Archive for Hot Stove Economics

Ryan Howard’s Extension

So, out of nowhere, it’s being reported that the Phillies and Ryan Howard have agreed on a five-year, $125 million contract extension. This appears to be on top of his current deal that pays him $19 million in 2010 and $20 million in 2011. My first thought upon hearing of this deal was that it’s too high, and my numbers seem to confirm my suspicions.

I project Howard to be worth about $97 million over this span, or between $5-6 million less per year than what he will be getting in his contract. My projection assumes that he will be playing on an average team, so he may be worth a bit more to the above-average Phillies than my basic estimate, possibly enough to put his salary in line with his marginal revenue product. The contract could reflect the front office’s confidence the organization is primed for a continued run of success. However, I think it’s unrealistic to assume that the Phillies will be as good as they are now for the next seven years.

But even if Howard will generate the production to justify the contract under the right conditions, I still question if this is the right move. In the context of the free-agent market with many good teams making bids for his services, a contract of this magnitude may make sense. But, a lot can happen before this contract kicks in. I’m all for signing players before they hit free agency, but it should be for a discount. If I’m the Phillies I take my chances that he walks in two years, because I think he’s ended up with a deal that is about as good as he can expect in two years.

Collusion?

The MLBPA is making noise about filing a grievance regarding collusion in the free-agent market.

“We have concerns about the operation of the post-2009 free agent market,” new union head Michael Weiner said Tuesday in a telephone interview with The Associated Press. “We have been investigating that market. Our investigation is far along but not yet complete.”

The sides reached a standstill agreement last year giving the union additional time to decide whether to proceed with a grievance against teams alleging misconduct after the 2008 season.

Management denies any violation of the collective bargaining agreement, which states clubs may not act in concert with respect to free agents.

“The free-agent market operated in a manner that was completely consistent with the requirements of the basic agreement,” said Rob Manfred, executive vice president of labor relations in the commissioner’s officer. “I feel confident that the MLBPA will come to the same conclusion when they complete their investigation.”

Agents for players, without going into specifics, have claimed they received multiple similar offers for free-agent clients and have pushed the union to contest the practice.

First, let me comment on the notion that players receiving similar offers is evidence of collusion. If owners were conspiring to hold down wages, it is likely that any offers players received—in the 1980s free agents didn’t receive offers at all—will be similar. But what would happen in a perfectly competitive market? We would expect teams to compete against one another and ultimately settle on offers that are roughly equivalent to their projected marginal revenue products. Thus, we would expect teams to be submitting similar offers to players. The evidence that supposedly damns the owners is also consistent with competitive pricing. Just as gasoline prices at different gas stations fluctuate together with petroleum prices, so too does the amount that different teams are willing to pay players according to each player’s financial worth.

Second, in the 1980s, there is no doubt that the owners were colluding, and they were found guilty of colluding in arbitration. At the time Gerald Scully used his marginal revenue product estimation framework to try to determine if there was any collusion. He found that free agents were earning about 70 percent less than their marginal revenue products, and he suspected that collusion was occurring.

I have my own updated Scully-estimates, so I thought I would take a look at the recent free-agent market to see if I can observe any obvious evidence of collusion in recent free-agent signings. I looked at the past two years of free agents who signed major-league contracts and compared them to their estimated marginal revenue products from production in the previous year to the median difference in salaries. For 2008 and 2009 I find that free-agent hitters received salaries that were about 70 percent of their marginal revenue products; there is no difference between years. For pitchers, in 2008 free-agent pitchers received salaries approximately 13 percent more than their marginal revenue products, and in 2009 they received approximately 70 percent more.

Now, these comparisons are rough. They assume that each player is added to an average team, and thus many free agents likely have higher marginal revenue products than I estimated, because the returns to winning are increasing (players added to winning teams are worth more). This may explain in part why on average free-agent pitchers have been earning more than the marginal revenue products. I also believe that the pitchers are a bit overvalued by the market.

Though the numbers are imperfect, I think they convey some interesting information when compared to Scully’s analysis. In the 1980s, when we know collusion was occurring, players were earning significantly less than their marginal revenue products. When compared to today’s players, the difference is striking. I don’t think the MLBPA has much of a data-driven case here.

The Beckett Extension

The Red Sox and Josh Beckett have agreed to a four-year, $68 million extension that locks up Beckett from 2011–2014.

Beckett is a good pitcher on a good team, but I think the Red Sox overpaid. On an average team, I have Beckett valued at $60 million over this stretch. Given that the Red Sox have been a good team recently, Beckett’s performance is worth more than that now, but I’m not sure it’s a good idea to project the Red Sox’s excellence that far into the future. Furthermore, given that Beckett still has another year on his deal, I think the team should have expected more of a discount before reaching an extension. Beckett’s not a free agent yet, and I think this is about the type of deal he would get on the free-agent market. What’s the rush to sign this deal? Don’t get me wrong, it’s not a horrible contract, but I think the Sox stretched and Beckett should be pleased with his agent.

Mauer’s Extension

Word has it that Joe Mauer and the Minnesota Twins have reached an agreement on an eight-year, $184 million extension.

I’m a big fan of Mauer—who isn’t?—but I worry that the Twins may have stretched a bit here with this long-term commitment. I have Mauer’s value ranging from $157 million to $182 million over the term of the extension. Certainly, that’s in the ballpark of the contract he’s agreed to, but Mauer didn’t sacrifice much income for the sake of security. He might be worth more than my projection given that the Twins have been an above-average team; however, assuming the team will be as good as they have been for the duration of the contract requires some optimism.

Hats off to Mauer’s agent Ron Shapiro for getting all that he could out of the Twins. But the Twins are one of the best-managed organizations in baseball, so I think they deserve the benefit of the doubt.

A’s Sign Sheets and Padres Sign Garland

Yesterday, the Oakland A’s agreed to terms with Ben Sheets and the San Diego Padres landed Jon Garland. Here are my thoughts on these deals.

Sheets received a one-year $10 million contract, with $2 million in incentives. I think this is way too high. I have Sheets valued at about $9 million in 2010. I’m completely ignoring his missed 2009, but I am taking into account that he hasn’t been a paragon of health for most of his career. Furthermore, anyone coming back from serious surgery poses some sort of additional risk that I’m not even accounting for. No word yet on what the incentives are, but unless they’re based on Cy Young votes or some other difficult-to-achieve honor—even an All-Star appearance is too low a threshold—I doubt he’ll be worth $12 million. Only once in his career (2004) was he ever worth that kind of money.

On the other hand, I like the Garland deal, which is a one-year, $5.3 million contract with an $6.75 million option for 2011. $600,000 of the guaranteed portion of the deal is a buyout—of which he only gets half if he declines the option—so the potential two-year total comes to $11.45 million. I have Garland valued at around $7.5 million next year. It’s a good deal for the Padres. If he pitches like he has, he’ll be on a good contract. If he pitches lights out, you get a good deal for one year and he bolts. If he pitches poorly, you can cut ties.

Mariners Lock Up King Felix

As Keith Law broke the story last night, the Seattle Mariners have reached an agreement with Felix Hernandez for an extension. Rumors have the contract in the $80 million range for the next five years. If this is true, then I think the Mariners overpaid.

Felix Hernandez is a good pitcher, and his 2009 was excellent. Based on last year’s performance alone (as I used for Josh Johnson), I have him worth about $89 million over the next five years. However, he’s still got two more years of arbitration where he’d likely get less than his worth. The M’s don’t appear to be getting much of a discount for signing him early. And, while his previous performances were good, I suspect that he’s not quite as good as his 2009, which whittles away some of his expected worth. But, it’s the Mariners’ risk to take, and they may feel that he’s every bit as good as his 2009.

But, I think this also gets to the heart of something I’m doing with my estimation of player’s worth. I’m not using a hedonic pricing model—estimating value from market prices. For example, when you buy a house, your lender will use a hedonic model to estimate the value of your home. Using characteristics such square footage, amenities, school zone, etc. the model spits out a projected worth of your new home based on the market prices for other homes in the area. As we’ve recently learned, when these models go bad, we get a bubble, and the pop can be dramatic. If I was to use a hedonic model, I think the Hernandez contract would look better.

Instead of using market prices, my model uses a fundamental value approach, which relies on revenue data to estimate how performance is associated with revenue generation for clubs. What teams are paying for certain player qualities never enters my model. Such models have the weakness of having to rely on financial information that isn’t known with a high degree of certainty, but fundamental value estimates have the advantage of being able to spot bargains and bubbles in market prices. Right now, I believe that teams are paying too much for pitching. It’s not by a huge amount, but enough to cause me to keep on eye out for a crash.

Hernandez is a good pitcher who is valuable, but I think the M’s would have been wise to hold out for a better deal. Buying out a player before he becomes a free agent should be done to receive a discount on a future contract, and I don’t think the Mariners got big enough discount to commit to this deal.

Marlins Add Payroll

Last week, the Marlins reached an agreement to increase payroll, largely thanks to a provision in the Collective Bargaining Agreement that I previously thought was unenforceable.

A principal objective of the Revenue Sharing Plan is to promote the growth of the Game and the industry on an individual Club and on an aggregate basis. Accordingly, each Club shall use its revenue sharing receipts (from the Base Plan, the Central Fund Component and the Commissioner’s Discretionary Fund) in an effort to improve its performance on the field. Each Payee Club, no later than April 1, shall report on the performance-related uses to which it put its revenue sharing receipts in the preceding Revenue Sharing Year. Consistent with his authority under the Major League Constitution, the Commissioner may impose penalties on any Club that violates this obligation (p. 112).

The team quickly responded by signing Josh Johnson to a four-year, $39 million deal. Just yesterdayDan Uggla and the Marlins avoided arbitration with a one-year $7.8 million contract.

I estimate Uggla to be worth $10 million next year. If Johnson was as healthy and good as he was in 2009, I estimate him to be worth $55 million over the next four years. Both these players appear to be worth more than what they will receive; however, I think the push of the settlement nudged these deals upwards.

I don’t think Uggla would have gotten that much in arbitration, and it probably would have been worth the gamble of going to arbitration and losing. The difference between the salary he got and what they might have lost is too small to worry about for most teams. But, I think the Marlins hoped to guarantee Uggla’s trade value. As it stands, he’s worth about $2 million in prospects to the Marlins ($10 million value — $7.8 million salary). Trading him with his arbitration obligation undetermined may induce uncertainty that lowers the value of potential prospects they want to receive. After all, the Marlins appear to be very good at identifying good young talent in other organizations.

Johnson, on the other hand, really got a good deal. 2009 was really his first full year of durable and excellent performance. If he repeats that and ages normally, his contract is about dead-on, given his service time. I think performance uncertainty would prevent the Marlins from signing this deal under normal circumstances.

Despite the cries about the Marlins low payroll, they haven’t just sat back and collected revenue sharing money while fielding an awful team. The Marlins are competitive almost every year. Even with all the buzz surrounding the Braves late-season run, the Marlins actually finished ahead of the Braves in the standings. The Marlins may not spend a lot on payroll, but what they do spend, they spend it wisely. They appear to have an excellent scouting department that is capable of spotting good talent. Even after developing players on the farm, they are able to trade them away as high-dollar players for more good prospects. That’s why I think it’s funny that the Marlins are the ones getting busted by the CBA provision. The goal was to preserve competitive balance, and the Marlins have pulled their weight. But, that doesn’t mean I don’t support the CBA provision. To the contrary, if revenue sharing is to exist it has to be enforced. It’s enforcement may be imperfect, but it provides an incentive to be more than a welfare recipient.

What Will Tim Lincecum Get In Arbitration?

Baseball Prospectus is running a contest to guess what Tim Lincecum will ask for in arbitration. The prize is a BP gift subscription.

What’s my guess? I think Lincecum will be worth about $18 million next season based on past performance. In most arbitration hearings, players are compared according to service time. However, the special performance clause in the CBA allows exceptional players to compare themselves to the entire league, not just to players with similar service. If there was ever a case for exercising this clause, this is it. Back-to-back Cy Youngs, are you kidding me? Throw service time out the window.

I think Lincecum will win $18 million, hands down, but that’s a different question as to what he should offer. The arbitration panel picks the offer (the team’s or the player’s) that they believe to be most correct. If the Giants propose $12 million and Lincecum goes $18, Lincecum wins. But, he also could win if he goes as high as $24! To suggest $18 million would be to leave possibly $6 million on the table. Now, I don’t think the Giants will go that low—they will go under $18 though—so, I wouldn’t recommend $24 million, but I think Lincecum will ask for more than $18. How much more has to do with factors that I know nothing about. Have the parties discussed figures for a long-run contract? I suspect they both know something about what the other party might offer.

So, I’ll guess $20 million, but I suspect that the parties will reach agreement before a hearing, possibly on a long-term deal. The difference between arbitration awards (say $15–$20 million) is small compared the potential gains that Lincecum will expect to receive over the long haul, as his value escalates with baseball revenue and player salaries. He is likely to give up a few million a year as insurance to guarantee him $100 million over the next few years of his career. I look for the Giants to offer a long-run deal that Lincecum might find attractive rather than risk going year-to-year with him.

Tigers Sign Valverde

The Detroit Tigers picked up a closer yesterday, signing Jose Valverde to a two-year $14 million contract, with a $9 million club option for a third year.

I’ll keep it short and sweet: I don’t like this deal for the Tigers. I have Valverde worth a total of $9 million for two years. If the Tigers were a better club, it might make sense to pay a little more and there was stiff competition for his services, but this is too much. I doubt Valverde would have gotten this much from anyone else. The good news is that I don’t see any way that the Tigers pick up the third year.

I generally like the Tigers’ moves, so I am a bit surprised to see them make it.

LaRoche Lands with the D-backs (with Kelly Johnson)

Adam LaRoche played hardball and lost…well, maybe he lost. John Heyman tweets that LaRoche agreed to a one-year contract between $4–$5 million. Supposedly, LaRoche turned down a two-year offer from the San Francisco Giants that for $17.5 million. So, that has to be a big let down.

I’m kind of surprised LaRoche decided to settle on this offer. I have him valued at about twice what he’s getting from the D-Backs, and about what the Giants reportedly offered him. If he was willing wait this long, why not wait a little longer? I can see him thinking the market is depressed, and he’s already plenty wealthy ($16m in career earnings), taking a year to reestablish his value and get a longer term deal. Preferences are subjective, but this seems like an awful risk, if this is his motivation.

His signing by the Diamondbacks reminded me that I had yet to comment on Kelly Johnson joining Arizona a few weeks ago. Johnson agreed to a $2.35 million contract to play for one season. Johnson had a bad 2010 that just screams fluke, and has the underlying patience and power skills that normally make a good ballplayer. Even factoring in his bad 2009, I have him as a $7.5 million player. Johnson also supposedly spurned higher offers from other clubs.

The market may very well be way down for these players, but I wonder if there is something that the D-backs are doing to attract players to play for less, especially players looking for a short-term audition. Maybe having the young A.J. Hinch, a controversial hire, was part of the plan to attract such players.