With all the big numbers being thrown around this offseason, there have been articles suggesting that teams are unwise to backload contracts. The basis for this opinion is the belief that teams will not have the money to pay the escalating costs, so would be better off paying the upfront fees. For individuals who lack fiscal discipline, it might be better to pay more upfront (kind of like withholding too much from your paycheck so you don’t get stuck with a tax bill in April), but presumably, major league franchises are employing cash management procedures to ensure they can meet future obligations (although the Dodgers and Mets may be teams who disprove that notion).
When a team backloads a contract, the money “saved” doesn’t disappear. If the organization is being run as a healthy business, the additional cash on hand is either invested or put to use in other ventures expected to earn an attractive return. Although these approaches can be risky, strong companies develop plans to ensure cash flow can meet near-term obligations. Tied up in this approach is something known as the time value of money.
Without going into the financial details, a dollar today is usually worth more than a dollar tomorrow (kind of like a bird in the hand is worth two in the bush). So, absent mitigating circumstances, such as the luxury tax threshold, teams are always better off delaying the payments owed to the players they sign. Listed below as an illustration is a present value comparison of Jose Reyes’ contract with the Marlins versus what would be owed if he was paid the average annual value each season. Based on included assumptions, the Marlins are saving $3.3 million by backloading Jose Reyes’ contract. Although that may not seem like a lot, especially in relation to the size of the contract, it is a savings nonetheless. (more…)
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