Cap Circumvention and Economic Illiteracy

I have a real bone to pick with Greg Wyshynski (GDub) at Puck Daddy this morning.  In an article going into the nuts and bolts of long-term contracts Greg goes off the economic deep end about the salaries being paid to Brad Richards and Christian Ehrhoff in the final 3 years of their contracts, namely $1 million each.
I guess Greg is offended by the idea that such high-profile players will be underpaid in their twilight years.

The Richards deal avoids this by going nine years and avoiding any contract years past 40 years old. Dreger again, from 2010:

Secondly, for long-term contracts that include years in which the player is 36, 37, 38, 39 and 40; the amount used for purposes of calculating his average annual value is a minimum of $1 million in each of those years (even if his actual compensation is less during those seasons).

In other words, the NHL allows Brad Richards to be a $1 million player in the fantasyland of long-term contracts at age 38, despite the fact that a player like Keith Tkachuk was still making $2.15 million at age 39.

And the NHL allows defenseman Christian Ehrhoff(notes) to make $1 million at age 37, despite the fact that a much lesser blue-liner like Sean O’Donnell was making $1.25 million at age 38.

Cap circumvention is alive and well in the NHL. Question is what, if anything, should be done about it?

Greg makes the classic mistake of trying to equate value outside of time and context, when at the moment of the transaction heightened factors are in play which govern the decision.   I don’t see why it’s wrong for either the Rangers or the Sabres or anyone else for that matter to overpay the player now and potentially underpay for him later.  The economics of the situation dictate that the player will value the money at the front of the contract more than the money at the end of it.   That’s a simple Net Present Value calculation.  It ain’t rocket science.  There is no guarantee that Brad Richards or Christian Ehrhoff will even be worth the $1 million dollars they are due in those years of their contracts.

Here’s the converse of Greg’s position.  Ready?  Two words.

Derek Roy.

Let it sink in.  Roy signed a 6 year $24 million contract and is right now considered one of the best bargains in the league.  Is it cap circumvention for Darcy Regier to be paying him $4.5 million this season when comparable players would be making $6 or more?  He’s a #1 center on a playoff team that has averaged nearly a PPG and plays in all situations, doing so in the past 4 years against the other team’s top opposition.  In what fantasy world of Greg’s is it right that he be paid only $4.5 million for this year.

Pick any kid over-achieving on his ELC.  The same argument applies.

Is it an advantage for cash-rich teams over those that are on a pay-as-you-go system?  Yes.  Is it fair?  That’s an irrelevant question.  There is no standard of ‘fairness’ in this.  Is it fair for the low revenue teams to take money from the high revenue teams to field their rosters?  Again, it’s irrelvant.  It is simply now part of the arrangement between the 30 teams that make up the NHL.

And it’s the crux of the trade-off for implementing revenue-sharing.  Teams with money will use the leverage of that money in the marketplace for players. The issue surrounding the long-term contract is simple.  Like it or not, the Buffalo Sabres, for example, had a perceived need for Christian Ehrhoff’s services in the next 3 years and were willing to pay him $22 million over those three years to play for them.   To get that money he had to take the trade-off of a guaranteed lower salary, potentially much lower salary, at ages 37 to39. Interestingly, Ehrhoff will be paid in years 3 through 7 of this deal an average of $3.8 million.  Is that too low?  Too high?  Just right?

Last year Kovalchuk’s contract was planning on over-paying him by $575k or so per year for the fantasy of him playing to age 44.  Now we’re complaining that Richards and Ehrhoff are under-paid at age 38.  Holy schnike, in the words of the Bucci-man.  The Ehrhoff and Richards deals were structured to minimize the money they would be paid over the rest of their careers.  Cost certainty has been achieved through the manipulation of mathematics. Greg is now, in effect, arguing that these monster deals are actually putting downward pressure on salaries in the NHL.

And this is a bad thing?

In the end who the hell do we think we are to say what a player should and should not be worth at a particular age.  The reductio of Greg’s complaint is that there should be a rigid structure for all contracts at all ages.  Of course, that’s nonsense.  I know that Greg is reacting to this instinctively.  This feels like cap circumvention.  But it’s not.  The risk associated with a player beyond the age of 35 in the NHL rises exponentially.  A player wishing to sign a long-term deal needs to know this.  Front-loading the contract is in everyone’s best interest, the teams’, the fans’, the player’s… everyone’s.

Every intervention into the market will require an ever greater intervention to ameliorate the conditions brought about by the previous round of intervention.  The CBA has taken a stab at normalizing the resource pool available to all the teams.  It’s done a pretty good job, to be honest.  Putting the kibosh on deals past the expiration date of a player’s career to get the cap down certainly circumvents the spirit of the CBA.  That loophole has been closed.  Putting the kibosh on contracts that underpay players approaching the end of said career is just bad business.

Ta,

9 comments

  1. One thing to keep in mind Tom, w.r.t. whom it’s not fair, is non-star players who have ‘cap hit = salary’-type contracts. When Ehrhoff, Luongo and others drive up the total salary paid in their early years, drives up everyone’s escrow payments, since the salaries outpace the cap. At year’s end, assuming the revenue forecasts which led to the setting if the cap hold true, the money that went into escrow won’t all be going back to the players (I won’t even get in to the NHLPA’s 5% Cap escalator clause…)

    This is all fine and dandy if everyone plays out the contracts they sign, because, as they age and their actual salaries drop relative to their static cap hit, these front-loaded player contracts will offset their earlier effect on the revenue-vs.-salaries calculation.

    However, if they retire before playing those years, we have to assume the teams will replace their cap hit with (an)other contract(s), presumably paying those player(s) actual salaries of more than $1-million. The players who, for instance, sign a 4-year deal at $1.1MM/yr at age 24, and don’t get another contract worth that ever again: they lose 10-20% of their paycheck (based on current escrow rates), and will never see (all of) that money again, because they a) won’t be in the league when Kovalchuck is 38, and b) won’t be able to snag a front-loaded contract of their own.

    Effectively, these star players are banking inflated salaries on the backs of players who don’t have the clout to negotiate such front-loaded deals. Now, that’s just capitalism/meritocracy at work (I think; Econ- and Philosophy-101 were long, long ago…), but that certainly can’t be good for the majority (of the NHLPA).

    I think this will be a big issue for the coming CBA neg. (we’re already seeing doom ‘n’ gloom headlines). I can see a solution where the escrow amount is proportional to one’s actual salary, or to one’s salary-above-cap-hit, which is probably fairer. I don’t know how much pull the big names have vs. the huddled masses in the NHLPA, but it will be interesting to see where the me-first attitude (which you have to have when negotiating a FA contract, otherwise GMs will walk all over you) takes these negotiations.

    I’m curious to hear your thoughts on the subject, since I (obviously) also have an interest in hockey econ.

    Cheers!

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  2. @Loomy: That’s an interesting point, though I’m not sure how you rectify the escrow angle without giving up guaranteed contracts, which is why the cap works in the first place.

    I don’t remember if the signing bonuses are counted as part of the escrow holdback, or is it just the salary. If they aren’t and they are not part of the total player compensation percentage that determines the escrow rate, then that’s okay. The signing bonus then would actually remove player compensation from the escrow calculation and the players’ salaries would be adjusted pro rata at season’s end.

    If you’ll note, though, even the lower end players this FA season are getting front-loaded deals.
    I know the Sabres well, so I’ll use this example:
    Cody McCormick, 3 years, $3.6 million. (1.4,1.2,1.0)
    Mike Weber 2 years, $1.9 million ($0.900; +$0.100 SB, $0.950)

    The cap system is an intervention. That intervention will create leverage wrt to the ruleset. That is unavoidable. It is the consequence of writing rules/laws. The market will continue to force NHL to stop underpaying young talent through arbitrary restrictions such as the ELC and RFA status, whether we like it or not.

    For me, keeping the number of rules on this to a minimum is key and to balance the amount of revenue sharing vs. the size of the cap and the range of the revenues of the individual clubs. That’s a tough enough balancing act.

    Last point, for the non-stars, the salary floor is inflating low end salaries at the same rate, if not moreso than the high-end salaries. Joel Ward got 4 years., $12 million simply because Dale Tallon needed to spend $48 million dollars. That will have a huge effect on RFA arbitration awards and might wind up being a bigger headache than Richards or Ehrhoff.

    Ta,

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  3. I think you missed the point… The issue isn’t about underpaying players in old age — the issue is players retire before their contract expires and the low salary years never have any relevance but driving down a cap number while the player is relevant.

    I think your evaluation is spot on if you assume players never retire while under contract, but this isn’t really the case. If I want to make 50 million over 10 years, I can get a contract at 10 years, 5 million per and meet that requirement. Now say in the first 5 years of my deal I’ll be in my prime and should probably get more money. OK we can structure the contract so that I am paid 35 million over the first five years and 15 over the last 5.

    Up until this point my longterm deal is reasonable and appropriately front loaded — I’m getting my money over my duration of time I’m willing to play. Good enough.

    Then arises the issue of parity for player value.

    I sit down with a GM and propose my 10 year 50 million deal. He says he likes it. He’s already spoke with the team owner and has been assured that paying that kind of salary will be no problem. His only issue is the team is already staffing top tier talent and doesn’t have significant cap space to absorb an annual cap hit of 5 million per season. The GM is faced with a problem where he needs to fill at least one more roster spot and will need about a million of cap room to do so, and especially with future expiring contracts, will need to save absolutely any cap room possible for the upcoming years. Again, paying the actual salary isn’t the issue, it’s merely the numbers game of the cap. Despite knowing my intentions are to only play hockey for the next 10 years, the GM counter offers with an extended contract — this time for 13 years, but is only offering me an additional million per season, bringing the contract to 53 million.

    I want to play for this GM’s team — they are a contender. I’ll probably retire after 10 years anyway, so if I decide I’m done playing hockey because it’s not worth it to me for a million a year that’s my plan. I sign the deal.

    I’m going to make the money I want, that’s not the problem. The team is going to franchise a player, it’s not the fan’s problem. The team is going to get their talent, it’s not their problem. But the other teams in the league that have to overpay to attract talent are severely disadvantaged.

    If I was going to get less talented team to sign me, it would have to be at at least 6 million a year — and I’d only want a 5 year deal, so if the team never improves I’ll have the means of changing franchises later in my career. This means the less contending team has to suffer a cap hit a million dollars more (and with a shorter duration) for the same talent. If this isn’t already a clear advantage, factor in the cap savings of the extra 3 years the GM included in the deal. 53 million for 13 years is just over a 4 million cap hit.

    The good team is now in a position where they are absorbing a cap hit 2 million less than the bad team for the same talent. The intrinsic disparity which provides the good team an advantage in the free agent market has been doubled — all because I’ve agreed to a contract which is 3 years longer than I’ll even be playing the sport.

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  4. @Boxy: All of what you describe is a consequence into interventions in the marketplace. Some form of this cap circumvention is going to take place because as I said in the article, the reductio of Greg’s (and presumably your) position is that there should be a fixed scale for players based on some set of metrics. Otherwise, no matter what the rule set, someone will be able to cry ‘circumvention!’ because the current rule set will be the standard by which the ‘circumvention’ is measured.

    The current rule set stipulates a salary cap on ELC’s. For a number of players this is an artificial suppression of their earnings. It’s one of the primary stressors in the NHL’s salary system… restricted free agency.

    Here’s another name for you… Tyler Ennis.

    In what fantasy world is Tyler Ennis, who will likely put up 70-80 points this season, worth only $875,000?!? Is his salary any more ludicrous than Christian Ehrhoff’s will be in 8 years? It, the ELC salary cap, is an arbitrary number based on rules created under the CBA. No more or less than Kovalchuk addendum is. But, that one never gets discussed. We take it as a given that in order to compete for a Cup a team has to have a number of players playing above their open-market salary in order to afford the open-market players and create a averaging out of value. In my mind you cannot complain about the Ehrhoff contract without also complaining about the Ennis or Myers contract… both exist within the framework of the CBA and both have been distorted from their open market values because of the CBA.

    I understand the point about retirement and the like. I get it. It’s a consequence for normalizing the resources across the 30 teams via the cap and revenue sharing. But, there is no perfect system to this. The salary cap is already distortion enough, as is the cap on ELC’s. Further tinkering will only create more problems and more regulation of salaries.

    The small revenue teams have revenue sharing to narrow the gap between them and the large revenue teams. Maybe the next CBA should focus on expanding that portion of the pie splitting as opposed to tinkering with the over 36 year old contract stipulations.

    Ta,

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  5. @Boxy: Moreover, both you and Greg refuse to admit that there is risk associated with the long-term contract where the money is guaranteed. That plays into all of this. Given the kind of player Ehrhoff is, he has a better chance than most of playing out his contract.

    The current good team has an advantage in the UFA marketplace through the use of money. The current bad teams have an advantage in terms of draft position. Too many teams look for the quick fix to their problems. So, when they are in that position they should be restructuring their organization to develop players internally. The unintended consequence of what you are talking about may just be more competence in NHL organization. The ELC salary cap is also a factor in this.

    I wrote years ago about how this CBA would do the opposite of what the doom-sayers like Tom Benjamin were predicitng… short-changing the young players. The liberalizing of free agency has put more money in their pockets at earlier ages than ever before and because of that we’re seeing stronger and stronger draft classes.

    Buffalo, for example, is in an embarrassment of riches position currently because they have, in year’s past, put money and resources into player development and not that little extra into salaries. Now that they have that plus Pegula’s money it’s giving them a short-term boost to leap up in designing their roster.

    The bigger markets and better teams have always had an advantage over the smaller ones in every aspect of the game. It exists. Life ain’t fair and it won’t ever be. If you have less you have to make tougher decisions and have a smaller margin for error. If you have too much you can afford to waste money looking for the right solution.

    Ta,

    Like

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