"Money often costs too much." -- Ralph Waldo Emerson, The Conduct of Life
The offseason Red Sox storylines have been numerous and fascinating: the saga of Jason Bay, the sudden and decisive move to sign John Lackey, the winter-long uncertainty of Mike Lowell, the team's defense-first sequence of signings meant to overhaul run prevention.
Cutting across all of those issues, however, has been a subject of almost surprising intrigue. With a payroll that will push against, and likely past, the luxury tax threshold of $170 million in 2010, the Sox have put on a winter-long clinic in creative accounting meant to minimize the team's tax hit.
Agent Scott Boras, following the agreement between client Adrian Beltre and the Sox in January, noted that he'd learned new wrinkles in designing contracts that minimized the competitive balance tax (CBT) levied on teams by Major League Baseball thanks to his conversations with the Sox. He has not been alone in receiving such an education from the Boston front office this winter.
The Sox have been keenly focused on the CBT for the past three months. That's been evident in deals such as Beltre's, the reworked contract signed by Tim Wakefield and the trade that shipped Casey Kotchman to the Mariners for Bill Hall, a player to be named and, perhaps most importantly, gobs of cash.
Across those moves, a few basic principles have become apparent for teams concerned about paying the luxury tax (a category, it is worth mentioning, that has included just four clubs -- the Yankees, Sox, Tigers and Angels -- in seven years):
-- Payroll for CBT purposes is determined by the average annual value of the entire contract, not the salary in a single season.
-- Player option years are considered guaranteed money.
-- Team options are not considered guaranteed.
-- A cash transfer from one team to another is deducted, in full, from payroll calculations for luxury tax purposes.
One might think that all of this stuff would seem about as engaging as, well, an accounting textbook. That being the case, perhaps I shouldn't be surprised that I've been getting responses to my articles on these accounting tactics from people such as "cpa_soxfan" and "CBT4U+ME."
That said, perhaps because the Collective Bargaining Agreement is even more inscrutable than some of the defensive metrics we've heard about all winter, I received ample mail on the subject, chiefly in response to this blog entry on how the Sox took on just $2 million in luxury tax payroll while adding Adrian Beltre and Bill Hall (and subtracting Casey Kotchman). I wanted to take a stab at answering these questions as best as I could.
The erstwhile "Felger Mail Bag" this is not. I kind of fit the mold of the kid who was beaten up and/or despised in high school by guys like Felger. I trust that most of the people who wrote to me also fall into this demographic.
That said, it is a proud time for geeks in our society. (Haverchuck for President!) And so, without shame or fear of indignity: The Money Mailbag.
Would you mind telling me where you found the 22.5 percent value for the luxury tax? I’ve been trying to find the actual percentage the Sox would pay and I’ve found 22.5 percent for a first offense (which I do not believe the Sox would qualify for, although it has been a couple years since the Sox paid the tax) and 40 percent for what the Yankees had to pay last season (although they pay it every year). I also heard 30 percent mentioned in another article that I read today. If you wouldn’t mind clarifying this for me, that would be great.
The luxury tax hits are outlined in the appendix of the Collective Bargaining Agreement. (And yes, I've read through the appendices of the CBA. Cue the Speak & Spell voice that they use to mimic me -- affectionately, no doubt (?) -- on the radio.) Because the Sox stayed under the luxury tax threshold in 2008 and 2009, their penalty re-sets to 22.5 percent for 2010, the lowest of the three possible levels of tax rates. The Yankees, by exceeding the threshold every year, stay at 40 percent. If the Sox exceeded the threshold in both 2010 and 2011, they would be penalized at a 30 percent level in 2011. It’s a bit complicated — there are 18 different scenarios for penalties outlined by the CBA. An effort to detail all of them would be about as useful as reciting pi to the 526th digit.
Thanks for the info — a quick question.
Surely, if Beltre declines the option then the contract becomes a one-year, $10 million contract for luxury tax purposes as well as the actual cost — like incentives are calculated at the end of a season for luxury tax purposes?
Otherwise, why would the Sox, for example, not have also given Beltre a second player option for 2012 for $1 million? Or does the two-year average of $7 million also count as $7 million against the 2011 Sox luxury tax total? Surely, the luxury tax cannot ultimately allow a team to add undesirable options which will be turned down as an easy way to dodge paying the tax?
Right now, the Beltre contract -- which is viewed for practical purposes as being a guaranteed two-year, $14 million deal -- counts for $7 million in CBT payroll for both 2010 and 2011.
If Beltre doesn't exercise his player option, then the difference between what the Sox actually pay him ($9 million, or $10 millon if he triggers his buyout -- more on that below) and his AAV ($7 million) is accounted for in the next year's payroll calculation. So, given the likelihood that Beltre declines his option, his salary would be calculated as $7 million of CBT payroll in 2010, and $2 million or $3 million (if he qualifies for the buyout) of CBT payroll in 2011.
As for the idea of a second player option at $1 million, that's better in theory than in practice thanks to a special provision of the CBA that makes a mess of contract options in 2012. Article XXIII Section E (5) (d) (ii) offers the following lively prose:
"If a Player Option Year falls in the 2012 Contract Year or later, and the Base Salary (plus any attributed Signing Bonus, deferred compensation or annuity costs) in the Player Option Year (“Player Option Year Value”) is less than 80% of the Base Salary (plus any attributed Signing Bonus, deferred compensation or annuity costs) in the Guaranteed Year with the smallest such figure before the first such Player Option Year (80% Figure), then the difference between the 80% Figure and the Player Option Year Value shall be allocated pro rata across the Guaranteed Years preceding the first such Player Option Year; provided, however, that if the 80% Figure is itself less than 75% of the Average Annual Value of the Contract (calculated as if the Player Option Year was not a Guaranteed Year), then the 80% Figure shall instead be 75% of the Average Annual Value calculation set out immediately above."
Quite frankly, my eyes crossed after reading that section several times. But, after entering the Matrix and consulting with The Oracle (Mary Alice? Gloria Foster? A character in Jersey Shore?), I was told that a deal along the lines of what you suggest -- Beltre's deal ($9 million guarantee, $5 million player option) with a second player option at $1 million in 2012 -- would actually have a CBT hit of $9.125 million.
Here's why: That $1 million option is below 80 percent of the lowest guaranteed year (the $5 million option), but the 80 percent figure is also less than 75 percent of the $7 million AAV. That being the case, one would take the difference between 75 percent of the AAV ($5.25 million) and the value of the player option ($1 million) -- which is $4.25 million. Then, one would add the $4.25 million to the $14 million guaranteed over the first two years of the contract for a total of $18.25 million. You would then divide that number by two to get a corresponding AAV of $9.125 million for 2010 and 2011.
Got that? The confusion surrounding the language of the CBA is nearly enough to deter a team from forging such a confusing contract. But given that a deal like this would actually lead to a bigger luxury tax hit than the one that the Sox structured, it seems safe to say that it's not a useful contract structure. (I should also note that when I ran this proposed contract structure by some baseball sources, they found it so unrealistic that they refused to clarify the luxury tax hit.)
Very informative article! Any news as to their (Red Sox') ability to maintain arbitration rights to secure draft choice compensation? It would increase the value of this deal but may decrease Beltre’s value.
There were no special conditions placed on whether or not the Sox can offer Beltre arbitration -- the team is free to do so. That said, there isn't that much risk for Beltre if the Sox do offer him arbitration, since Beltre's abysmal 2009 offensive statistics would almost surely prevent him from qualifying for Type A free agency, since free-agent classifications are determined over two-year periods. Only Type A status requires a team to forfeit a draft pick in addition to the compensation pick awarded a club that loses a free agent who is offered arbitration; teams that lose a Type B free agent (such as Beltre this year) are awarded a compensatory pick in the sandwich round by Major League Baseball, but the signing team doesn't forfeit a pick.
As a Yankees fan, I have one question about the Beltre signing and the motives that everyone is overlooking. If he is offered three years and $24 million (which by my basic math is $8 million a year) -- coming off an off-year -- how is it a good move for the Sox to give a guy off his worst year a million more than anyone else was offering? He’d be a fool not to take the offer, and then land a bigger deal by having a healthy productive year. He is using you guys as a step ladder to a bigger deal. So he’s getting more money per year … and a chance to land a bigger contract off an average healthy year by him. Doesn’t say much about his willingness to play for y’all, just his willingness to make more of the almighty dollar.
You're absolutely right - there is no question that Beltre wants to have a big year (in a park that is likely to reward his approach as a right-handed pull hitter) and then hit the open market again in search of a long-term deal that has a greater average annual value than what was on the table this offseason. No shame in that -- if a player believes that the market for his services has been dampened by an injury, then taking a one-year make-good deal to bump up his long-term value has obvious appeal.
The Sox have no qualms about offering a slightly higher one-year salary in order to avoid the risks associated with a longer-term deal, particularly since they were able to sign Beltre while minimizing their CBT payroll hit in 2010.
One-year contracts almost inherently minimize risk -- that's part of the reason why the Sox look back with few regrets on the decisions to sign John Smoltz and Brad Penny, but with plenty of regret about signing Edgar Renteria and Julio Lugo to four-year deals. (On the subject of Lugo: the next CBA should include a clause that relieves a team of the amount of salary spent by a player on alligator-skin shoes.)
The risk for Beltre is that he suffers another major injury, or another season of poor offensive production. If that happened, then Beltre might never make the money he could have gotten this offseason; he would instead be left to exercise his $5 million player option, with no guarantees for his future beyond 2011.
But clearly, going with a one-year deal was a risk he felt was worth taking. (After all, the notion was couched by Boras in the comfortable idea of a "pillow contract.") If Beltre performs anywhere near his 2006-08 offensive and defensive levels this coming year, he'll probably see a multi-year deal in excess of $10 million a year. Moreover, if he does that, the Sox will be delighted by the return that they get on this deal, and wish Beltre well in free agency if they don't re-sign him.
Love the article, and I love the detail, but how do you feel about Cameron AND Ellsbury in the outfield? Am I the only one that thinks Ellsbury’s speed is completely wasted in left field at Fenway and we should get better power numbers at corner outfielder than he’s likely to produce? Ells is one of my favorite players, but I just have trouble understanding the move.
Clearly, the Sox disagree. Jacoby Ellsbury was a spectacular defender for the Sox when he played left field in place of Manny Ramirez for parts of the 2007 and 2008 seasons. As Terry Francona pointed out, the Sox have been watching Carl Crawford make a difference as a defender in Fenway Park for years. Ellsbury can still have an impact doing the same. Moreover, one could just as easily say that the talents of Mike Cameron -- considered one of the best centerfielders of this generation -- would be similarly wasted in left.
Random thought: Crawford's everyday line in his second full season (2004) - .296/.331/.450/.781, 11 HR, 59 steals. Ellsbury's everyday line in his second full season (2009) - .301/.355/.415/.770, 8 HR, 70 steals. Granted, Crawford was just 22 while Ellsbury was 25 in those campaigns. Nonetheless, the two have strikingly similar skill sets.
Main question here: How are they going to afford Aroldis Chapman? If they pass on this guy this whole offseason is a bust IMO. I really hope they bite they bullet and get him even if he is 20 percent more than what they actually pay … besides, it's only one year.
Obviously, I'm a bit late in getting back to you on this one. It seems a bit extreme to call the entire offseason a bust if for any team that failed to sign Chapman, including the Red Sox, particularly given the shape of the farm system for 2011 and beyond. Clearly, Chapman has great stuff, but his lack of a dominating track record in Cuba and the makeup questions engendered during his time on the mound in the WBC caused the Sox to conclude that the price for him was too high.
Chapman could develop into a phenomenal top-of-the-rotation talent, but what if he becomes a back-end starter or setup man? Moreover, some of the international scouts with whom I talked suggested that he might be a guy best suited for a pro debut in Double A or even High A, so even if he's a long-term success, the Reds should not bank on a major-league contribution in 2010, particularly given the transitional challenges faced by many players who have come from Cuba. (I recall talking to Yankees officials in '03 who were kicking themselves for not having assigned Jose Contreras to the minors in that first year while he acclimated to the States.)
There's a lot of risk associated with Chapman. The Reds should feel extremely excited for his ceiling, and given that their finances rarely permit them to play in the deep end of the pool for established, free-agent major-league talent, this was a gamble that made quite a bit of sense. But it's unlikely that any team feels that its offseason was ruined by a failure to sign him. (Although pity the A's: reportedly runners-up this offseason in the Chapman, Marco Scutaro and Beltre derbies.)
Quick question - can you address how incentives/bonuses are considered in calculating the AAV? For example, I read reports that Beltre’s contract may contain incentives regarding AB’s in 2010 that could escalate the $5 million option for 2011 (not sure if these reports were accurate or not). Or, as another example, doesn’t Holliday’s recently signed contract include a huge bonus if he finishes in the top 10 for MVP voting in the last guaranteed year of the contract? If incentives/bonuses aren’t included in the calculation for AAV, would something prevent a team and player from creating a contract with an unrealistically low base value and adding easily obtainable incentives?
A couple of things here. 1) A player option is treated as guaranteed money for purposes of calculating the average annual value (AAV) to determine a team's payroll for luxury tax purposes. Because there is less than a 100 percent chance of triggering an escalator clause or a vesting option, such clauses are not treated as guaranteed. 2) In this case, it is virtually impossible that Beltre will have enough at-bats to trigger the escalator clause in the 2011 player option. 3) Beltre has another clause that could trigger a $1 million buyout if he gets to a reachable number of plate appearances. If he reaches that level (575 plate appearances) and declines his player option, then the triggering of the buyout would add another $1 million to the amount that would be calculated against the Sox' 2011 payroll for luxury tax purposes for a total of $3 million.
This was one of the more clever structural pieces of the contract -- rather than give Beltre a straight playing-time incentive for reaching 575 plate appearances, which would have potentially tacked on an additional $1 million in 2010 CBT calculations, the conditional buyout means that the CBT hit will not take place until 2011. This was one of the items in the contract that Boras said offered a further education to him about the CBA and luxury tax. 4) Incentives and performance bonuses ARE, in fact, used to calculate AAV, so the scenario you propose would fail to circumvent the luxury tax.
Question: Wouldn’t the reported $1 million 2011 buyout come into play if he opts out of his player option, for a total of $3 million toward AAV for 2011?
Yup, if Beltre gets enough plate appearances to bring the buyout into play and opts out of the contract, he will count as $3 million against the 2011 CBT payroll.
Nice deal, but is it really going to be that much better with Beltre and Kevin Youkilis vs. Youk and Kotchman? Doesn’t Kotchman have the larger upside potential at only $3.5 million? Casey Kotchman (based upon a full year performance) would have also given the Sox other options for 2011 where (by all acounts) Beltre will not factor into the 2011 Red Sox picture.
As a couple of others have noted … we should compare Beltre and Kotchman 2010 stats to really see if this was a good deal.
Put it this way: Monitoring Kotchman and (presumably) Mike Lowell next year as a compare-and-contrast exercise with Beltre will be an interesting one. But in terms of comparing the two, Beltre is a virtual guarantee to turn in insanely good defense, enough so that he is viewed as an above-average player even if he replicates his dismal 2009 season. He should also benefit from Fenway.
Kotchman, already power deficient (part of the reason why the Braves seemed willing to trade him to the Sox for Adam LaRoche last summer), would be able to generate little power at Fenway, and his defense qualifies as above-average rather than superstar-caliber. That said, the Sox were convinced that Kotchman could be a useful contributor based on his very impressive career trajectory through 2007, and the Mariners felt similarly, so it may be worth checking in on that front later this season.
BONUS ANSWER TO A QUESTION THAT WAS NOT ASKED:
Realistically, could the Red Sox have done anything to bring back Jason Bay at roughly a four-year, $60 million deal while minimizing the luxury tax hit in 2010?
This was an interesting theoretical exercise before Bay signed with the Mets. Even so, given that there were suggestions that the Sox could try to backload a contract so that they could minimize the CBT hit of re-signing Bay after the deals for Lackey, Scutaro and Cameron had been reached, it's worth clarifying that doing so would have been virtually impossible.
For example: a deal that had paid Bay $6 million in 2010 and a guaranteed $18 million in each of the next three years (2011-13) would have an AAV of $15 million a year. Hence, such a deal would have counted for $15 million of payroll for luxury tax purposes.
A deal that had paid Bay $6 million in 2010 with three player options at $18 million each would be viewed under the terms of the Collective Bargaining Agreement as a guaranteed four-year, $60 million deal. Hence, it, too, would have been treated as a deal with a $15 million AAV.
A deal that had paid Bay $6 million in 2010 with three club options at $18 million each would have been singularly objectionable for Bay, of course -- why sign a deal when a team can get one cheap year of your services and then curb you? Yet even if Bay had agreed to such a deal, it still wouldn't have helped the Sox from a CBT standpoint, thanks to another inscrutable clause of the CBA (there are a lot of those) related to team options in 2012:
"If the Club Option Year Value exceeds 122.5% of the Highest Guaranteed Year Value, then the difference between the Club Option Year Value and 122.5% of the Highest Guaranteed Year Value shall be treated as a Signing Bonus in the Contract's Average Annual Value."
So, a $6 million deal with three club options at $18 million would actually be calculated as having a $16.65 million AAV: the $6 million base, plus $10.65 million (which is the difference between the $18 million option and $7.35 million, a sum that represents 122.5 percent of the guaranteed salary) that would be calculated as a signing bonus.
In short, there was no realistic way that the Sox could have re-signed Bay without adding a ton of payroll for luxury tax purposes.