after three years, but the only way he opts out are if he pitches well. If he pitches poorly, congrats, you just locked yourself into a monster salary.
The Stanton contract is the future of opt-outs imo. Back-load it to where if a dude plays lights out, the real money is on the back end, so he’s less incentivized to opt out.
We can’t really know the details of the negotiation, but both parties presumable recognized the opt-out as having value for Price.
But, yes, it’s possible the discount wasn’t realized because Price was bluffing and would have signed for 7/$217 even w/o the clause. But it’s also possible that Price “paid” more for the opt-out than the Sox would have agreed to.
The fact that he wasn’t offered more by anyone else (As far as I can tell), indicates there is no discount to be opt-out. The original A-Rod deal was the biggest contract ever and had an opt-out. Where is this magical discount?
Even if we assume that no other team’s offer was close it would still be possible for the discount to come into play. Price could have said “I’ll sign for 7/$225m or 7/$217m plus this opt-out otherwise I’ll go sign with the Cardinals for 7/$195m because they’re a better team.”
A large contract does not mean an opt-out discount wasn’t included. Harper may get the biggest contract in baseball history in a few years, and it could well come with an opt-out. The fact that he gets 500M doesn’t mean he wasn’t willing to drop from 513M in exchange for that consideration (or that the team offered the opt-out when he said he wanted more than 500M).
If one offer greatly exceeds all others AND includes the opt-out, then you’re talking about a negligible at best discount being factored in. Do you really think ARod isn’t signing his original 250 million dollar deal if there’s no opt out? Or CC’s first deal with the Yankees? Clearly money made Price go Sox over Cards if the reports are to be believed. If he was willing to take a 30 million dollar less deal (with or without the opt out, I’d assume including the opt out), the total value was driving his decision.
When I see a player get deal x and deal x – y, and tak deal x -y instead, then I’ll give credence to some sort of discount for the opt out. Until then, I’m not buying into me taking the largest megadeal that also includes an opt out saying I give anything more than a negligible discount at best.
Setting aside David Price for a moment, why do you think the public in general gets complete and/or reliable information about other offers in free agent negotiations? Or do you have private sources that give you access to the 2nd-best bids?
I’m open to the fact that there is information we don’t get, but on these massive opt out deals, we have yet to get an inkling of information implying larger, non opt-out deals were offered. And numerous reports have said the Cards were the second biggest deal, in regard to David Price. And it’s consensus that A-Rod’s first megadeal was the largest contract offered.
Exactamundo. But when a player gets an offer well beyond (reportedly) the 2nd-best one, this is suggestive of his agent snookering the GM out of a goodly portion of that excess.
The possibility that is never discussed is that maybe Price performs great in years 1-3 and decides to stay in Boston at the discount rate. Maybe he likes it. Maybe his family likes it. Maybe he had a small stroke. Who knows? But it’s not outside the realm of potential outcomes.
And though history tells us it’s unlikely: maybe the CBA disincentives big deals for older FAs in favor of younger players, maybe the market slows of its own accord, etc.
In that case, the opt out was worth zero dollars to the team. 7/217 is what they paid Price.
“Price only opts out in situations where his market value is greater than the remaining $127 million left on his contract” Dave, your insinuation in this statement is apples/oranges. Price would opt out at age 33 if he could exceed $127 million yes, but to do so he would have to sign a new contract for more than the 4 years remaining on his current contract. So yes, he would opt out, but not for $127/4 years. But for more $$ for more years. The Red Sox paying players in his place is not based upon the $127 million they would have paid Price, but what they would need to pay Price to keep him in a new contract – which would exceed the $127 million. So the better premise is “Can the Red Sox replace Price (at age 33-40) for x ($150M?) amount of $$”? And the obvious answer to that, even if Price performs exceptionally in the pre-opt out, is yes. They would pay $$ for either a free agent, home grown, or trade & sign candidate in his prime, which would be more appealing than age 33-40 of David Price. Once you’ve gotten age 30-33 out of Price, his value will diminish. I believe this articulates at least one point readers have had with your “opt out favors the player 100%” premise.
A = Guaranteed contract value at opt out
B = Market value at opt out
C = Frictional Cost of trade
D = Team value of player at opt out
There are four options:
1) B A and D > A: player opts out, team loses greater of D – A or B – C – A
3) B > A and D = 0: player opts out, team loses B – C – A
4) B > A and D < A and B – C – A < 0: player opts out, team gains C – (B – A)
As C approaches 0, option 4 becomes option 3. The probability that #4 happens is small because it is proportional to C, and the magnitude of gain is limited to C, which is also likely small. So while possible for the team to gain, there very little argument that the probability weighted value of 4 offsets 1+2+3. Most of the arguments to the contrary involve some assumption of an irrational behavior, which is not how rational people make decisions.
Try again, four options:
1) B A and D > A, player opts out, team loses greater of D – A or B – C – A
3) B > A and D = 0, player opts out, team loses B – C – A
4) B > A and D < A and B – C – A < 0, player opts out, team gains C – (B – A)
Something funny happens when I hit post comment. Ignore what is posted and assume I am right!
I feel guilty giving you a +1 without seeing option 2. But I really like this illustration
Then again these “rational decision makers” that set economics folks’ hearts a-flutter are not often found in the real world. They are hiding out with the unicorns, the yeti, the chupacabra.
‘Rational Decision Maker’ is an ‘ideal type’ assumption (see Weber, Max) so is used for the purpose of constructing models. Which models have worked great (see Economy, Market; also the job market for Econ majors, who businesses love to hire). When they build an Intellectual Constructs Hall of Fame, ‘rational decision maker’ will be an inner-tier member. (with folks whining ‘but he didn’t hit behind the runner well!’)
Does anybody out there actually think the Dodgers right now, knowing only what we presently know, would be better off having a draft pick, or owning the rights to one of the best pitchers in the universe for the remainder of his (now former) contract?
An option is basically a bet (though used for hedging, of course). So it’s only utilized when that actual day’s price is worse than that of the option.
So basically, whenever the option is exercised, the player won and the club lost. Still leaving the question of margin of victory, of course. And how much $$$ the club saved in the first place by granting the option.
And whether it was really necessary to the deal at all, or did the GM just get played, maneuvered by the agent into bidding against himself? See Dombrowski, Dave.
Many of the “benefits” of a player opt-out, as posited in the comments section, are already present with a regular contract. A player would only opt-out if he projects the market to pay him more. But if he projects the market in this way, it means a team could trade the player, or waive him if friction in the trading market is too high. It removes this choice from the team, however, and places it in the hands of the player.
This isn’t to deny that a team may prefer to avoid the last four years of this deal even if Price is good in the first three years. It’s quite possible they would — internal evaluations may differ from the market after year three. But a player opt-out removes from the team the choice to keep the player at that point if they prefer the deal.
At the end of the day, options have value regardless of how likely or unlikely they are to be exercised. They derive value from both time and the value of the underlying asset, here the player. As Price’s value increases with positive performance, his ability to opt out for more money or the same AAV but more years increases, thus increasing the value of his option. If he gets hurt or pitches poorly, he’s worth less and the option is worthless, so he remains an overvalued asset on Boston’s books. Either way, it’s bad for Boston unless they pay him less per year upfront (which they do) and is also why the contract is backloaded to at least try to entice him to stay even if he outpitches the first 3 years of the contract.
The frictional costs should have minimal impact as Boston should be happy if he pitches well and stays, because they would hold surplus value in the player relative to the contract. So they’d be paying less per year for each win provided than the market cost at the time.
It’s silly to think that the opt out provides Boston any value other than reducing their financial outlay. Price only leaves if he can make more elsewhere. If he’s worth less, he stays and Boston receives the negative value of the contract. Another way to think about it is that Boston is giving Price free insurance against future injury or decline in performance. They’d never do that without being paid for it, and presumably they are in the form of salary reduction.
You’re assuming an efficient market. This isn’t an efficient market, though, and two different teams can have wildly different valuations of the same player. That one or two teams out there are willing to pay Price $X doesn’t mean he’s actually worth $X. $X is his market value… but there may only be one, two, or three teams out there that actually thinks he’s worth $X.
That’s all to say that while options have value and the option favors Price… There is a situation where the option helps the Red Sox. As long as you realize that MLB is really far from a perfect market.
There is no way the option favors Boston, other than to reduce salary on the contract. You don’t even need to assume an efficient market to make that statement. You can suggest that Boston overpaid for Price, and I wouldn’t argue with you on hay point. But the efficiency (or lack thereof) of the market is more a function of the total value of the contract, not the opt out clause. If Boston indeed paid $30mm more over 7 years than anyone else would, then that is negative value associated with the total contract. In 3 years, Price could perform poorly and there would be even more negative value. Or Price could perform incredibly and based on salary inflation, be worth perhaps $35-40mm a year over the next 4 years. In the latter scenario, Boston would be happy to have him at the contract annual rates, but Price would opt out. You don’t need to assume efficient markets, you just need to assume rational behavior where both parties seek to maximize their utility.
There is no way the option favors Boston, other than to reduce salary on the contract. You don’t even need to assume an efficient market to make that statement. You can suggest that Boston overpaid for Price, and I wouldn’t argue with you on that point. But the efficiency (or lack thereof) of the market is more a function of the total value of the contract, not the opt out clause. If Boston indeed paid $30mm more over 7 years than anyone else would, then that is negative value associated with the total contract. In 3 years, Price could perform poorly and there would be even more negative value. Or Price could perform incredibly and based on salary inflation, be worth perhaps $35-40mm a year over the next 4 years. In the latter scenario, Boston would be happy to have him at the contract annual rates, but Price would opt out. You don’t need to assume efficient markets, you just need to assume rational behavior where both parties seek to maximize their utility.
Dave, A+ writing here to go back and rexamine your position based on a comment. I completely agree with your conclusion. In theory, the opt out benefits Price only and not the Red Sox. But that’s under the assumption that the rational decision is made, when as you said very often decisions are made in practice that are irrational. He may technically have trade value the red Sox lose when he opts out, but the odds of them collecting that value (if he didn’t have the opt out) are probably low in reality. When you combine that with the money Price left on the table to get the opt out, and the QO the Sox would get, I think there is clear benefit.
Excellent job articulating a concept people seemed to feel was true but didn’t know precisely why.
The behavioural economics angle makes sense here. Sure, they have a large number of windows over a seven year contract where they are able to trade a player with surplus value. However, would they? With an opt out, the signing team gets a clear second decision point where they are able to walk away. It encourages the signing team to make a rational decision.
Dave, your take assumes the market is efficient. That is to say, you’re assuming that because at least one team is willing to pay Price $127M+ in three years his value to the Red Sox is necessarily his value to the highest paying team… his market value. In fact, I believe you are assuming a perfect market.
The MLB market isn’t very efficient, though. Team X could value Price at $150M while the Red Sox value him at $100M.
Essentially, in the specific case where Price opts out, there might be a market inefficiency where teams overpay for old players that the Red Sox can take advantage of.
My view is this: in order to get to enjoy the benefit of te first few years of Price’s contract (where he is most likely to generate value above and beyond his actual salary), it was necessary to offer a substantial guarantee. As various writers at Fangraphs have pointed out, this is the way big free agent contracts work (throw in no-trade clauses, etc.) The free agent wants to be protected.
So it is clear that at some point in the life of the contract, instead of generating surplus value, the performance of the player actually does not live up to the salary anymore and the contract becomes an albatross. The best case scenario for the team is that they have extracted already so much value at the beginning that overall it was still worth it.
So, the team at some point would most likely rather not have the player, but when that point is reached, they would need to trade him and other front offices might not be so eager or they might require that you pick up a hefty part of the price tag. But if the player has an opt-out, what becomes relevant is if the player (and his agent) believe there is a market for his services.
Under the assumption made previously (start at 5.3 WAR for next season, knock of 0.5 WAR each year for aging, inflate the price per win by 5% each year), the Red Sox will have generate about 30 million in surplus value in the first three years. Over the last 4 years, they might reasonable expect to loose 6.8 million of value, considering they would have to pay him more for less performance. Under these assumptions the total value of the contract will have been worth it, but you would still be happy to not have to accept the cost of the last 4 years.
In fact, the maximum point is reached after 4 years under these assumptions, so you have to wonder why the opt-out kicks in at 3 years and not at 4 years. Presumably the Red Sox would prefer to have more possibility to extract value from the early years (valuable), but Price would be a year older (not valuable for him). So as the end result of this negotiation they settled on 3 years.
In 2018, Price could be expected to have a 4.3 WAR season, about top-20 this year (Between Hamels and Cueto). That should probably be enough to make the player consider that another round of free agency would be worth it. And that, for the Red Sox might not be a bad outcome, considering that the years that come after that, are the most likely to at best be break-even.
Then again, Price might defy the aging curve. That is a risk the Red Sox have to take. But even then, the highest value years will have been the first 3.
As I see it, the opt out is nothing but a positive for the Red Sox and this is why.
If the Red Sox, or any team, had to choose between offering Price a 3/90 or a 7/217 contract every single franchise would choose the former. Every single franchise. Every time. Given Price’s age and the number of dollars involved it is impossible to imagine any team choosing the later. Ever. Unless they had a crystal ball that could foretell seven years into the future of a 30+ year old pitcher with a substantial amount of mileage on his arm. All else being equal the 3/90 contract is far better for any team, especially given Price’s age and the vicissitudes of pitcher health.
So why did the Red Sox offer Price 7/217, you ask? Because they had to. They are a big market team that needs to mollify a restive fan base and usher out one of their all-time greats, Papi, on a winning note. The market dictates that 30 something starting pitchers with any kind of successful resume get overpaid for their declining years. That’s simply a fact of MLB reality. The examples are too numerous to list. One can rail against this reality but that won’t change the reality. Life is unfair. Billionaire owners have to pay over the hill pitchers tens of millions of dollars that they will likely never earn. C’est la vie.
So why is the opt out advantageous to the Red Sox under any circumstances, you ask? Because there is no possible downside given the reality the Red Sox live in. If Price stinks and decides not to opt out, the Red Sox were going to sign Price, or another of his ilk, for substantially the same contract. As long as the Red Sox were determined to land a front line FA pitcher this off season, and they clearly were, a nine figure contract was inevitable. The opt out does nothing to change that reality. If Price pitches well and decides to opt out, that is even better for the Red Sox. To begin with they get three years of an Ace level pitcher for market value while he generates both surplus value and actual on field performance. That’s great for the Red Sox. And for Price too! He will then get to renegotiate a more lucrative deal for himself with any team he likes. The Red Sox will have the chance to see Price up close for three years and then revaluate both the pitcher and where their team is at competitively speaking. (I don’t think it’s a coincidence that Kimbrel’s deal, including the team option, ends at the same time as this opt out potentially kicks in). If the Red Sox decide they want to resign Price for more money so what? I doubt it will be any more costly than Scherzer’s deferred money on his big contract. The flexibility the Red Sox will have at that point is worth the risk of not being able to resign Price if he opts out. Even paying more for Price in three years time does not out weigh the value of that potential flexibility.
The opt out is an unqualified good for both sides.
There is certainly a healthy discussion on this subject. We don’t know if the Sox saved money (or some other valuable thing) by including the opt-out. But that part is fairly straightforward and the real question is value in opting out itself.
Can the Red Sox receive value because Price opts out? Sure, but that is largely hindsight. Can the Red Sox recieve value because Price opts out at the time he opts out? Tougher to explain but some think Yes it seems. Trade value and waivers counter a lot of what would appear to make that true.
As Dave says, some of what we’re surmising by this value is that the Sox are forced to play it “smart/safe” when they otherwise wouldn’t and ditch Price before he can be a burden. I have a hard time as a Sox fan saying I don’t perceive some comfort in this although I’m not sure I should.
I also was comfortable end of 2003 after 3 years of Manny being Manny that the new ownership, via Theo, put him on irrevocable waivers (although that was only partly about age). Would they still have won if someone had taken Manny, who knows, but it worked out well to keep that contract.
Hey, imagine my surprise, reading an article here that addresses at length a comment I made in a previous thread. Cool stuff.
Why’d you delete my comment saying you drastically misused the concept of correlation and causation?
Why’d you delete my comment saying you misused the concept of correlation and causation?