Understanding the Duality of Deferrals in MLB Contracts

[Matthew Trueblood]

Image courtesy of © David Banks-Imagn Images

Deferred payments in big-league contracts continue to be a hot topic, even as the hot stove winds down and the season itself draws near. For many fans, ever since Shohei Ohtani signed a contract deferring over 90% of his salary each year to maximize the Dodgers' ability to build a championship-caliber team around him, deferrals have been the bogeyman: always lurking just out of sight, but always a threat. Part of the problem is that fans shouldn't be asked (and shouldn't so often volunteer) to wade into complicated financial rules to determine the full implications of their favorite team—or arch rival—signing a star free agent. However, another part of the problem is a garbled message about the nature of deferrals, coming from national sports media outlets.

We can fix that second problem, so let's do so. It's time to quickly, cleanly lay out what deferrals are, what they aren't, whom they benefit, and why, so we can stop talking about them from now on. To start that process, let's peg the key things wrong with how most baseball pundits talk about deferrals.

1. They oversimplify the issue. This is the most common problem humans have when tackling any mildly complicated process or procedure. The temptation to boil things down to a single sentence overwhelms, and the would-be explainer boils off some of their own comprehension, such that their efforts at concision are hopeless.
2. They're not context-specific enough in their discussions of each deferred deal. There's really no time when a fan needs to know both the face value of a contract and the competitive-balance tax number assigned to it, after factoring in deferrals and balancing the annual average value. If a team is flirting with or above the competitive-balance tax threshold, the only number that really matters is the CBT one. If a team is playing far below that line anyway, the only number that matters is the face value. When reporters give both numbers and emphasize the difference between them, it implies an importance in that gap that simply doesn't exist.
3. They treat players like teams. This, in my opinion, is the biggie. In fact, it's worth saving the guts of this part for a longer breakdown, rather than crunching it into this paragrpah. Suffice it to say, though, that teams and players look at deferrals differently—more differently than reporters tend to convey to their audiences.

Here's the dissonance that must be resolved to understand contract deferrals correctly: big-league teams are huge, ravenous money monsters. They take in enormous sums, but they spend cash incredibly fast, too. Burn rate is a real and important consideration for franchises. They're richer than they want you to believe, but liquidity is a real problem for many of them. Thus, delaying large payments is a boon to their business. They get a humongous benefit from deferrals—one that easily eclipses the discount rate applied by either the player's union or the league itself to their spending. For a team, pushing $15 million of a $35-million salary five years down the road is worth millions of dollars, even though they have to fund an escrow account to ensure that that deferred money is available to pay the player in question come the payments' due dates. Teams have front-office staffers and accountants assigned solely to these projects, and they still more than pay for themselves.

For a player, though, a deferral just doesn't mean anything. It might technically mean that the spending power of their $35 million is reduced to $30 million or so, but for a person—even for a family, or multiple generations of a family, and even accounting for an extravagant lifestyle—there is simply no difference between $30 million and $35 million. Perhaps a better way to put that is: there is no difference between getting $35 million all at once and getting $20 million in one year, than $15 million spread over a handful of later years. Every player accepting such a deal will make more money over that kind of contract than they could spend over a responsible lifetime, and more than their children can spend over responsible lifetimes.

The cherry on the top of that sundae is that, for many players, deferrals also create tax benefits that claw back a bit of whatever nominal loss in value they suffer by taking their cash down the road. A big-league salary is taxed according to the income tax rates in each of the states in which they play throughout a season, weighed according to the games they play in each. Deferring a huge chunk of that salary until some time after one's retirement, though, can mean paying no income tax at all, if a player lives in a state without that tax. Even if a player and their family chooses not to be bound by that consideration, they can easily establish a residence in some relatively low-tax district. The spending power of deferred payments is diminished by inflation between the time when the money is earned and when it's actually received, but it's pushed back up by the ability to reduce one's tax burden.

Deferrals, then, aren't easy to value in a simple, agreed-upon way. The player's union and the league don't even really try to do so. The sides agree on a formula for discounting future payments to establish the competitive-balance tax hit of contracts in each collective bargaining agreement, and the league considers that official, but the union maintains its own numbers. Deferrals are highly beneficial to teams, but they don't hurt players at all. Being a franchise with a 10-figure valuation but $400 million in annual expenses is such a different thing than being a young family that the impact of even tens of millions of dollars in deferrals is huge for one but nil for the other.

Even among very smart analysts of the game, there's a strong tendency to pick a winner and a loser when it comes to each clause of a contract. An opt-out clearly favors a player; so does a no-trade clause. A club option favors the team. With deferrals, though, that kind of thinking doesn't work. Nor do dichotomies between small- and large-market teams. Clubs that end up in situations where deferrals offer substantial help don't reliably fall into one category or the other. The circumstances that make them helpful are idiosyncratic.

Life is complicated, and individual situations often defy broad principles. Deferrals, like those no-trade clauses and option years, exist to make contracts more flexible and palatable to each side. To properly understand them, one must embrace complexity and eschew the oversimplified binary of contract terms favoring either the player or the team.

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[Michael Trzinski]

I have been saying this for more years than you have been alive, Matt...long-term contracts and deferrals are bad for baseball. 

How many six or seven year contracts have you seen that worked out good for both parties? One-quarter maybe? Three clinkers come to mind for the Brewers: Teodoro Higuera, Jeff Suppan, and Christian Yelich.

Deferrals just make it even worse. How many times have you gotten paid for work you didn't do? Why should athletes?

A future 'Just for Fun' piece: If I was Commissioner for a Day.'

I will discuss it in greater detail.

[bean5302]

Wrote up this piece a while back.
 

How Deferrals REALLY Work with example. Because most sources are useless. - Other Baseball - Twins Daily

TWINSDAILY.COM

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Alrighty! So this has been brought up a lot of times. The Dodgers are ruining baseball, teams are mortgaging their futures, these players will stop signing their contracts when the first team...

First, deferrals must be fully funded by the end of the player's employment.
Second, unless the player specifically allows it, the deferrals must be held in escrow outside the team.
Third, there is some substantial risk to teams if the investment they use to indirectly fund the benefit (deferred payment) has a poor return. It means a team might have to come up with shortfall payments every year, and those shortfalls could be pretty brutal.

Honestly, the biggest issue I see with deferrals is the shortfall in funding followed by the way it could cripple a team if the CBA ever adds a salary cap.

I don't think unlimited deferrals are good for MLB because there's too much risk of a shortfall or a franchise going overboard and crippling themselves directly or indirectly through a CBA change.

[THOMAS JOSEPH]

17 hours ago, Michael Trzinski said:

I have been saying this for more years than you have been alive, Matt...long-term contracts and deferrals are bad for baseball. 

How many six or seven year contracts have you seen that worked out good for both parties? One-quarter maybe? Three clinkers come to mind for the Brewers: Teodoro Higuera, Jeff Suppan, and Christian Yelich.

Deferrals just make it even worse. How many times have you gotten paid for work you didn't do? Why should athletes?

A future 'Just for Fun' piece: If I was Commissioner for a Day.'

I will discuss it in greater detail.

I think you are spot on regarding the length of contracts. By their fruits, as they say. Even the long-term extensions are hardly successful, with some of the most well-known players creating serious logjams for their respective teams after extending. Votto, Miggy, Trout. Not only are the deals terrible vis-à-vis production for the money, but we know the other devastating consequences.  Deferrals, despite the howling of Dodger fans that they are "within the rules," deferrals are not viable for more than half the league. 

I also wrote a "Commissioner for a Day" piece on the Fish on First site - really venting - and it felt good!

Cheers.