The Peavy Salary Myth

I keep reading that one reason that teams want to acquire Jake Peavy is because he makes only $15 million a year. David O’Brien is the latest offender.

Among other pitchers available, Peavy is the most accomplished and would have a lower salary than comparable free agents.

The logic seems simple. An ace like CC Sabathia will get $20+ million;therefore, Peavy’s $15 million contract represents a big savings over the free-agent alternative. (Peavy actually isn’t quite as valuable as Sabathia, but let’s just assume they are for simplicity.)

But the $5 million difference in salaries does not represent savings to the acquiring club. Peavy and Sabathia are assets who represent future income streams to their employers. Teams ought to be willing to pay salaries equal to the discounted present value of these revenue streams. As a free agent, Sabathia will capture all the returns of his expected value, and so would Peavy if he could be signed as a free agent. Instead, the Padres own the right to an annual income stream of greater than $15 million which they gladly lease for $15 million a season for the next four years. The fact that Peavy only gets $15 million doesn’t mean that’s all he costs. The Padres must be compensated for that additional lost income stream—a price that his new team will pay.

The only team who benefits from Peavy holding a good contract is the Padres, and this is likely a big factor in the team’s decision to move him. They hold a valuable asset and plan to cash it in.

11 Responses “The Peavy Salary Myth”

  1. Zach says:

    I think calling Peavy’s affordable salary a “myth” is overstating it a bit.  I think everyone is aware that teams are going to have to give up quite a bit of future talent to acquire Peavy and his $15 million salary which is quite affordable in today’s market for a frontline starter.  Of course the Braves will pay a price for Peavy but teams are always willing to trade players with a high future value because they are more risky than the veteran player they are getting in return.  It’s the nature of trading prospects for veterans, not a “myth” about a players worth.

  2. Robert says:

    While this post makes a good point (if Peavy and CC are considered equal, then any team trading for Peavy would only get a discount if they give up less than $5 million a year for the next 4 years in prospects), it fails to acknowledge the fact that prospects only have value to the major league team once they are called up.  Before that, they are simply trading pieces used to acquire talent for the major league team.  For instance, lets say Team A has a set payroll over the next 4 years of $100 million.  If they sign CC Sabathia at 4 years/$20 million per, they now have $80 million to spread over the other 24 players on the roster.  Assuming everyone is signed at market price (not a realistic scenario, but necessary for comparative purposes), the “value” of this team will be $100 million for the next 4 years.  The prospects in it’s minor league system do not contribute to the value of the 25-man, MLB roster.  Now lets assume Team A traded prospects for Jake Peavy instead of signing CC Sabathia, and that none of those prospects would have been called up in 2009.  Since we’ve already established Peavy’s “value” at $20 million a year, his $15 million salary is a discount.  So now Team A has $85 million of it’s $100 million payroll to spread across the other 24 players, giving the team a “value” of $105 million for 2009, instead of the $100 million it would have had with CC.  As the prospects traded start to get called up to the major leagues, Team A begins to lose it’s $5 million discount, but that’s the nature of present value vs. future value.  For a team looking to compete in 2009, the present value of prospects is less than the $5 million difference in salaries between Peavy and CC, and therefore trading for Peavy is an astute move (if the goal is to win now).

  3. mravery says:

    To be fair, what DOB is saying is that this lower salary is one of of the things that would make him more valuable to the Braves. The corollary to that is that he will therefore cost more.

    Moreover, some teams have different asset structures than others. Teams like the Braves have a limit to the amount of cash they can spend on players. However, if “spend” young players (in the form of trades for players with below-market-value contracts) rather than cash (in the form of contracts to FAs at market value), you can effectively acquire more resources while keeping the (cash) balance sheet at the same level. From a baseball perspective, it may be all the same, but to a parent company that wants you to limit payroll to some amount (as Wren has implied is the case), it looks different.

  4. Abe says:

    As an Economist (ok maybe just someone who got his Bachelors in Econ from GSU), I think you hit it right on the head JC.

    Its like the difference in getting hired as a driver for $20 hr plus gas expenses vs. $27 hr all inclusive.

    As a Braves fan, I would also rather see the Braves target Sabathia over Peavy due to the amount of talent that we have coming up in the minors (and not wanting to part with that talent).

  5. Jon says:

    I’m confused.  He is tremendously valuable because he is getting paid less than he is worth.  Thus any team that he plays for will have an expected profit.

    An acquiring team would effectively pay for the gap between his salary and with prospects.   This doesn’t make the fact that he’s a bargain a “myth”.  He’s still a bargain with respect to what he’s getting paid, regardless of what team he plays for.

    Whether it’s worth it for a team to surrender prospects for him is another story, based on how they value those prospects.

    I think you’re simply stating the obvious.  Obviously since Peavy has positive value, a team has to give up something (presumably of equal value) to get him. 

    Would you say that no prospect or pre-arbitration player, for example, has any value to any team other than his current one?

    Or taking it even further, would you say that any item in a store has no value to anyone but the store? Of course not. If I am shopping for a fridge, I buy it if I think the $800 price tag is worth it. Since I was willing to pay $800 for the fridge, its value to me, is greater than $800. Just because I have to pay $800 for it doesn’t make it any less valuable.

    The Padres are the store, and Peavy’s the fridge.

    If I’m missing your point, I’d gladly welcome any corrections…

  6. BamaFanInTN says:

    Dude, come on now.  DOB was purely talking about the CONTRACT (in $$$) of Jake Peavy over the next few years.  It’s beyond OBVIOUS that you are ALWAYS giving up more in PROSPECTS when you trade for a proven ML player.  Not to mention, there is going to be a SWEEPSTAKES when it comes to Sabathia that will definitely reach $20M and could reach the mid to upper $20′s if the Sox and Yanks get in a bidding war as the Yankees are expected to.   Plus, I think JP is supposed to make around $11M next year, with the amount going UP each year thereafter.  If so, it’s quite likely that CC could make DOUBLE what JP makes each of the next two or three years.  That’s a bargain my friend.

  7. JC says:

    Then I guess it’s time to take away Coase’s Nobel.

  8. Millsy says:

    Jon, you’re just completely wrong.  If the price tag is $800, and you were willing to pay up to $800 for it, then it’s worth $800, not more.  If you were willing to pay more, then fine maybe you got some surplus out of it.  But this case isn’t like a refrigerator.  You’re giving up that $800 for what you think is a $1000 refrigerator…but you don’t give them anything else.  In this case, you’re giving $11 million or whatever to Peavy, and some prospects to the Padres.  I do think that claiming the deal a ‘myth’ to be somewhat overstated, but that’s not the point.

    Basically the deal comes down to ‘win now’ vs. ‘win later’ in the eyes of those trading.  Rather than use Peavy now, the Padres are looking to win in the future.  What makes this difficult is that the risk is much higher for prospects than for Peavy.  Those trading for Peavy, I would imagine, are more risk averse in this point in time (win now), whereas the Padres are going to be risk taking after their disasterous year.  Each team assumes that the expected value (or added value) of the players is equal, that’s why the trade happens.  But for all the Padres know, every player they trade for could be a bust. 

    Yes, in terms of payroll, Peavy keeps it down.  I would be very happy to have Jake Peavy on my team at $11 million.  In terms of long-term sustainability of success, there is some comprimise there.  Where you stand on the value of this is what makes the trade happen

  9. JimK says:

    Consider that $5 million gap in salaries, and the value of the young players the Braves are being asked to deal for Peavy.

    If unproven first round draftees are worth several million, what is the value of players who are successes in AA, or moving up toward the major league roster? (Players who will be under control well below market value for several seasons.) You can’t even put a price on guys like that.

    If the Braves could pay the Rays for David Price, what would be a fair price? Probably more than one year of CC Sabathia! Tommy Hanson may not be worth quite that much yet, but even a Jo-Jo Reyes could arguably worth $5 million by those standards. This is precisely why MLB won’t clear straight player sales. Small market teams would be tempted to make their budget as virutal Yankee farm club.

    Someone should estimate the cash value of the players the Braves sent to Texas for Mark Teixeira. I’ll bet the total would be more than Teixeira will get as an annual salary next year.

    Bottom line: don’t trade prospects!

  10. mravery says:

    JC-

    I don’t think people are trying to disagree with Coase here. My point, at least, was that it feels a bit like you’re just playing semantics. Clearly, the decision that netted the value here was the Padres decision to make a long-term commitment to Peavy. Currently, the expected revenue stream Peavy will generate excedes that value (according to your model, by an average of above $3 million per year). In acquiring Peavy, the loss from no longer having that revenue stream is something the Braves have to compensate the Padres for and so it’ll be factored into his price.

    My point above was that surrendering young talent rather than its equivalent value in dollars for front-line starting pitching may be to the Braves advantage, since they have both a cap on the dollar amount they can spend on talent (handed down from the parent company) as well as a comperatative advantage in drafting and developing players relative to the rest of the league. (From what I can tell, anyways; YMMV.) So if you’re Frank Wren and you’ve got to decide between paying, say, Sabathia market value or paying Peavy something less than market value at the expense of some young players, maybe that’s the better way to go given the team’s payroll structure and strength in player developement.

  11. Ron E. says:

    “Bottom line: don’t trade prospects!”

    Shorter bottom line: don’t try to win!