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Baseball has a timeless tradition of unwritten rules, but this off season, a new law has been added: “Thou shalt not exceed the luxury tax threshold”.

Because of the escalating surcharges in the current competitive balance tax (CBT) scheme, avoiding the penalty has become a priority for every team, even the game’s biggest spenders. However, tax reform doesn’t always inspire compliance. Sometimes, the pursuit of loopholes is an even greater guarantee than the tax itself.

CBT loopholes are not new. In 2013, the Yankees used some creative accounting to turn Vernon Wells’ bloated contract into a luxury tax rebate for the following year. The Yankees’ never did get below the threshold in 2014, but a similar strategy might have made trading Jacoby Ellsbury more palatable this off season…if only the loophole hadn’t been closed. Because the new CBA stipulates that cash consideration be applied on a “pro-rata basis over the remaining Guaranteed Years of the assigned Contract”, teams no long have the ability to use selectively applied cash payments to avoid the tax man.

MLB has done a good job making its CBT system iron clad, but there is at least one wrinkle that teams can still exploit. Guaranteed years are defined by the CBA as “any championship season included in a Uniform Player’s Contract for which more than 50% of the Player’s Base Salary is guaranteed by the Contract in the event of termination.” So, what’s the loophole? 50%.

Because only 50% of a player’s base salary must be assured to qualify as a guaranteed year, player options can be structured in such a way to make a one-year contract appear much smaller in terms of its average annual value (AAV). The chart below illustrates how the loophole would work, but prefacing the data with a real world example provides for a clearer explanation. Let’s say the Yankees would like to sign Jake Arrieta and still remain below the luxury tax threshold. With only about $25 million of wiggle room, even a one-year pillow contract could push the Yankees to the limit. However, if a player option was added, the Yankees could guarantee Arrieta more money on a one-year deal, while considerably lowering the AAV impact.

The “Guaranteed Year” Loophole

Luxury Tax = Base/Guaranteed Years*
2018 Guarantee = AAV + Opt out payment
Injury Insurance = Base – 2018 guarantee
*Player option years are guaranteed if the buyout is not more than 50% of the base. Years after an opt out are guaranteed if buyout is not more than 50% of remaining amount owed on all years.

Source: MLB CBA, proprietary calculations Continue Reading »

(This updated post was originally published on February 16, 2011)

For over 20 years, Tampa has been the Yankees’ spring training home, but it still seems like just yesterday when the team’s camp was located down the coast in Ft. Lauderdale. I am sure most fans who grew up in the 1970s and 1980s still reflexively harken back to those days of yore, while the real old timers’ memories take them all the way back to St. Petersburg, where Yankees’ legends from Ruth to Mantle toiled under the Florida sun.

Over the years, spring training has evolved significantly. Once upon a time, it was a pre-season retreat designed to help out-of-shape ballplayers shed the pounds added over the winter. In the early part of the last century, before even reporting to camp, players would often attend spas in places like Hot Springs, where they would purge their bodies of the iniquities from the offseason. Then, games would either be played among split squads (in the old days, the camps would be split into teams of veterans and hopeful rookies, the latter often called Yannigans) or against local minor league and college ball clubs. Finally, the teams would barnstorm their way back up north before finally kicking off the regular season.

Today, spring training is more big business than quaint tradition. Thanks to the growing competition between cities in Arizona and Florida (each state now hosts 15 major league clubs), teams have been able to extract sweetheart stadium deals, allowing them to turn the exhibition season into a significant profit center. Still, at the heart of spring training is hope and renewal as teams begin the long journey that is the baseball season.

The Yankees’ spring history has been a journey all its own. Below is an outline of some significant mileposts along the way.

Yankees’ Spring Training Homes Since 1901
yankees-st

Continue Reading »

Provided below is a graphical illustration of total player compensation (in terms of year over year growth and percentage of industry net revenue) segmented by CBA iteration and presiding MLBPA executive director.

Also presented are two interactive charts displaying how much each Major League Baseball team has spent on players relative to their annual revenue, as estimated by Forbes. To display or hide an individual team in the chart at the top, click on the circle icon next to each name. To display or hide a specific period in the chart at the bottom, click on the circle icon next to each year.

In the absence of free agent signings, the notion of labor strife in MLB has become a prevailing theme this off season, but are some of the conclusions exaggerated? The final results from this winter, as well as the next few to come, will settle that question, but in the meantime, the data below provides more context to the debate.

Player Cost (Payroll/Luxury Tax) as a Percentage of Team Revenue, 2001, 2003-2017

Note: Revenue is net of revenue sharing and stadium debt service. Payroll excludes benefits and is based on final figures for each year released by MLB, and may not necessarily equal the amount upon which the luxury tax is based.
Source: MLB releases published by AP (final payroll), MLB releases published by AP (luxury tax) and Forbes (revenue)

Who pulled the plug on baseball’s hot stove? With so many prominent free agents still out in the cold, theories as to why have become more common than news of a big name signing. Some have even whispered “collusion”, while others have suggested the game is in the midst of a fundamental financial shift attributed, at least in part, to failures of the MLBPA in recent CBA negotiations. Have the business dynamics of the game really changed dramatically, or is the emerging conventional wisdom simply overacting to an off season marked by extenuating circumstances?

One popular narrative is based on the notion that the MLBPA fumbled the most recent CBA negotiations, resulting in a dramatically diminishing share of industry revenue. The basis for this argument is a comparison of player salaries reported by various sources to the gross revenue number MLB has released to the media over the years. As the aforementioned link notes, “After peaking at a little more than 56% in 2002…player payroll [in 2015] accounts for just over 38% of MLB’s total revenues, a figure that just ten years ago would have been unimaginably low.” Framed in that context, it’s easy to see why so many think alarm bells should be going off at the MLBPA. However, the comparison is based on flawed data, and so, naturally, it yields a flawed conclusion.

For starters, taking payroll data from a multiple unverified sources is unreliable, especially when AP reports on the official payroll numbers every year. What’s more, payroll data culled from these sources (USA Today and Cotts Contracts, in this instance) do not include other streams of compensation, including benefits and post season shares. Finally, the gross revenue figure, which isn’t exact, is not broken down into sources, making it impossible to determine what would be considered baseball related, an important consideration when comparing the percentage of revenue shared by MLB players to their counterparts in the NFL, NBA and NHL…leagues that share revenue only after factoring in exclusions or segmentation (*see appendix paragraph for further elaboration).

2017 Players’ Share of MLB Revenue

Notes: Revenue is net of stadium debt service (MLB reports “over $10 billion in gross revenue“). For 2017E, revenue is estimated as 7.1% greater than Forbes 2016 calculation (the average of the previous two years’ growth). All other 2017 data are actual. Total compensation is actual payroll + player benefit costs + players’ share of the postseason revenue pool. For pre-2015, benefit costs were determined by working backward from the known 2015 amount and assuming a 4% growth rate (CBA calls for increases up to 10%).
Source: MLB releases published by AP (actual payroll, post season revenue), baseball-almanac (older postseason revenue) and Forbes (net revenue)

The chart above attempts to provide a more accurate baseline with better data. In addition to using official payroll figures released by MLB, a more complete picture of player compensation is provided by including benefits and post season shares. The denominator is Forbes annual estimate of net revenue, which excludes stadium debt financing, but includes revenue derived from the use of the stadium for non-baseball events. Providing an allowance for this kind of debt seems reasonable, especially when you consider the revenue generating impact of a new stadium and the inclusion of non-baseball event revenue to prevent double dipping on the benefit. Using this framework, a different picture emerges. Instead of a steady decline since the advent of the competitive balance tax in 2003, we see a sudden correction followed by a gradual ebb and flow in which the players’ share of revenue hovers around 50%.

But, wait. Doesn’t the decline in share of revenue from 70% in 2003 to 50% in 2016 support the conventional wisdom? Well, yes, it does, provided you believe the game’s financial condition was stable and healthy when players were getting up to 70% of revenue and many teams carried heavy debt burdens. Those were, after all, the conditions that led to Bud Selig’s blue ribbon panel, which was convened in 1999 to study the game’s economic structure. The committee’s findings were the genesis of the revamped competitive balance tax (CBT).

The original CBT plan called for a 50% tax on payrolls over $84 million, but when the MLBPA finally acquiesced to the system as part of the 2002 CBA, the threshold was increased to $117 million and the initial tax dropped to 17.5%. With the threshold capacity amounting to 90% of industry net revenue, the new system was little more than a Yankee tax, and that’s pretty much what it turned out to be until the Dodgers joined the fray. In the first two years under the new system, the Yankees didn’t stop spending, but most other teams did, even though they weren’t subject to the tax. Meanwhile, revenues started to accelerate. The result was a decline in overall player compensation and a significant drop in the players’ inflated share of the revenue pie. From that point, however, the system reached a state of equilibrium, allowing the owners and players to prosper. Revenue kept increasing, and salaries followed close behind, a trend that has continued right up to the current deal. Continue Reading »

Major League Baseball has released official final payrolls along with the average annual value calculations used to determine the luxury tax, and once again, the Yankees sit near the top of each list. With a payroll of just over $208 million and tax bill approaching $16 million, the Bronx Bombers look like big spenders, but each figure represents not only a gradual decline, but continued progress toward the team’s goal of getting below the luxury tax threshold in 2018.

Yankees’ Payroll and Luxury Tax Payments, 2001, 2003-2017

Note: Final payrolls encompass the 40-man rosters and include salaries, incentive bonuses, and pro-rated shares of signing bonuses, present value of deferred payments, buyouts and other cash payments and non-cash compensation.  These payrolls ARE NOT AAV valuations used for luxury tax purposes. 2018E assumes Yankees spend up to, but not beyond the $197 million luxury tax threshold.
Source: MLB release published by AP

In real terms, the Yankees’ $208 million payroll was the lowest since 2006, and its luxury tax bill of $15.7 million was the lightest levy since 2011. What’s more, when compared to the 2013 peak in both measures, the decline is much more substantial. That shouldn’t come as a surprise, as the Yankees have long been trying to get below the luxury threshold. It’s taken longer than expected, with a few bumps along the way, but after six years, the Yankees finally seem poised to achieve that goal. But, is the organization’s focus on cost control justified?

Yankees’ Financial Snapshot, 2003-2016

Note: Revenue for each team is net of stadium debt and revenue sharing.
Source: Forbes.com

Yankees Expected Rights Fee Payments from FOX, 2013 to 2042

Note: Amortized upfront payment is based on $584 million payment from FOX to the Yankees pursuant to initial equity investment.  Continue Reading »

The Dodgers came within one game of winning the World Series, but they didn’t fall short in the final MLB payroll rankings. For the fourth straight year, Los Angeles led all teams with nearly $247 million spent on players, widening its lead over the Yankees as the sport’s top spender.

2017 Final MLB Payrolls

Note: Final payrolls encompass the 40-man rosters and include salaries, incentive bonuses, and pro-rated shares of signing bonuses, present value of deferred payments, buyouts and other cash payments and non-cash compensation.  These payrolls ARE NOT AAV valuations used for luxury tax purposes.
Source: MLB release published by AP

The Bronx Bombers may still be smarting over their loss to the Astros in the ALCS, but you can bet Hal Steinbrenner doesn’t mind looking up at the Dodgers’ payroll. In 2017, the Yankees trimmed their payroll by over 7% to $208.4 million, their lowest total since 2006. And, they weren’t alone among big market teams who tightened their belts last year. Even the Dodgers’ shed over 4%, joining the Red Sox and Tigers as other high payroll teams seeking a little relief.

Year-Over-Year Payroll Changes (Final), 2017 vs. 2016

Note: Final payrolls encompass the 40-man rosters and include salaries, incentive bonuses, and pro-rated shares of signing bonuses, present value of deferred payments, buyouts and other cash payments and non-cash compensation.  These payrolls ARE NOT AAV valuations used for luxury tax purposes.
Source: MLB release published by AP

Having big market teams cut back seems like bad news for the players, but only nine of the 30 clubs recorded a reduction in player expenses, including three teams (White Sox, Padres, Athletics) in the midst of a rebuilding plan. The rest of the league spent more on payroll in 2017, with, ironically, the Miami Marlins recording the largest jump at 44%. Eight other teams saw double-digit increases in payroll, including the World Champion Astros, who reported their fourth straight bump of at least 25%.

2017 Players’ Share of MLB Revenue
Notes: Revenue is net of stadium debt service (MLB reports “over $10 billion in gross revenue“). For 2017E, revenue is estimated as 7.1% greater than Forbes 2016 calculation (the average of the previous two years’ growth). All other 2017 data are actual. Total compensation is actual payroll + player benefit costs + players’ share of the postseason revenue pool. For pre-2015, benefit costs were determined by working backward from the known 2015 amount and assuming a 4% growth rate (CBA calls for increases up to 10%).
Source: MLB releases published by AP (actual payroll, post season revenue), baseball-almanac (older postseason revenue) and Forbes (net revenue) Continue Reading »

The Yankees began the off season trumpeting their intention to fall below the luxury tax threshold for the first time. With a superstar free agent class looming in 2018, avoiding the tax and resetting the penalty from 50% to 20% was deemed an economic imperative. So, what did Brian Cashman do? He traded for the most expensive contract in baseball history.

By acquiring Giancarlo Stanton, the Yankees hit the jackpot, but didn’t break the bank. Because of how the deal has reportedly been structured, Cashman was able to turn a contract with a $295 million balance into a relative bargain. The chart below contains a breakdown of Stanton’s contract based on its impact to the Yankees’ luxury tax position. Included is an explanation of how the average annual value is calculated, both for the contract alone and how it’s applied to the Yankees’ payroll. In addition, there is an analysis of how a potential opt out by Stanton would effect the Yankees’ payroll after the 2020 season.

Breakdown of Giancarlo Stanton’s Contract Based on Luxury Tax Implications

Source: 2017–2021 MLB Basic Agreement and Captain’s Blog

What makes Stanton’s high price tag affordable is the length of the deal, which reduces a record setting total value to a more pedestrian $25 million average annual value (AAV). Further mitigating the impact to the Yankees is the pro rated $30 million being sent by the Marlins, which, though contingent upon Stanton remaining in pinstripes beyond 2020, is applied to the team’s payroll calculation immediately. The result is a $22 million hit against the luxury tax threshold.

The Yankees began the winter with about $35 million to spend, so even at an AAV of $22 million, Stanton’s contract is still substantial. That’s one reason Starlin Castro was included in the deal. By shedding Castro’s contract, which had an AAV of about $8.5 million (including pro rated bonuses), the Yankees were able to increase their cushion to about $20 million, which should be enough to fill the two remaining roster holes (most notably a starting pitcher) and leave room for a mid-season acquisition or two (click here for a look at the Yankees’ estimated preliminary 2018 payroll).

Without shedding more payroll, the Yankees seem to be in a good position to trim their payroll below the $197 million tax threshold. But, that doesn’t mean Brian Cashman won’t attempt to create more wiggle room. The most obvious way to do that would be by dumping Jacoby Ellsbury’s contract. Even if the Yankees paid 70% of what’s owed on his deal, they’d still save over $6 million. That sum could come in handy at the trade deadline. There are other candidates for savings,  such as Dellin Betances, Chase Headley, and Brett Gardner, but Ellsbury would clearly be the preferred option because of his seemingly limited role on the team.

The Yankees may have rocked the baseball world by acquiring Stanton, but their attempt to dip below the luxury tax threshold remains on solid ground. To the extent that Stanton’s on-field value lessens the need for the Yankees to acquire more (expensive) players, his contract is more than just affordable, it’s a facilitator of the team’s financial aspirations. When you further consider the minimal prospect cost, the Yankees’ acquisition of Stanton is more than just a home run…it’s a walk off grand slam in the middle of December.

 

 

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